PE R SPEC T I V E S I N C OM PA N Y L AW A N D

F I NA NC I A L R EGU L AT ION

Th is collection of essays has been compiled in honour of Professor Eddy

Wymeersch on the occasion of his retirement as professor at Ghent
University. His main international academic peers explore develop-
ments on the crossroads of company law and fi nancial regulation in
Europe and the United States, providing a unique view on the dynamics
of regulatory competition in an era of economic globalization, whether
in the fields of rule making, organizing the mobility of capital or the
enforcement of rules. The deepening of European fi nancial integration
and the transatlantic regulatory dialogue has generated new paradigms
of rule setting in a multinational framework and reinforced the need
to develop adequate instruments for cooperation between regulators.
Regulators increasingly use concepts such as equivalence or mutual rec-
ognition to regulate cross-border relations.

m ic h e l t i s on, h a n s de w u l f, r e i n h a r d s t e e n no t and
c h r i s t op h va n de r e l s t are professors at the Financial Law
Institute at Ghent University.
 i n t e r nat iona l c or por at e l aw a n d
fi na nci a l m a r k et r egu l at ion

Recent years have seen an upsurge of change and reform in corporate law and fi nan-
cial market regulation internationally as the corporate and institutional investor sec-
tor increasingly turns to the international fi nancial markets. Th is follows large-scale
institutional and regulatory reform after a series of international corporate govern-
ance and fi nancial disclosure scandals exemplified by the collapse of Enron in the
United States. There is now a great demand for analysis in this area from the aca-
demic, practitioner, regulatory and policy sectors.
The International Corporate Law and Financial Market Regulation series will
respond to that demand by creating a critical mass of titles which will address the
need for information and high-quality analysis in this fast-developing area.
Series Editors
Professor Eilis Ferran, University of Cambridge
Professor Niamh Moloney, London School of Economics
Professor Howell E. Jackson, Harvard Law School
Editorial Board
Professor Marco Becht, Professor of Finance and Economics at Université Libre de
Bruxelles and Executive Director of the European Corporate Governance Institute
(ECGI).
Professor Brian Cheffi ns, S.J. Berwin Professor of Corporate Law at the Faculty of
Law, University of Cambridge.
Professor Paul Davies, Cassel Professor of Commercial Law at the London School of
Economics and Political Science.
Professor Luca Enriques, Professor of Business Law in the Faculty of Law at the
University of Bologna.
Professor Guido Ferrarini, Professor of Law at the University of Genoa and Honorary
Professor, Faculty of Law, University College London.
Professor Jennifer Hill, Professor of Corporate Law at Sydney Law School.
Professor Klaus J. Hopt, Director of the Max Planck Institute of Comparative and
International Private Law, Hamburg, Germany.
Professor Hideki Kanda, Professor of Law at the University of Tokyo.
Professor Colin Mayer, Peter Moores Professor of Management Studies at the Saïd
Business School and Director of the Oxford Financial Research Centre.
James Palmer, Partner of Herbert Smith, London.
Professor Michel Tison, Professor at the Financial Law Institute of the University of
Ghent.
Andrew Whittaker, General Counsel to the Board at the UK Financial Services
Authority.
Professor Eddy Wymeersch, Chairman of the Committee of European Securities
Regulators (CESR); Co-Chair of the CESR-European Central Bank Working Group
on Clearing and Settlement.
PE R SPEC T I V E S I N COM PA N Y
L AW A N D F I NA NCI A L
R EGU L AT ION
Essays in Honour of Eddy Wymeersch

edited by
M ICH E L T ISON , H A NS DE W U L F ,
C H R ISTOPH VA N DE R E L ST A N D
R E I N H A R D ST E E N NOT
 c a m br i d g e u n i v e r s i t y p r e s s
Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi
Cambridge University Press
The Edinburgh Building, Cambridge CB2 8RU, UK
Published in the United States of America by Cambridge University Press, New York

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© Cambridge University Press 2009

Th is publication is in copyright. Subject to statutory exception

and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without
the written permission of Cambridge University Press.

First published 2009

Printed in the United Kingdom at the University Press, Cambridge

A catalogue record for this publication is available from the British Library

Library of Congress Cataloguing in Publication data

Perspectives in company law and fi nancial regulation : essays in honour of
Eddy Wymeersch / [edited by] Michel Tison ... [et al.].
p. cm. – (International corporate law and fi nancial market regulation)
ISBN 978-0-521-51570-2 (hardback) 1. Corporation law. I. Wymeersch, E.
II. Tison, Michel. III. Title. IV. Series.
K1315.P47 2009
346⬘.066–dc22
2009002692

ISBN 978-0-521-51570-2 hardback

Cambridge University Press has no responsibility for the persistence or

accuracy of URLs for external or third-party internet websites referred to
in this publication, and does not guarantee that any content on such
websites is, or will remain, accurate or appropriate.
 C ON T E N T S

List of contributors ix
Foreword xxv

part i Perspectives in company law

section  European company law: regulatory
competition and free movement of companies
1. The European Model Company Act Project 5
Theodor Baums and Paul Krüger Andersen
2. The Societas Privata Europaea: a basic reform of EU law on
business organizations 18
Theo Raaijmakers
3. Ius Audacibus. The future of EU company law 43
Jaap Winter
4. Free movement of capital and protectionism after
Volkswagen and Viking Line 61
Jonathan Rickford
5. Centros and the cost of branching 91
Marco Becht, Luca Enriques and Veronika Korom
6. Towards the end of the real seat theory in Europe? 124
Michel Menjucq
7. The Commission Recommendations of 14 December 2004
and of 15 February 2005 and their implementation in
Germany 132
Marcus Lutter

v
vi contents

8. The Nordic corporate governance model – a

European model? 145
Jesper Lau Hansen

section  Corporate governance, shareholders’ rights

and auditing
9. Stakeholders and the legal theory of the corporation 165
Peter Nobel
10. The renaissance of organized shareholder representation
in Europe 183
Stefan Grundmann
11. In search of a middle ground between the perceived excesses
of US-style class actions and the generally ineffective
collective action procedures in Europe 200
Douglas W. Hawes
12. Some modest proposals to provide viable damages remedies
for French investors 223
Marie-Claude Robert Hawes
13. Pre-clearance in European accounting law – the
right step? 231
Wolfgang Schön
14. International standards on auditing and their adoption in the
EU: legal aspects and unsettled questions 244
Hanno Merkt
15. Corporate governance: directors’ duties, financial
reporting and liability – remarks from a German
perspective 264
Peter Hommelhoff
16. Some aspects of capital maintenance law in the UK 276
John Vella and Dan Prentice
17. Luxembourg company law – a total overhaul 302
André Prüm
 contents vii

18. Role of corporate governance reform and enforcement in the

Netherlands 322
Joseph A. McCahery and Erik P. M. Vermeulen

section  Takeover law

19. Adoption of the European Directive on takeover bids:
an on-again, off-again story 345
Joëlle Simon
20. Application of the Dutch investigation procedure
on two listed companies: the Gucci and
ABN AMRO cases 363
Levinus Timmerman
21. Obstacles to corporate restructuring: observations from a
European and German perspective 373
Klaus J. Hopt
22. Protection of third-party interests under German
takeover law 397
Harald Baum
23. Takeover defences and the role of law: a Japanese
perspective 413
Hideki Kanda

part ii Perspectives in financial regulation

section  European perspectives
24. Principles-based, risk-based regulation and effective
enforcement 427
Eilis Ferran
25. The Committee of European Securities Regulators and level 3
of the Lamfalussy Process 449
Niamh Moloney
26. Market transparency and best execution: bond trading
under MiFID 477
Guido Ferrarini
viii contents

27. The statutory authority of the European Central Bank

and euro-area national central banks over
TARGET2-Securities 497
Peter O. Mülbert and Rebekka M. Wiemann

section  Transatlantic perspectives

28. Learning from Eddy: a meditation upon organizational
reform of financial supervision in Europe 523
Howell E. Jackson
29. The SEC embraces mutual recognition 540
Roberta S. Karmel
30. Steps toward the Europeanization of US securities regulation,
with thoughts on the evolution and design of a multinational
securities regulator 555
Donald C. Langevoort
31. The subprime crisis – does it ask for more regulation? 570
Friedrich Kübler
32. Juries and the political economy of legal origin 583
Mark J. Roe

part iii Miscellaneous

33. The practitioner and the professor – is there a theory of
commercial law? 607
Jean Nicolas Druey
34. A short paean for Eddy: Clever, Wise, August, Funny and
European 617
Ruben Lee

Index 619
 L IS T OF C ON T R I BU TOR S

Paul Krüger Andersen

Paul Krüger Andersen is professor in company law at Aarhus School
of Business, University of Aarhus. He holds a PhD in marketing law
(1976) and Dr jur. (1997) (studies in Danish corporate group law)
and is co-founder of the Nordic Research Network for Company
Law and co-founder and editor of the Nordic Journal of Company Law
(Nordisk Tidsskrift for Selskabsret). Member of the board of the Danish
Association of Corporate Governance (DACP). In 2003 he was legal
adviser for the Latvian Company Register. In 2004 he was appointed
Distinguished Professorial Fellow at the British Institute of International
and Comparative Law, London. In 2005 he was appointed Dr h.c. at the
Turku School of Economics and Business Administration, Finland. He
is chairman of the European Model Company Law Group and author
and co-author of several textbooks and numerous articles in Danish and
international journals on private law, marketing law, company law and
securities law.

Harald Baum
Harald Baum is Senior Research Fellow and Head of the Japan
Law Department at the Max Planck Institute for Comparative and
International Private Law, Hamburg, Germany. He graduated from
Freiburg University and practiced law as a member of the Hamburg
bar before joining the Institute in 1985. Dr iuris, Hamburg, 1985;
Habilitation, Hamburg 2004. He teaches at the University of Hamburg
and is Research Associate at the European Corporate Governance
Institute, Brussels. Dr Baum is the Founding Editor of the Journal of
Japanese Law. In 2005 he served as Visiting Professor at the University
of Tokyo. He has authored numerous books and articles on business

ix
x list of contr ibutors

law, corporate governance, takeovers, and capital markets regulation in

Germany, the EU, Japan and the US.

Theodor Baums
Theodor Baums holds an endowed chair for business law at Goethe
Universität Frankfurt and is a Director at the Institute for Law and
Finance (ILF). His academic career comprises positions at the univer-
sities of Bonn; Münster; Osnabrück; Frankfurt/Main (since 2000); vis-
iting professorships at UC Berkeley; Vienna; Stanford/CA; Columbia/
New York and Luxembourg. He has frequently advised public institu-
tions (World Bank; EU Commission; German Federal Parliament and
Government) on company and securities market regulation. He was
the chairman of the Federal Government’s Commission on Corporate
Governance and Company Law Reform. Currently he is a member of
the advisory boards of the EU Commission (on company law); of the
German Capital Markets Supervisory Agency (BAFin); and of the
German Accounting Enforcement Agency (DPR); an adviser on corpor-
ate governance issues to the Vorstand of the Deutsche Bundesbank; and
serves on several boards of private companies. Theo Baums is fellow of
the ECGI, a member of the European Model Company Law Group and
has written more than 140 books and articles on corporations, civil and
antitrust law. He has been awarded the Order of Merit 1st class of the
Federal Republic of Germany.

Marco Becht
Marco Becht is a Professor of Finance and Economics at Université Libre
de Bruxelles, a Resident Fellow at the European Centre for Advanced
Research in Economics and Statistics at ULB and the Executive Director
of the European Corporate Governance Institute. Teaching at the ULB,
his research currently focuses on law and fi nance, with particular
emphasis on corporate governance. In 2003, he was Visiting Professor
at the Saïd Business School, University of Oxford and in 2008 Max
Schmidheiny Visiting Professor for Entrepreneurship and Risk at the
University of St. Gallen.
He has been instrumental in launching the Transatlantic Corporate
Governance Dialogue (TCGD) and is the scientist in charge of the
European Corporate Governance Training Network (ECGTN).
 list of contr ibutors xi

Jean Nicolas Druey

Jean Nicolas Druey (born 1937) is an Emeritus of the University of
St Gallen (Switzerland) and lives in Basel. He was a student of law at
the Universities of Geneva and of Basel and at Harvard Law School. He
served in the legal office of the pharmaceutical company of Hoff mann-La
Roche 1968–1974 and in the auditing firm known today as Ernst &
Young, Zurich branch, 1974–1980 and as a consultant up to the present
day. In 1980 he was elected to a teaching chair in the fields of private and
commercial law at the University of St Gallen which he held until his
retirement in 2000.
His book publications include a thesis on moral damage (1966) and on
the right of privacy of enterprises (1976), then books on developments of
the law on corporate groups (Zeitschr. f. schweiz. Recht 1980 II), securi-
ties (1985, with Jäggi and v. Greyerz), inheritance law (1986, 1988, 1992,
1997, 2002, next edition due in spring 2009), Swiss commercial law (in
the context of the law of obligations treatise by Guhl, 1991, 1995, 2000,
next edition due in 2009), information as a subject of law (1995) and on
Swiss court practice in matters of corporate groups (1999). All books are
in German.
He served from 1991 to 2000 on the board of the Swiss Association of
Jurists, 1997 to 2000 as chairman.

Luca Enriques
Luca Enriques joined the Faculty of Law at the University of Bologna in
1999. A Full Professor there since 2007, he is now on leave to serve as a
Commissioner at Consob (the Italian SEC). Before entering academia,
Professor Enriques worked for the Bank of Italy in Rome. He has pub-
lished two books and several articles in Italian as well as international
law reviews on topics relating to corporate law, corporate governance,
takeovers, institutional investors and corporate groups. He has been
adviser to the Italian Ministry of Economy and Finance from 2000 to
2006 and, from 2005 to 2007, a member of the Forum of Market Experts
on Auditors’ Liability set up by the European Commission.

Eilís Ferran
Professor Eilís Ferran is Professor of Company and Securities Law at
the University of Cambridge and co-director of the University’s Centre
xii list of contr ibutors

for Corporate and Commercial Law (3CL). Her recent publications

include Principles of Corporate Finance Law (OUP, 2008) and Building
an EU Securities Market (CUP, 2004), as well as numerous articles and
other pieces. She has been a visiting professor in Hong Kong and New
Zealand and has spoken at conferences in Europe, Asia and North
America. She is an editor of the Journal of Corporate Law Studies (Hart
Publishing), a contributing editor of Palmer’s Company Law (Sweet &
Maxwell, looseleaf) and a research associate of the European Corporate
Governance Institute. She is Series Editor (with Professor Niamh
Moloney and Professor Howell Jackson) of the Cambridge University
Press monograph series International Corporate Law and Capital
Market Regulation.

Guido Ferrarini
Guido Ferrarini graduated from the Genoa Law School in 1972, and
obtained an LL.M. from Yale Law School in 1978. He is Professor of
Business Law at the University of Genoa and Director, Centre for Law
and Finance.
He is Independent Director of Atlantia s.p.a. and Chairman of TLX
(an Italian MTF and investment exchange). He is Vice-Chairman of the
European Corporate Governance Institute (ECGI), Brussels.
He was Lead Independent Director of Telecom Italia s.p.a. and a mem-
ber of the Board of Trustees of the International Accounting Standards
Committee (IASC), London.
He is the author of various books and articles in the fields of finan-
cial law, corporate law and business law. He was a Visiting Professor at
Bonn University (Graduate College of European Law), Columbia Law
School, Frankfurt University (Institute for Law and Finance), Hamburg
University (Law Faculty), NYU Law School and University College
London (Faculty of Laws).

Stefan Grundmann
Professor Dr Stefan Grundmann LL.M. has been Professor at Humboldt
University, Berlin, for German, European and International Private and
Business Law since 2004. He heads the Institute for banking and cap-
ital market law and is the deputy of the faculty for the European Law
School. From 1995 to 2001 and 2001 to 2004 he was professor for the
 list of contr ibutors xiii

same subjects at Halle-Wittenberg and at Erlangen, where he initiated

and was responsible for study courses on International Business Law.
After studies in Munich, Aix-en-Provence, Lausanne, Lisbon and
Berkeley he wrote a dissertation on the basic theme ‘Qualification’
(1985). He then concentrated on confl icts of law within integrated mar-
kets (Common Market). Today he specializes in the areas of business
law, banking and capital market law, and European contract and pri-
vate law, always including interdisciplinary aspects. He is the author
of various books in all of these areas: ‘Fiduciary Relationships’ (1997);
‘European Bank Supervisory Law’ (1990); ‘European Contract Law’
(1999, 2009); ‘European Company Law’ including Capital Market Law
(2nd edn in 2007). He also wrote numerous papers and commentaries
on about half of the banking laws for the large Commentary Ebenroth/
Boujong/Joost (2001 and 2008). Professor Grundmann also founded the
Society of European Contract Law (SECOLA). Since 2005 he is editor-
in-chief of the European Review of Contract Law. Stefan Grundmann
also studied philosophy and the history of art and has written three
books in this area.

Jesper Lau Hansen

Jesper Lau Hansen was educated as a lawyer (Candidatus Juris) at the
University of Copenhagen, Denmark, in 1989 and as a Master of Law
(LL.M.) from the University of Cambridge in 1993. He worked for six
years for a major law fi rm, where he was admitted to the appeals court
bar in 1992. He returned to the University of Copenhagen in 1995,
where he became Doctor Juris in 2001 on a dissertation on the regu-
lation of information in stock exchange law. He has held the chair of
Professor in Financial Markets Law since 2003. He is currently serv-
ing as the head of the research centre FOCOFIMA at the University of
Copenhagen Law Faculty. Further information is available at www.jur.
ku.dk/jlh.

Douglas W. Hawes
Retired from Dewey & LeBoeuf LLP, international law firm in 2005,
where he specialized in mergers and acquisitions and other corpor-
ate and securities matters. He became a partner in 1964 and was based
in the New York office. During part of that time he taught full time at
Vanderbilt University School of Law from 1972–4 and as an adjunct
xiv list of contr ibutors

there and later at New York University School of Law until 1989 when
he moved to France. Author of Utility Holding Companies (1985, Clark
Boardman) and numerous law review articles.
Douglas Hawes is currently involved in non-fiction writing and ven-
ture capital. He published Oradour – The Final Verdict (2007) in English;
to be published in French in 2009 by Editions de Seuil.

Peter Hommelhoff
Professor Dr Dres. h.c. Peter Hommelhoff (born 1942) was Director of
the Institute of German and European Corporate and Economic Law
at the University of Heidelberg from 1991 until his retirement in 2007.
During his last years at the University of Heidelberg he also served as
its Rector (Chancellor) and was executive director of the Association
of German-speaking Civil Law Instructors. Before his time at the
University, Hommelhoff served as judge at the Higher Regional Court of
Hamm/Westphalia and later in Karlsruhe. Over several decades he was
a member of the board of examiners for certified accountants in North
Rhine-Westphalia and Baden-Wuerttemberg. He is honorary doctor of
the universities of Krakow and Montpellier and a member of the Chilean
Academy of Sciences. Hommelhoff was awarded the German Federal
Cross of Merit in 2007.

Klaus J. Hopt
Director Max Planck Institute for Private Law, Hamburg/Germany; for-
merly professor of law Tübingen, Florence, Bern, Munich. Professional:
Judge Court of Appeals Stuttgart 1981–5; member of: High Level Group
of Company Law Experts, board of the ECGI; vice-president of the
German Research Foundation; expert: German Parliament, European
Commission, BIS, World Bank. Visiting prof.: Paris, Rome, Brussels
(ULB), Tilburg, Chicago, NYU, Harvard, Kyoto, Tokyo. (Co-)Author:
Corporate Group Law for Europe, 2000; Anatomy of Corporate Law, 2004.
(Co-)Ed.: Comparative Corporate Governance, 1998; Capital Markets
and Company Law, 2003; Reforming Company and Takeover Law, 2004;
Corporate Governance in Context, 2005 (all Oxford and together with
Wymeersch). Honors: Dr iur. h.c. mult. (U. Libre de Bruxelles 1997,
U. Catholique de Louvain 1997, Paris Descartes 2000, Athens 2007).
Various prizes.
 list of contr ibutors xv

Howell E. Jackson
Howell Jackson is the James S. Reid, Jr, Professor of Law at Harvard
Law School. His research interests include financial regulation, inter-
national finance and consumer protection. He is a member of the
National Academy on Social Insurance, a trustee of the College
Retirement Equities Fund (CREF) and its affi liated TIAA-CREF invest-
ment companies, a member of the panel of outside scholars for the
NBER Retirement Research Center, and a senior editor for Cambridge
University Press Series on International Corporate Law and Financial
Regulation. Professor Jackson was a law clerk for Associate Justice
Thurgood Marshall and practiced law in Washington, DC. Professor
Jackson received JD and MBA degrees from Harvard University in 1982
and a BA from Brown University in 1976.

Hideki Kanda
Professor of Law at the University of Tokyo, Japan. His main areas of
specialization include commercial law, corporate law, banking regula-
tion and securities regulation. Mr Kanda served as Visiting Professor
of Law at the University of Chicago Law School in 1989, 1991, 1993 and
2006 and Visiting Professor at Harvard Law School in 1996.

Roberta S. Karmel
Roberta S. Karmel is Centennial Professor of Law and Co-Director of
the Dennis J. Block Center for the Study of International Business Law
at Brooklyn Law School. She was engaged in the private practice of law
in New York City for over thirty years at Willkie Farr & Gallagher,
Rogers & Wells, and Kelley Drye & Warren. She was a Commissioner
of the Securities and Exchange Commission from 1977–80, a pub-
lic director of the New York Stock Exchange, Inc. from 1983–9, and
a member of the National Adjudicatory Council of the NASDR from
1998–2001.
She received a BA cum laude from Radcliffe College in 1959 and an
LLB cum laude from New York University School of Law in 1962.
Professor Karmel is a Trustee of the Practising Law Institute. She
is Co-Chair of the International Coordinating Committee of the
Section of Business Law of the American Bar Association and a mem-
ber of the Advisory Committee on capital markets law to Unidroit, a
xvi list of contr ibutors

member of the American Law Institute, a Fellow of the American Bar

Foundation, and on the Boards of Advisors of Securities Regulation
and Law Report, The Review of Securities and Commodities
Regulation, and the World Securities Law Report. She was a Fulbright
Scholar in 1991–2.
Professor Karmel is the author of over fi ft y articles in books and legal
journals, and writes a regular column on securities regulation for the
New York Law Journal. She is a frequent lecturer on financial regula-
tion. Her book entitled Regulation by Prosecution: The Securities and
Exchange Commission vs. Corporate America was published by Simon
and Schuster in 1982.

Veronika E. Korom
Veronika E. Korom, dr iur. (Budapest), lic. droit (Aix-Marseille), MJur
(Oxford), LLB is a PhD candidate at the Centre de Droit Economique
(Aix-Marseille), member of the START-Project II ‘Legal Evolution –
European Company Law Harmonisation’ at the Vienna University of
Economics and Business Administration and trainee solicitor at Clifford
Chance LLP, London.

Friedrich Kübler
Studied law and history in Tübingen, Lausanne, Reading/Berks.
and Bonn. Teaching assistent in Tübingen and Paris. In 1961 doctor
iuris and 1966 Habilitation in Tübingen. Professor of law in Giessen
(1966–71), Konstanz (1971–6) and Frankfurt (since 1976, emeritus since
1998). In 1968 visiting lecturer Harvard Law School; 1975 and 1982 vis-
iting professor Pennsylvania Law School; since 1985 Professor of Law
at Penn. In 1973–86 member of the Board of Deutsche Gesellschaft
für Rechtsvergleichung; 1974–86 member of the board of Deutscher
Juristentag. 1997–2003 member of the (German) Commission for the
Assessment of Concentration in the Broadasting Industry. In 1998–
2006 counsel Clifford Chance, Frankfurt am Main. Member of the
American Law Institute, of the European Shadow Financial Regulatory
Committee and of the Frankfurt Academy of Sciences. Areas of interest
and research: contracts and property, corporations and securities regu-
lation, banking and international finance, mass media, comparative law,
modern legal history, law and economics.
 list of contr ibutors xvii

Donald C. Langevoort
Donald C. Langevoort is the Thomas Aquinas Reynolds Professor of Law
at Georgetown University Law Center, Washington, DC. He joined the
Georgetown faculty in 1999 after eighteen years at Vanderbilt University
School of Law, where he had been the Lee S. & Charles A. Speir Professor.
He has also been a visiting professor at the University of Michigan,
Harvard Law School and the University of Sydney in Australia. Professor
Langevoort graduated from the Harvard Law School in 1976, and went
into private practice with the law firm of Wilmer, Cutler & Pickering in
Washington. Later, he joined the staff of the US Securities & Exchange
Commission as Special Counsel in the Office of the General Counsel,
where he served until 1981.

Ruben Lee
Ruben Lee is the CEO and Founder of the Oxford Finance Group, a
research and consulting firm which concentrates on business, economic,
legal, regulatory and strategic aspects of financial markets. From 1989
to 1992, Dr Lee was a Fellow of Nuffield College, Oxford University,
where he specialized in financial economics and law. He worked from
1980 to 1984 in the capital markets in New York and London for Salomon
Brothers International. Dr Lee has published widely on many topics con-
cerning financial markets, including exchanges, clearing and settlement,
and EU securities regulation. He is the author of the book What is an
Exchange? The Automation, Management, and Regulation, of Financial
Markets, and is currently leading a project on the governance of mar-
ket infrastructure institutions. Ruben Lee is a member of the Conseil
Scientifique of the Autorité des Marchés Financiers in France, and was
previously on the Advisory Panel of Financial Services Experts, estab-
lished by the Economics and Monetary Affairs Committee, European
Parliament.

Marcus Lutter
Born 1930 in Munich, Prof. Dr Dr h.c. mult. Marcus Lutter got his
PhD from the University of Freiburg and his Habilitation from the
University of Mainz. He was then Professor for German and European
Company Law at the University of Bochum and later at the University
of Bonn. He is now speaker of the Centre for European Economic Law
xviii list of contr ibutors

at the University of Bonn. He received a Doctor honoris causa from

the Wirtschaftsuniversität Wien, the University of Warszawa and the
University of Jena.

Joseph A. McCahery
Joseph A. McCahery is Professor of Corporate Governance and
Innovation at the University of Amsterdam Faculty of Economics and
Econometrics and Professor of Financial Market Regulation at Tilburg
University Faculty of Law and the Tilburg Law and Economics Centre.
He is co-director of the Amsterdam Centre for Corporate Finance
and a Research Associate of the European Corporate Governance
Institute.

Michel Menjucq
Professor at the University of Paris 1 Panthéon-Sorbonne since 2000
and Director of the center of research ‘Sorbonne-affairs’. Doctor in
International and European Company Law, he is the author of books on
La mobilité des sociétés dans l’espace européen (LGDJ, 1997), Droit inter-
national et européen des sociétés (Précis Domat, Montchrestien, 2nd edn,
2008) and also has directed a book on Droit du commerce international
(Traité Litec, 2005). His recently published articles in European journals
include ‘Regulation no 1346/2000 on Insolvency Proceedings and the
groups of companies’ (ECFR, June 2008, 135), and ‘The European com-
pany under French Law : main features’ (with Fages and Vuidard, EBOR
9(1), 2008, 137).

Hanno Merkt
Professor of Law and Director of the Institute for Foreign Law and
International Private Law at the University of Freiburg i. Br., Germany
and Judge at the Court of Appeals of Karlsruhe. He received law degrees
from the University of Bonn, the University of Chicago, the University
of Münster i.Westf. (doctor iuris) and the University of Hamburg.
In 1990 he was admitted to the New York Bar. He teaches German,
European and international commercial and corporate law and secur-
ities regulation. He is author of various books, commentaries and art-
icles on German commercial, company and accounting law as well as
 list of contr ibutors xix

on American law of corporations. He is also co-editor of the European

Company and Financial Law Review (ECFR) and various other business
law journals.

Niamh Moloney
Niamh Moloney is Professor of Capital Markets Law at the
University of Nottingham; from January 2009 she is Professor of
Financial Markets Law at the London School of Economics. She is
a graduate of Trinity College Dublin and Harvard Law School. Her
research field is EC company law and securities regulation and her
major publications include EC Securities Regulation , OUP, 2 nd edn
2008. She is a board member of the European Business Organisation
Law Review, a Series Editor of the Cambridge University Press Series
on International Corporate Law and Capital Market Regulation ,
Consultant Editor on EC Company Law to D. Vaughan and
A. Robertson (eds), Encyclopedia of EC Law (OUP), and consult-
ant editor on corporations and finance and investment to the New
Oxford Companion to Law (OUP).

Peter O. Mülbert
Professor of Corporation Law, Securities Law and Banking Law, and
Director of the Centre for German and International Law of Financial
Services, Johannes Gutenberg-Universität, Mainz; Member, Panel
of Financial Services Experts of the Committee on Economic and
Monetary Affairs of the European Parliament; Member, Administrative
Protest Committee of the Federal Financial Supervisory Authority;
Research Fellow, European Corporate Governance Institute; Member,
Management Board of ‘Bankrechtliche Vereinigung e.V – wissen-
schaft liche Gesellschaft für Bankrecht e.V.’; Co-Editor, ‘Zeitschrift
für das gesamte Handelsrecht und Wirtschaftsrecht’, Co-Editor,
‘Neue Zeitschrift für Gesellschaftsrecht’; Member, Advisory Board of
‘Wertpapiermitteilungen’; 1976, Universities of Tübingen and Genf;
1984, PhD Degree in Law, University of Tübingen; 1994, Habilitation,
University of München; 1994, Professor of Law, Universities of
Heidelberg, Trier and Mainz; books and articles in the area of corporation
law, groups of corporation, capital market law, banking law.
xx list of contr ibutors

Peter Nobel
Prof. Dr rer. publ., Attorney at Law in Zurich since 1980 (own law firm
since 1982); Professor for Private, Trade and Commercial Law at the
University of St. Gallen since 1984. Professor in ordinary ad personam
for Swiss and International Trade and Commercial Law at the University
of Zurich since March 2007. Substitute judge at the Court of Commerce
of the Canton of Zurich since 1998; member of the Swiss Federal Banking
Commission 1988 until 2000. Frequently appointed as arbitrator or medi-
ator in international and domestic arbitration; various assignments as
chairman. Editor-in-chief of the Swiss Review of Business and Financial
Market Law since 1995; co-editor of Jusletter. Author to numerous publi-
cations in various legal areas of commercial law and litigations.

Dan Prentice
Allen & Overy Professor of Corporate Law, University of Oxford; Fellow
of Pembroke College; author of various texts and articles on company
law, insolvency and the law relating to financial markets; barrister,
Erskine Chambers, Lincoln’s Inn.

André Prüm
Nominated professor of the French universities in 1995, André Prüm
joined the University of Luxembourg in 2005 where he holds the chair in
financial and business law. He is also visiting professor at the University
of Paris 1 Panthéon-Sorbonne and Paris 2 Panthéon-Assas teaching
European banking and financial law. In 1996, he created the Laboratory
of Economic Law in Luxembourg that has contributed to the prepara-
tion of several draft bills in the field of company law, the law of trust
and fiduciary contracts, the law on securitization, competition law, the
law of electronic commerce and others. In October 2005, André Prüm
was elected Dean of the Faculty of Law, Economics and Finance of the
University of Luxembourg. His teaching and research activities are
enriched by his work as an adviser and arbitrator.

Theo Raaijmakers
Theo Raaijmakers is professor of the law on business organizations
(Tilburg University) since 1986 and director of its Center for Company
 list of contr ibutors xxi

Law. Until 2001 he was also Legal Adviser to Royal Philips Electronics
NV and Executive Vice President of Philips International. Other func-
tions inter alia: part-time judge District Court Den Bosch (1980–93),
part-time Justice Court of Appeals Arnhem (since 1994), Chairman
Netherlands Association of Corporate Lawyers (1985–89), chairman
UNICE Committee Company Law (1982–97), chairman Advisory
Committee on Modernization of Bankruptcy Law, member Committee
on Capital Markets of Netherlands Autoriteit Financiële Markten. PhD
thesis was on character and group relationships of joint ventures. Other
publications: books and articles on corporate reorganizations, partner-
ships, corporate governance, securities law and a major comment on
Netherlands law on business organizations.

Jonathan Rickford
Jonathan Rickford has been Visiting Professor in European corporate
law at the London School of Economics since 2003.
He was: Project Director of the UK’s independent Review of Company
Law in 1998–2001; a member of the Commission’s High Level Group
(‘Winter’ Group) on company law in 2001–2 and Unilever Professor at
Leiden in 2002.
He has also been: a member of the UK Competition Commission
(1997–2004); successively Chief Legal Adviser, and Director of Regulation
and Corporate Strategy with British Telecommunications plc (1987–96);
and in the UK Government Legal Service (1972–87), including Head of
Company Law and Solicitor (General Counsel) to the Department of
Trade and Industry. From 1968–72 he taught at Berkeley (California)
and the London School of Economics.

Mark J. Roe
Mark J. Roe teaches corporate law and corporate bankruptcy at Harvard
Law School. He wrote Strong Managers, Weak Owners: The Political Roots
of American Corporate Finance (Princeton, 1994), Political Determinants
of Corporate Governance (Oxford, 2003), and Bankruptcy and Corporate
Reorganization (2nd edn, Foundation Press, 2007). Recent articles include
‘Legal Origins, Politics, and Modern Stock Markets’, Harvard Law
Review 120, 460 (2006), ‘Regulatory Competition in Making Corporate
Law in the United States – And Its Limits’, Oxford Review of Economic
Policy 21, 232 (2005), ‘Delaware’s Politics’, Harvard Law Review 118, 2491
xxii list of contr ibutors

(2005), ‘The Inevitable Instability of American Corporate Governance’,

in American Academy of Arts and Sciences (eds), Restoring Trust
in American Business (MIT Press, 2004), ‘Delaware’s Competition’,
Harvard Law Review 117, 588 (2003), and ‘Corporate Law’s Limits’,
Journal of Legal Studies 31, 233 (2002).

Marie-Claude Robert Hawes

Marie-Claude Robert Hawes served at the French Commission des
Operations de Bourse (current title Autorité des Marchés Financiers)
from April 1968 to November 2000: Section head of the Legal Department
(1968–79); Deputy head of the Research Department 1979–85); Head of
the International and Public Relations Department (1985–91); Head
of the Public Relations Department (1991–97); First Mediator appointed
by the Commission (1997–2000).
She was Adjunct Professor, University of Paris School of Law (II)
(1979–91) and Associate member of the International Faculty for Capital
Markets and Corporate Law (1976–95).
She is currently a member of the Consultative Committee of the
Autorité des Marchés Financiers on Protection of Investors.
Honours : Knight of the Order of Legion d’Honneur, January 2000.

Wolfgang Schön
Wolfgang Schön is since 2002 a Director at the Max Planck Institute
for Intellectual Property, Competition and Tax Law (Department of
Accounting and Taxation) in Munich and Honorary Professor at Munich
University. He was appointed Anton Philips Professor at Tilburg/NL
University’s Centre for Company Law for the Academic Year 2004/2005
and was invited to join the Global Law Faculty at NYU in 2006. Since
2008 he has served as Vice-President of the Max Planck Society.

Joëlle Simon
Juris Doctor (magna cum laude), Paris II University – 1982; Director
for Legal Affairs, MEDEF – French Business Confederation; Chevalier,
Ordre National du Mérite (France). Member of the Advisory Group on
Corporate Governance and Company Law (since May 2005); Member of
the High Level Group of Company Law Experts, European Commission
(2001–2); Member of the technical committees of the VIENOT (1999)
 list of contr ibutors xxiii

and BOUTON Committees (2002) on corporate governance.; Member

of the Commission on ‘Landmine destruction’ (CNEMA /OTTAWA
Convention) (1999–2005); Vice-chairperson, Company Affairs
Committee, UNICE (1997–2001); Member of the French Economic &
Social Committee (1989–91, 1995–97); Member of the Unfair Trading
Terms Committee (1992–3); General Secretary of the French Association
of Business Lawyers (until 1993).

Levinus Timmerman
Levinus Timmerman was professor in commercial law and company
law at the University of Groningen in the Netherlands. He is since 2003
advocate-general with the Dutch Supreme Court and professor in the
principles of company law at the Erasmus University in Rotterdam. He
was editor-in-chief of the Dutch periodical Ondernemingsrecht and acts
as chairman of the Dutch commission on company law.

John Vella
John Vella is Norton Rose Career Development Fellow in Company Law
at the Faculty of Law, University of Oxford. He first studied law at the
University of Malta, obtaining a BA and an LLD. He was admitted to the
Maltese bar and practised briefly. He then obtained an LLM and a PhD
from the University of Cambridge. He has been a visiting researcher at
the Oxford University Centre for Business Taxation and has acted as
a co-arbitrator on a tax dispute before the ICC International Court of
Arbitration. His main research interests and publications are in corpo-
rate fi nance and tax law. At Oxford, he teaches company law, corporate
finance law, EC law and Roman law.

Erik P. M. Vermeulen
Erik Vermeulen is Professor of Financial Market Regulation at the
Tilburg Law and Economics Centre (TILEC) and Professor of Law and
Management at Tilburg University Faculty of Law. He teaches corpor-
ate law, corporate finance, corporate acquisitions and joint ventures. He
has written articles on a variety of subjects in corporate law, corporate
governance, securities regulation, and private equity and venture capital
contracts. Erik Vermeulen is also a vice-president at the corporate legal
department of Philips International B.V. in the Netherlands. He is the
xxiv list of contr ibutors

author of The Evolution of Legal Business Forms in Europe and the United
States (Kluwer, 2003) and co-author of The Corporate Governance of
Non-Listed Companies (Oxford University Press, 2008).

Rebekka M. Wiemann
As a fellow of the German National Academic Foundation, Rebecca
Wiemann studied law at the Universities of Passau (Germany),
Concepción (Chile) and Mainz (Germany), where she graduated in
2006. In 2006–7 she worked as a research assistant with Professor Peter
O. Muelbert (University of Mainz). Currently she is pursuing her legal
clerkship (German Referendariat) at the European Commission in
Brussels. Her academic and professional focus is on international eco-
nomic law and European law.

Jaap Winter
Jaap Winter is partner at the law firm De Brauw Blackstone Westbroek
in Amsterdam. His practice areas include mergers and acquisitions,
corporate governance and corporate litigation. He is also Professor of
International Company Law at the University of Amsterdam and visit-
ing professor at Columbia Law School in New York.
He was chairman of the High Level Group of Company Law Experts
set up in 2001 by the European Commission to advise it on a modern
regulatory framework for company law in Europe. The Group in January
2002 first advised on issues related to takeover bids. The final report of
the Group on a Modern Regulatory Framework for Company Law in
Europe (November 2002) was the basis for the Commission’s Company
Law Action Plan.
He was a member of the Dutch Corporate Governance Committee,
chaired by Morris Tabaksblat, that has drafted the Dutch Corporate
Governance Code of December 2003.
Jaap Winter is a member of the European Corporate Governance
Forum set up by the European Commission in 2004 to advise it on
corporate governance developments in Europe. He received the 2004
International Corporate Governance Award from the International
Corporate Governance Network. He is also a member of the Supervisory
Board of the Dutch securities regulator AFM.
 FOR E WOR D

The wide-ranging content of this book can be seen as a reflection of the

academic career of the person it is dedicated to, Eddy Wymeersch. After
receiving a Law degree at Ghent University in Belgium and a Master of
Laws degree at Harvard Law School in the USA, Eddy Wymeersch ven-
tured into academia as an assistant to Professor Jean Limpens at Ghent
University. He briefly worked for the Belgian banking supervisor, then
called Banking Commission, but soon left, only to return as the chair of
its executive committee in 2001. In 1972 he was appointed professor at
the newly established University of Antwerp. In 1984 he returned to his
alma mater, Ghent University, to remain there until his retirement in
2008. At Ghent University, Wymeersch and his colleague Guy Schrans
founded the Financial Law Institute in 1990, as a research center but
also as a forum where (Belgian) academics and practitioners can meet
to discuss new developments in company and financial law. Professor
Wymeersch is still a source of inspiration to all members of the Institute
and we all hope he will continue to stimulate younger members with his
direct and critical but always constructive comments.
Speaking and/or reading Dutch, English, French, German and Italian
and, being from little, outward-looking Belgium, Wymeersch has
always closely monitored legal developments internationally, both in
Europe and the USA, at a time when many were only interested in the
technical intricacies of their national legal systems. Th is partly explains
his exceptionally good nose for what would become the topics of future
legal research in European company and financial law. He was a pioneer
in many fields related to securities, corporate and banking law. In the
1970s the European Commission charged him with a seminal study on
“The Control of the Securities Markets in the European Community”
(published in 1978). Hardly anything had been written on the topic at
that time, but Eddy Wymeersch revealed a wealth of important issues,
many of which were only dealt with in European regulation at the start
of the twenty-first century, by which time he had become the chairman
xxv
xxvi for ewor d

of the Committee of European Securities Regulators (CESR). He estab-

lished contact with Klaus Hopt and together they would embark on a
series of groundbreaking conferences, which were always accompan-
ied by important and widely consulted conference volumes and which
brought together many of the leading, internationally minded schol-
ars in areas such as banking, securities and corporate law from across
Europe and the USA. The first two such conferences dealt with Insider
dealing and takeover bids in Europe. Later Guido Ferrarini would trans-
form the couple into a triumvirate of close friends. They would continue
to meet each other in various fora and locations. The award of the pres-
tigious Max Planck Research Prize in 1998 enabled Eddy Wymeersch to
fund some of the later conferences. Other fora, such as the International
Faculty for Corporate Law and Securities Regulation, or the Forum
Europaeum, which worked on principles of group law, were equally pro-
ductive in terms of academic output.
In 1992 Eddy Wymeersch spoke about corporate governance at
Cambridge, at a (still just pre-Cadbury) time when hardly any scholar,
board member or institutional investor on the Continent had heard
about the concept. He would soon start spreading the gospel, leading
to him more or less single-handedly writing the Belgian Corporate
Governance Act of 2002, being involved in the draft ing of every offi-
cial Belgian corporate governance Code for listed companies and being
chosen as a member of the European Corporate Governance Forum.
At that time he already had years of consulting for, among others, the
IMF and World Bank behind him, which had given him the opportunity
to advise several eastern European states on the introduction of stock
exchange regulation and other aspects of what was for these countries,
in the immediate aftermath of the fall of the Berlin Wall, the new cap-
italist system of funding companies. Eddy Wymeersch also chaired the
European SLIM-working group (which stands for Simpler Legislation
for the Internal Market) that had a significant impact on the moderniza-
tion and simplification of the First and Second Company Law Directives
related to legal capital and disclosure.
For European legal academics under 45 years old who write in English
– still a small but rapidly expanding minority – some knowledge of
basic law and economics concepts is self-evident. This was certainly not
always the case, and Wymeersch was an early, although always cautious
enthusiast of the movement and even more of purely economic literature
and attention to empirical data. For Professor Wymeersch, multidisci-
plinarity is essential for the legal scholar: legal research must be open to
 for ewor d xxvii

other disciplines like economics and even politics. But one should avoid
meta-analysis of rules without first familiarizing oneself with their often
important technical details, and think twice about developing grand
theoretical schemes that stand no chance whatsoever of being applied
to real world situations. He also force-fed the Financial Times, the
Economist and Harvard Business Review to anyone who wanted to write
a doctoral thesis under his guidance – and being prepared to write a
PhD was a requirement if you wanted to become a full-time researcher at
the Financial Law Institute. Another requirement was learning enough
German to understand the German literature that is often two or three
years ahead of the rest of Europe. Not a year went by in which Eddy
Wymeersch did not visit at least two or three German universities and
academic conferences and from the beginning of the 1990s onwards he
published more in German and other foreign journals than in Belgian
ones, turning him into one of the most downloaded European authors
on SSRN and making some junior Belgian colleagues wonder whether
he was actually truly Belgian. Anyone familiar with Eddy Wymeersch
knew, though, that for him an international outlook had never been
incompatible with an interest in local developments. On the contrary,
awareness of what was going on elsewhere seemed to him to be essential
if one wanted to intervene in a useful way in national debates. In his fare-
well speech at the academic session organized to mark his official retire-
ment as a professor at Ghent Law School in October 2008, he expressed
his worries about the decline of the knowledge of French among Flemish
professionals, including academics. It would prevent them, he warned,
from performing the bridge function his generation had tried to play
between the “Germanic” and “Latin” worlds of northern and southern
Europe – worlds that meet in places like Brussels, 50 kilometers from
Ghent.
While his roots and interests are certainly in the academic sphere,
Eddy Wymeersch never limited his academic research to a purely dog-
matic, positivist dissection of texts, as is still rather common in Europe.
After he had given a solid foundation to his academic career, Wymeersch
placed his knowledge and insights at the disposal of practice and policy:
to name only a few of them, he was appointed to the Belgian Council
of State (which vets Bills before they are introduced into Parliament);
became a member of the board of Governors of the National Bank of
Belgium; chairman of the board of BIAC, the national airport com-
pany; chairman of the executive committee of the Belgian banking and
securities supervisor, which he transformed into the Belgian Banking,
xxviii for ewor d

Finance and Insurance Commission (CBFA) by incorporating the previ-

ously independent insurance supervisor; followed by the chairmanship
of the supervisory board of this CBFA. In 2007 he was elected as chair-
man of the Committee of Securities Regulators (CESR).
This book is dedicated to Eddy Wymeersch. It was accompanied by an
international conference, ‘Perspectives in Company Law and Financial
Regulation’, held in December 2008 in Ghent in honour of Eddy
Wymeersch. This conference was an attempt by Eddy Wymeersch’s
successors at Ghent Law School to emulate the success of the Siena and
Syracuse conferences and to fruitfully combine intellectual work and
food for thought in an atmosphere of friendship.
This collection of essays is the result of the collective effort of Eddy
Wymeersch’s main academic peers and friends worldwide. We are
extremely grateful to every one of the contributors for having freed
scarce time to participate in this tribute to Eddy Wymeersch. Eilis
Ferran, Howell Jackson and Niamh Moloney kindly hosted the collec-
tion of essays in the International Corporate Law and Financial Market
Regulation series they edit at Cambridge University Press. We are also
grateful to the publishers at Cambridge University Press, notably Kim
Hughes and Richard Woodham, and to Jamie Hood at Out of House
Publishing Solutions for their relentless efforts and patience through
all the productions stages of this volume. Finally, the assistance of
the researchers at the Financial Law Institute (Filip Bogaert, Diederik
Bruloot, Isabel Coppens, Wendy Dammans, Sarah De Geyter, Delphine
Goens, Evelyne Hellebuyck,, Kristof Maresceau, Sara Pauwels, Fran
Ravelingien and Lientje Van Den Steen), and of its secretariat (Nicolle
Kransfeld and Annelies Rademaker) in the editing and proof-reading of
the manuscripts was critical in meeting the production deadlines.
The more than 30 contributions in this volume highlight a wide range
of current issues in company law and financial regulation in various
jurisdictions, both in Europe, the USA and Japan. Most contributions
were finalized during Spring 2008, and could not, therefore, incorporate
the most recent market and regulatory developments that have charac-
terized the current financial crisis since the second semester of 2008. We
hope this volume will provide some more inspiration for future research
to Eddy’s no doubt already overflowing list of things to do once CESR
and officialdom give him back some time – although we will not stop
him if he prefers to take his cue from Voltaire and dedicate himself to
the most civilized of all tasks, tending his magnificent garden – where
 for ewor d xxix

he also produces some of the most red and fleshy tomatoes north of the
Alps.
We wish Eddy Wymeersch all the luck for his future activities and
other new inspiring challenges and ventures. We also hope and are con-
vinced he will continue to spend some of his valuable time to share his
views, ideas and inspiration with the Financial Law Institute at Ghent.

Hans De Wulf
Reinhard Steennot
Michel Tison
Christoph Van der Elst
 PA RT I

Perspectives in company law

 SEC T ION 1

European company law:

regulatory competition and free
movement of companies
 1

The European Model Company

Act Project
Theodor Baums and
Paul Krüger Andersen

I. Introduction
On 27 and 28 September 2007, a commission formed on the initi-
ative of the authors1 held its first meeting in Aarhus, Denmark to
deliberate on its goal of drafting a European Model Company Act
(EMCA). This project, outlined in the following pages, aims neither
to force a mandatory harmonization of national company law nor
to create a further, European corporate form. The goal is rather to
draft model rules for a corporation that national legislatures would
be free to adopt in whole or in part. Thus, the project is thought of
as an alternative and supplement to the existing EU instruments for
the convergence of company law. The present EU instruments, their
prerequisites and limits will be discussed in more detail in Part II,
below. Part III will examine the US experience with such ‘model acts’
in the area of company law. Part IV will then conclude by discussing
several topics concerning the content of an EMCA, introducing the
members of the EMCA Working Group, and explaining the Group’s
preliminary working plan.

1
See P. Krüger Andersen, ‘Regulation or Deregulation in European Company Law – a
Challenge’, in U. Bernitz (ed.), Modern Company Law for a European Economy – Ways
and Means, (Stockholm: Norstedts Juridik Förlag, 2006), 263 et seq.; T. Baums, ‘The
law of corporate fi nance in Europe – an essay’, Nordic Company Law, 31 (2008), et seq.;
also see Ebke’s earlier proposal to set up a ‘European Law Institute’ modelled on the
American Law Institute in order to draft a European Model Company Law Statute; W.
Ebke, ‘Unternehmensrechtsangleichung in der Europäischen Union’, in Festschrift für
B. Großfeld, (Heidelberg: Recht und Wirtschaft, 1999), 189, 212 et seq., and J. Wouters,
‘European Company Law: Quo Vadis?’, Common Market Law Review, 37 (2000), 257–
307, especially 298.
5
6 Perspectiv es in compa n y l aw

II. European company law legislation: traditional

instruments and a new tool
A. The limits of European company law legislation
Until now, the European Union has employed three tools to ensure that
the legal rules in the area of company law are compatible with the goal
of a functioning internal market: first, the harmonization of national
company law through directives adopted under art. 44(2)(g) Treaty
Establishing the European Community (EC Treaty) that national leg-
islatures must implement; second, the creation of new supranational
organizational forms on the basis of art. 308 EC Treaty, forms which exist
alongside their national counterparts as alternative vehicles for compa-
nies; and third, the judicial policing of national company law under the
right of free establishment (arts. 43 and 48 EC Treaty) as performed by
the European Court of Justice (ECJ), which in a series of landmark deci-
sions since 1999 – among them the well-known Centros, Überseering
and Inspire Art cases – has rejected a number of national limitations
and thus triggered a ‘regulatory competition’ among national corporate
laws, the results of which are not yet foreseeable.
Each of these methods of structuring the law has its own prerequi-
sites and conditions of application – which here will be mentioned only
summarily2 – that make supplementation through a uniform, albeit
non-mandatory, European Model Company Act both meaningful and
desirable.
Harmonization by means of directives is understood as a technique for
achieving less than full unity of law and is subject to the Treaty condi-
tion that the measure be implemented only if and to the extent required
for reaching the goal of a common market (arts. 3(1)(h) and 44(2)(g) EC
Treaty). This approximation of laws presupposes the existence of a vari-
ety of individual national legal systems that will continue to exist, and
also of diverse, possible legal solutions. As a form of ‘harmonization lite’,
it seeks merely to ensure that each member state enacts provisions that
do not disrupt the internal market. Beyond that floor, each member state
remains free to shape its company law in any way it chooses, provided
the result conforms to the minimum needs of the Union. Although this

2
See the detailed discussion by C. Teichmann, Binnenmarktkonformes Gesellschaft-
srecht (Berlin: de Gruyter Recht, 2006), pp. 73 et seq., and e.g. K. Engsig Sørensen and
P. Runge Nielsen, EU-retten, (Copenhagen: Jurist- og Økonomforbundets Forlag,
2004), 675 et seq.
 The Eu ropea n Model Compa n y Act Project 7

solution effectively allows the use of ‘states as laboratories’ to develop

competing corporate models3 and helps counteract a petrification of a
status quo reached by centrally developed norms,4 beyond the mini-
mally harmonized area a basic tension remains with the expectations of
corporations operating on a European scale, which rather ask for stand-
ardization of operating rules and seek uniformity in laws on investor
protection and the disclosure of information, so as to reduce their infor-
mation and transaction costs.
Supranational organizational forms like the European Company (SE),
the European Co-operative (ECS) or the European Economic Interest
Grouping (EEIG) would only meet these needs if the statutes of the indi-
vidual member states in which they are based had substantially simi-
lar content. This is a condition that the current state of affairs does not
meet, given that the statutes creating supranational entities contain

3
For a detailed discussion of competition between legislatures, see E. M. Kieninger,
Wettbewerb der Privatrechtsordnungen im Europäischen Binnenmarkt, (Tübingen:
Mohr Siebeck, 2002); K. Heine, Regulierungswettbewerb im Gesellschaftsrecht, (Berlin:
Duncker & Humblot, 2003); Teichmann, Binnenmarktkonformes Gesellschaftsrecht,
(note 2, above), 330 et seq.; J. Armour, ‘Who should make Corporate Law? EC Legislation
versus Regulatory Competition’, ECGI- Law Working Paper, 54 (2005), available at
http://ssrn.com/abstract=860444; J. Andersson, ‘Competition between Member States
as Corporate Legislator’, in U. Bernitz (ed.), Modern Company Law for a European
Economy – Ways and Means (Stockholm: Norstedts Juridik Förlag, 2006), 143 et seq.;
H. Søndergård Birkmose, ‘Regulatory Competition and the European Harmonisation
Process’, European Business Law Review, 17 (2006), 1079–97. The discussion on com-
petition is particularly related to the European Legal Capital Regime as determined by
the Second Company Law Directive. Thus, there is a debate on what the directive allows –
is it possible for the member states to create a competitive new model for regulations
within the framework of the directive, or is it necessary to create an alternative system?
In a newly published contribute to that debate (P. Santella and R. Turrini, ‘A contribu-
tion to the debate on the legal capital regime in the EU: What the Second Company
Law Directive allows’, in P. Krüger Andersen and K. Engsig Sørensen (eds.), Company
Law and Finance, (Copenhagen: Thomson, 2007), 85 et seq.), the authors argue that the
Second Company Law Directive is a very flexible instrument which to a very large extent
allows member states to develop new and efficient capital rules. An example to illus-
trate this could be the new (2006) and liberal Finnish Company Act. See J. Mahönen,
‘Capital Maintenance and Distribution Rules in Modern European Company Law’, in
Andersen and Sørensen (eds.), Company Law and Finance, p. 119; and M. Airaiksinen
‘The Delaware of Europe Financial Instruments in the new Finnish Company Act’, in
Andersen and Sørensen (eds.), Company Law and Finance, 311.
4
On the disadvantages of centrally developed norms (keywords: elimination of regulatory
competition; ‘petrification’ of the law because of the EU legislative process; costs of change)
see C. Teichmann, ‘Wettbewerb der Gesetzgeber im Europäischen Gesellschaft srecht’,
in E. Reimer et al. (eds.), Europäisches Gesellschaft s- und Steuerrecht, (Munich: Beck
Juristischer Verlag, 2007), 313, 329 with further references.
8 Perspectiv es in compa n y l aw

numerous references to national laws as gap-fi llers. In this way, the

enacted company forms by no means create uniform rules, but rather
each member state presents a different mosaic of supranational and
national rules to the market. In the case of the SE, above all, EU law cre-
ates a mere torso of a corporation. There are undisputable advantages
to this type of form (e.g., combining free structuring with a uniform
‘European Trademark’). However, the advantages of a truly unified cor-
porate form remain beyond reach. It remains to be seen whether it will
be possible to develop a genuinely European company in the planned
‘European Private Limited Company’ (EPC).
Judicial policing of national company law for conformance with the
right of free establishment can in the fi nal determination only clear away
barriers on a case-by-case basis, but cannot serve to positively create
workable forms. Although offending national norms are removed, they
are not replaced with provisions serving the internal market. Rather,
ECJ company law decisions have since 1999 launched a competition for
corporate charters in which member states have started to adopt differ-
ing measures within the open area left by the ECJ. In this respect it has
been argued that the establishment of a market for corporate charters
does not necessarily lead to regulatory competition as the supply side
(the member states) lack sufficient incentives to compete for charters.5
The work of the Group might help to improve this as its procurement of
detailed information on national company law will create the transpar-
ency that is a prerequisite for competition.

B. The present aims of EU regulation: from harmonization

to convergence
The objectives of EU regulation in the area of company law have changed
substantially over time – in spite of their unchanged basis in Article
44(3)(g) of the EC Treaty. In an article on the subject, Jan Wouters ana-
lysed the development from the 1960s (the adoption of the first series of
directives) until the year 2000.6 During the 1960s, the ambitious goal was
to harmonize company law, comprising all aspects of such law from the
formation of companies to investment, dividends, mergers and liquida-
tions. After adoption of the first series of harmonization directives, this

5
See H. Søndergård Birkmose, ‘A Race to the Bottom in the EU’, Maastricht Journal of
European and Comparative Law, 1 (2006), 35–80.
6
Wouters, ‘European Company Law: Quo Vadis?’, (note 1, above), 257–307.
 The Eu ropea n Model Compa n y Act Project 9

development gradually stopped. It turned out that it was impossible to

realize full harmonization in several areas, and the goal of harmonization
was subjected to debate. Wouters describes the EU’s activity in company
law around the turn of the millennium as characterized by a four-fold
crisis: conceptually (e.g. participation versus consultation of employees),
in relation to competence (i.e., an emphasis on subsidiarity), questioning
legitimacy (i.e., a new preference for a decentralized development of the
law) and a growing local loyalty (member states’ resistance to implemen-
tation of EU norms).7 He argued that the Commission did not have any
coherent vision or agenda in the field of company law. Shortly after the
publication of this article, the Commission (on 4 September 2001) set up
a Group of Company Law Experts. This Group was due to provide rec-
ommendations for creating a modern framework for European company
law. Based on the Group’s final report,8 the Commission elaborated its
Action Plan in 2003.9 To use the words of Rolf Skog,10 one might well say
that EU’s work with company law gained new wind in the sails.
Although the initial Action Plan of 2003 has been reviewed and devel-
oped further meanwhile,11 the three ‘guiding political criteria’ that the
regulatory activity at the European level needs to respect remain impor-
tant also in the context of the Model Law Project.12 These criteria are (1)
the subsidiarity and proportionality principle of the Treaty, (2) that the
regulatory response is flexible in application, but firm in principles, and
(3) that it should shape international regulatory developments.
To sum up, the present aim of the EU regulation is not to harmonize
the companies acts of the member states. Directives are not the primary
regulatory tool. Better regulation can include alternative tools – such as
a model law that can foster convergence and best practice on a European
level. Creating a European Model Company Act is completely in line
with this view expressed by the Commission.

7
Wouters, ‘European Company Law: Quo Vadis?’, (note 1, above), 275.
8
Report of the High Level Group of Company Law Experts on a Modern Regulatory
Framework for Company Law in Europe, Brussels, 4 November 2002.
9
Modernising Company Law and Enhancing Corporate Governance in the European
Union – A Plan to Move Forward (COM(2003) 284 Final).
10
See R. Skog, ‘Harmoniseringen af bolags- og börsrätten indom EU – ny vind I seglen?’,
NTS (Nordisk Journal of Company Law), (2001), 331; R. Skog, ‘Harmoniseringen af bolag-
srätten indom EU – fortfarende vind i seglen?’, NTS, 1(2007), 66.
11
See T. Baums, ‘European Company Law beyond the 2003 Action Plan’, European Business
Organization Law Review, 8 (2007), 143 et seq.
12
See Modernising Company Law and Enhancing Corporate Governance in the European
Union – A Plan to Move Forward (COM(2003) 284 Final), 4.
10 Perspectiv es in compa n y l aw

C. Concluding thoughts on the EU company law programme

As has been shown above, today member states have a significant
amount of legislative free space in the area of company law. Th is area is
limited only in certain areas by the ECJ’s decisions protecting freedom
of establishment, and has been – and will continue to be – harmonized
only in certain other areas by EU directives. On the one hand, this free
space should, in light of the disadvantages of centrally harmonizing sub-
stantive law13 and the advantages of decentralized, competing legislative
efforts,14 be retained and defended. On the other hand, as said, cer-
tain disadvantages are connected with relinquishing further substan-
tive harmonization of national company law. Thus, the abandonment
of central harmonization can cause three conceivable losses: first, the
standardization of norms creates economic savings by eliminating the
costs of obtaining information about diverse laws and adapting busi-
ness to them;15 second, a regulatory competition which is driven prima-
rily by the preferences of managers and investors may not always lead
to optimal results for the affected third-party constituencies;16 third,
legislation promulgated from a central government can break through
impediments to reform that are well entrenched at the level of individual
states.
The potential loss of these benefits does not, however, speak uncon-
ditionally for a programme of central harmonization. For example, it
does not seem that the competition for corporate charters in Europe
that has only just begun has injured third parties to an extent which
would call for the prompt creation of harmonized norms for private
limited companies. It is also the very purpose of regulatory competi-
tion to subject to market competition those local particularities seen
by one party as an impediment to reform while valued by the other as
desirable options, rather than simply either eliminating or perpetuat-
ing them through centralized rules. However, the fact remains that a
basic tension exists between the goal of a unified, internal market and
the continued existence of different systems of corporate law, a ten-
sion that entails both advantages and disadvantages. Can a unified,
13 14
Note 4, above. Note 3, above.
15
See E. Kitch, ‘Business Organization Law: State or Federal? – An Inquiry into the
Allocation of Political Competence in Relation to Issues of Business Organization Law
in a Federal System’ in R. M. Buxbaum et al. (eds.), European Business Law: Legal and
Economic Analyses on Integration and Harmonization (Berlin: de Gruyter, 1991), pp. 35,
40 et seq.
16
On this point see the literature and references note 3, above.
 The Eu ropea n Model Compa n y Act Project 11

voluntary model law serve to preserve the advantages of decentralized

legislative energy and imagination while assuring most advantages of
centralized harmonization? The following paragraphs consider this
possibility.

D. The functions of an EMCA

A European Model Corporation Act17 would not lead to a legal instru-
ment issued by the European Union: the member states would neither
be ordered to implement an EU directive nor would the Union create yet
another European business form. To this extent, the concept of a European
Model Company Act must not be misunderstood. Emphasis should be
on the word ‘model’. The project is to develop a model for a companies
act that the member states are free to adopt or reject. The content of the
model should include broadly acceptable uniform rules, building on the
common legal traditions of the member states and the existing acquis
communautaire, but also contribute to developing best practice based on
experiences from the modern companies acts of various member states.
The draft should both leave individual states free space for their own take
on the model, so as to account for local and national particularities, and
offer incorporators maximum flexibility with which to structure the ulti-
mate business enterprise.
Of course, even now every carefully prepared amendment of law
is preceded by a thorough comparative analysis. Nevertheless, such
comparative analyses are often restricted to the most economically
important jurisdictions and are often performed in a perfunctory way.
Alone on the basis of having a member from each of the twenty-seven
EU member states,18 the EMCA draft ing commission will incorporate
experience from all the legal traditions found in the European Union
within its comparative study and draft a model act that takes this
experience into account. Th is should be of use not only for the smaller
member states – which are often pressed to staff and dispatch a team
of legal experts for the draft ing of such measures – when it comes time
to consider adopting the EMCA. In addition, it may be hoped that
national legislatures, including those of the larger member states, will
hesitate before evoking national particularities in order to deviate from

17
Regarding the type of corporations that should be regulated by the EMCA, see infra
Part IV.A.
18
See infra Part IV.B.
12 Perspectiv es in compa n y l aw

the European ‘benchmark’ when faced with a model act that has been
specifically designed for uniform use throughout the Union. Lastly, a
provision of national law that restricts freedom of establishment will
likely be scrutinized even more strictly when it is not compatible with a
model act that has been designed and adopted by all member states.
In addition to the advantages discussed above, the development of
a model companies act fits nicely within the current legislative plan
of the European Commission, see also Part II.2, above. On the one
hand, the Commission is currently examining the existing EU norms
in the area of company law for possible simplification and deregula-
tion, where this is possible and meaningful.19 A model act that could
replace the imperative command of a directive or regulation with an
informed recommendation to the member states could prove a work-
able alternative to the current EU regulatory mix. On the other hand,
by developing genuinely European forms for business organization
(SE, SCE, EEIG, and, probably, the EPC) the European Commission is
also trying to enrich the assortment of available options for users. For
this reason as well, the Commission sees with interest and favour the
attempt to develop a model company form on the basis of a thorough
comparative analysis that can – unlike existing supranational com-
pany forms – operate largely independently from references to other
national laws. The next part of this article will discuss the US experi-
ence with model laws.

III. Model acts in the United States

Comparative analyses often refer to the work of the National
Conference of Commissioners on Uniform State Laws (NCCUSL)
in the United States20 as an example of unifying law through the

19
See in this regard the reports by Baums, ‘European Company Law beyond the 2003 Action
Plan’, (note 11, above), 143–160; and D. Weber-Rey, ‘Effects of the Better Regulation
Approach on European Company Law and Corporate Governance’ European Company
and Financial Law Review, 3 (2007), 370, 374 et seq.
20
For a general discussion see K. Zweigert and H. Kötz, An Introduction to Comparative
Law, third edition (Oxford: Clarendon, 1998), § 17.III; specifically on company law
see R. Romano, The Genius of American Corporate Law (Washington: American enter-
prise institute for public policy research, 1993), 128 et seq.; J. von Hein, ‘Competitive
Company Law: Comparisons with the USA’, in U. Bernitz (ed.), Modern Company Law
for a European Economy – Ways and Means, (Stockholm: Norstedts Juridik Förlag,
2006), 25 et seq.
 The Eu ropea n Model Compa n y Act Project 13

formulation of recommendations at a central source in spite of leg-

islative competence remaining lodged with decentralized, individual
states. For the purposes of this paper, a brief sketch of the US experi-
ence should suffice. 21 The EMCA drafting commission will seek to
benefit from the experience gained in the United States by bringing in
a US legal expert as a consultant.
US attempts to draft a corporation statute to unify the laws of the
individual US states date back to the 1920s. The NCCUSL completed
a Uniform Business Corporation Act (UBCA) in 1928. The UBCA was
conceived as a uniform act governing all corporations, and was to be
uniformly adopted in identical form without change by the states.
However, the UBCA was not a success (it was adopted by only a few
small states, such as Louisiana, Washington, and Kentucky) and in 1943
the NCCUSL changed its status into the more flexible form of a model
act, although this did not bring about an improvement in its fortunes
and the Act was withdrawn in 1958. During this period, the American
Bar Association (ABA) had independently set out to develop its own
‘Model Business Corporation Act’ (MBCA), which it released in 1946,
and it eventually took over the NCCUSL’s project, which has since that
time been carried forward by the ABA’s Committee on Corporate Laws
of its Section on Corporation, Banking, and Business Law.22 In contrast
to the UBCA, the MBCA has been a great success and has been adopted
by the majority of US states and has served as a resource of company
law doctrine for state legislatures and courts.23 The MBCA was thor-
oughly revised in 1984, and released as the ‘Revised Model Business
Corporation Act (RMBCA).24 The Model Business Corporation Act is

21
For a more detailed discussion, see R.W. Hamilton, ‘The Revised Model Business
Corporation Act: Comment and Observation. Reflections of a Reporter’, Texas Law
Review, 63(1985), 1455; J. Macey, Macey on Corporation Laws (Aspen Publishers, 2002),
Introduction.
22
See Hamilton, ‘The Revised Model Business Corporation Act’, (note 21, above), 1457.
23
See R. A. Booth, ‘Model Business Corporation Act – 50th Anniversary’, Bus. Law., 56
(2000), 63. The article discusses statistics proving that the MBCA has been remarka-
bly influential not only for state statutes, but also for court decisions. The Act has also
been cited or discussed in numerous law review articles. See also J. A. Barnett et al., ‘The
MBCA and state corporation law – a tabular comparison of selected financial provi-
sions’, Bus. Law., 56 (2000), 69. In US law schools corporate courses are usually based
on the Model Act, often combined with, e.g., the Delaware General Corporation Law.
Similar developments could arise in the EU with respect to EMCA/national law.
24
Reprinted in M. A. Eisenberg, Corporations and Other Business Associations. Statutes,
Rules, Materials, and Forms (New York: Foundation Press, 2007), 677.
14 Perspectiv es in compa n y l aw

revised every year, and proposed revisions are published in the ABA’s
Business Lawyer magazine.
The basic entity intended to be created under the RMBCA is a publicly
held corporation. To this end, the RMBCA is accompanied by a Model
Statutory Close Corporation Supplement, which was first released in
1982. Beginning in the 1990s, however, small entrepreneurs came for tax
and other reasons to favour the Limited Liability Company (LLC), and all
of the fift y US states now have some form of LLC statute. The NCCUSL
published a ‘Uniform Limited Liability Company Act’ in 1995, and this
model was revised in 2006.25
In addition to these model acts, the American Law Institute’s
‘Principles of Corporate Governance’, which were first released in 1994,
have great importance for company law.26 The Principles are not recom-
mendations to the states for possible implementation, but rather restate
leading judicial decisions and scholarship in the field of corporate gov-
ernance, synthesizing best practice behaviour for boards and sharehold-
ers in a form of ‘soft law’.

IV. Individual issues

Here we discuss answers to individual questions that are currently being
raised regarding the EMCA project. The first question, which will be
discussed in Section A, regards the EMCA’s contents, i.e., the defi nition
of the topics and areas that are currently expected to be regulated by
the draft EMCA. The second question, discussed in Section B, is on the
draft ing commission itself, its members, modus operandi and relation to
the European Commission. Lastly, the preliminary plan for draft ing the
Act itself will be discussed in Section C.

A. The content of the EMCA

The draft ing commission will initially occupy itself with public com-
panies limited by shares (Aktiengesellschaft, société anonyme, società
per azioni, etc.), including listed companies. Private limited companies
will be drawn into the project at a later date. This does not imply any

25
Reprinted in Eisenberg, Corporations and Other Business Associations. (note 24, above),
418.
26
American Law Institute, Principles of Corporate Governance: Analysis and
Recommendations, 1994.
 The Eu ropea n Model Compa n y Act Project 15

recommendation that a unified law on business corporations, as exists

in some member states, should be offered.
A further question regards those areas that, through EU directives,
have already largely been harmonized, such as the disclosure of market
relevant information and capital contributions and maintenance. This
existing harmonization and the fact that national legislatures may not
deviate from existing directives in force speaks for the position that the
EMCA should not include proposals deviating from the existing acquis
communautaire. Exceptions may present themselves in cases where
change is being discussed at the EU level, so that a concrete possibility
would exist that member states could legally adopt EMCA provisions
deviating from outgoing EU law.
The stock of norms that are grouped together under the rubric
‘company law’ is defined differently in the various member states.
Functional analysis shows that a number of rules from tort law, civil
procedure, insolvency law, securities regulation, and international
private law (conf lict of laws) can be seen as integral to company law.
A convincing, conceptual distinction between company law and
these overlapping areas can only be achieved through examination of
the individual fact patterns addressed by the provisions, evaluation
of the solutions currently used by member states for such situations,
and formulation of the most appropriate, proposed boundary – irre-
spective of whether this rule would be considered part of company
law in one legislation and part of, e.g., tort law or insolvency law in
another.
A similar method or approach seems to recommend itself for the law
of corporate groups. Legal issues in connection with the domination of
a group of companies, information problems within the group, and the
liability of the dominant company and its management, inter alia, must
all be examined in the respective context. The extent to which a separate
set of legal rules on company groups would be found advisable will then
be a technical question.
Options will have to be preserved for the seating of employee rep-
resentatives on boards and the division of the board into management
and supervisory components for those member states that currently
have co-determination or a two-tier board structure, or may be inter-
ested in adopting one of these governance tools. This would not
exclude the possibility of formulating recommendations in this area,
such as with regard to the size of the supervisory board or the board
of directors.
16 Perspectiv es in compa n y l aw

B. The Drafting Commission

Each of the twenty-seven EU member states is represented by a com-
pany law expert in the draft ing commission.27 Th is Commission is
chaired by Professor Paul Kr üger Andersen of the Aarhus School of
Business, University of Aarhus, and the Group’s secretariat is situated
at that location and headed by Associate Professor Hanne Sønderg ård
Birkmose. The draft ing commission will, as needed, consult experts in
specialized topics for assistance as such questions arise. The EMCA
project is not sponsored by the European Commission, although the
two bodies have agreed to regular exchanges of information, and the
European Commission may dispatch its own people to represent it at
working group meetings.

C. The preliminary working plan

As one would expect, the work on the EMCA will proceed in a number
of individual stages that correspond to the individual chapters of the
Act. Each member of the draft ing commission will prepare a report on
his or her national law to accompany the draft ing of each chapter of
the Act. A general reporter for each chapter will analyse the national
reports and prepare a summary report, setting forth the various solu-
tions and making recommendations, which the draft ing commission
will then discuss, supplement and adopt. It is expected that there will
be plenary meetings every six months. The proposals, i.e., the recom-
mended provisions with explanatory comments and references to
national rules, will be published chapter by chapter so that the entire
academic and business community can take part in the process of
developing the EMCA.
Chapters currently in progress are the rather technical provisions
for the formation of companies (whether through incorporation or
reorganization) and the central chapter on ‘directors’ duties’, the
drafting of which is an exploration of whether a common position can

27
As of January 2008, the following persons comprise the Commission: Susanne Kalss
(AT); Hans de Wulf (BE); Alexander Belohlávek (CZ); Theodor Baums (DE); Paul Krüger
Andersen (DK; Chair); Juan Sanchez-Calero (ES); Matti Sillanpää (FI); Isabelle Urbain-
Parleani (FR); Evanghelos Perakis (GR); András Kisfaludi (HU); Blanaid Clarke (IR); Guido
Ferrarini (IT); André Prüm (LU); Harm-Jan de Kluiver (NL); Stanislaw Soltysinski (PL);
José Engrácia Antunes (PT); Rolf Skog (SE); Maria Patakyova (SK); Paul Davies (UK).
 The Eu ropea n Model Compa n y Act Project 17

indeed be found in this very important but hitherto unharmonized

area.
The difficulties standing in the way of successfully completing this
project are not few and should not be underestimated, but we believe
that the EMCA draft ing commission can overcome such difficulties,
and we also believe that the project will contribute to the efficiency and
competitiveness of European business.
 2

The Societas Privata Europaea: a basic reform of

EU law on business organizations
Theo R a aijmak ers

I. Introduction
It is a great pleasure to contribute to this liber amicorum in honour
of Eddy Wymeersch. His vast and seemingly unlimited interest in
company and securities law offered an equally broad choice of sub-
jects for this article. Working with a team of researchers in Tilburg’s
Center for Company Law on a broader project aiming at revealing
the basic elements and guiding principles of reform of company and
enterprise law, I decided to carve out from this project some observa-
tions on the intended introduction of a statute for European Private
Companies.
The idea for an EPC is not new. Shortly after publication of the fi rst
draft for the SE Statute, Mme Boucourechliev published her ‘Pour une
SARL Européenne’. Together with Drury, Hommelhof inter alia, she
was involved in draft ing a proposal that was published by CREDA/
Medef in 1998. The High Level Group of Company Law Experts reiter-
ated the case for an EPC and the EC in its 2003 Action Plan and gave
it a mid-term priority. In 2006 a consultation document was published
focusing on the scope and nature of an EPC statute: (a) should it be
available to single-owned firms and quasi-partnerships or also to pri-
vate fi rms with ‘dispersed’ ownership?; (b) should the statute be stan-
dalone and exhaustive or – like the SE statute – build on and refer to
national law? Though the responses are somewhat diff use, respond-
ents focus on enhancing start-ups and cross-border activities of SMEs
and almost unanimously plead for contractual freedom and flexibility,
avoidance of complexities for subsidiaries and time-consuming, costly
procedures and formal requirements (like notarization of documents)
as well as for introduction of a stand-alone statute that does not cre-
ate twenty-seven different statutes by referring to national law. The
emphasis is on organization, not on re- organization. Meanwhile the EC

18
 Societas Pr ivata Europaea : basic r efor m of EU l aw 19

announced that it would take further decisions on a Statute (regulation)

for a Societas Privata Europaea (SPE).1
The SPE project should be placed against the background of EU
constitutional law, the Lisboa agenda (2000, as amended), the pre-
vailing case law of the European Court of Jusitce (ECJ), the regula-
tory competition fuelled thereby and the reforms of the law on private
(close) companies as now being scheduled and/or discussed in several
member states. In the perspective of global competition, it is equally
important to assess the regulatory actions in other jurisdictions, more
specifically the Limited Liability Corporation and the Limited Liability
Partnership, since both combine a high degree of contractual free-
dom with limitation of liability. Th is combination seems to cause one
of the main obstacles to reform towards more flexible business forms
for SMEs. Th is article therefore aims to contribute to the forthcoming
debate by an analysis of the combination of contractual and corporate
devices as developed in the LLC using the text of the US Model Act
(ULLCA).
Taking the constitutional aspects first, the annex to the revised Roman
Treaty follows the Social Charter (2000) and proclaims the freedom of
entrepreneurship, the freedom of association (not excluding commer-
cial cooperation) and the protection of property. These constitutional
principles evidently do not prevent the EU nor its member states from
protecting the business community and general public by rules on busi-
ness organizations and their activities in providing goods or services,
but it forces them to respect such limitations and contrast them to the
overall societal objective of enhancing entrepreneurship by means of an
advanced law on business organizations for SMEs and large firms. The
ECJ plays an important role. It held that the freedom of establishment
prevents member states from refusing to recognize (pseudo) foreign
corporations (business organizations, firms) on the mere ground that
these do not meet the protective standards that member states have set
for their national business forms or pseudo-foreign corporations. Such
restrictions by member states and others to prevent clear fraud are not
completely foreclosed but their reach can be challenged before the ECJ.
Its case law allows entrepreneurs to freely select business forms of other
member states – the choice shall in principle be recognized in the case
where registered office and real seat are not located in the same member

1
See: http://ec.europa.eu/internal_market/company/epc/index_en.htm
20 Perspectiv es in compa n y l aw

state. The prohibition of such a ‘split’ in art. 9 of the SE Statute seems to

be obsolete now.
The ECJ case law fuelled a certain degree of regulatory competition
within the EU and an acceleration of reform initiatives for national stat-
utes for close corporations, e.g. the amended French SàS regime and the
Netherlands project to revise the BV statute. Since an SPE Statute would
enlarge the menu of business organizations available to entrepreneurs
in the EU, it would therefore also and per se have a competitive effect
in the selection of business forms. The discussion on the outlines of an
SPE Statute therefore is also relevant for such reforms of national law
on business organizations. Reforms continuously appear to be burden-
some, ‘path dependent’ as they are. The eligibility of close corporations
providing limited liability and the concern to prohibit abuse and fraud
is closely linked to the basic principles of company and partnership law
or – in a wider sense – of the law on business organizations, including
the most common form of sole ownerships. An SPE Statute offers the
challenge to be drafted from scratch, but also at EU level this may be
constrained by the acquis communautaire that effectively fi xes starting
conditions as an EU path of its own and prevents the creation of a com-
petitive business vehicle for European entrepreneurs fitting into and
serving the Lisbon agenda, the constitutional freedoms and the Treaty’s
principles of freedom of establishment and capital.
The Lisbon ambitions urge the development of the law on busi-
ness organizations in the EU and also the SPE project as part thereof
to be placed in the wider context of global regulatory competition and
strengthening the EU common market. Furthering the integration of the
EU common market as well as enhancing entrepreneurship and compet-
itiveness in a globalizing economy, urges benchmarking with develop-
ments outside the EU to enable sharper identification of constraints to, as
well as of, opportunities for change and the impact thereof. Specifically
the development of the very successful Limited Liability Corporation
(LLC) in the US offers such a fresh look to regulatory concepts as being
developed over centuries in different jurisdictions. This modest contri-
bution therefore contrasts the ideas on a possible SPE statute with these
business forms. This article respectfully builds on research dedicated
by many scholars who, I hope, will appreciate that the limited size of
this article caused me to refrain from documenting these sources. Th is
will follow in a more extensive publication anticipated by the Tilburg
research team.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 21

II. Preliminary observations: the need for a European flexible,

cost-effective (corporate) vehicle for entrepreneurs in
small- and medium-size enterprises
Entrepreneurs, whatever the scope of their business activities, usually
start as sole proprietors but may soon be confronted with the need to
select a corporate vehicle from the menu of business organizations to
incorporate their business. Usually they will select a form from the
menu of their home state, but may also select this from another member
state’s menu. If they develop permanent cross-border activities in other
member states they have to decide whether to organize their business
as a separate corporate vehicle (‘sister’, in a horizontal structure held
by themselves), a branch of their home state firm or as a subsidiary. An
SPE Statute should clearly envisage each of these organizational seg-
ments of cross-border activities and the practical need for all SMEs to
organize their cross-border activities as a group of companies: a parent
(SPE or other form) to be selected from the menu of the home or another
member state and one or more subsidiaries in other member states. For
the parent the European label of an SPE may enhance its image in the
business community of other member states, also if cross-border activi-
ties are organized as branches, but less so in case the latter would be
incorporated as ‘local’ SPE subsidiaries. The major concern that seems
to drive the SPE initiative is to facilitate and enhance the organization
of a multi-state business in the EU. The design of the SPE Statute should,
however, clearly reflect that the structure of the European common
market substantially differs from that of other major markets, such as
in the US, China, Russia and India, that allow a simple single business
entity to operate in other states or provinces in their own market. The
EU will remain to consist of different jurisdictions characterized by dif-
ferent languages, cultures, traditions, commercial and societal customs,
financing possibilities for SMEs, private and commercial law, taxation,
insolvency rules and principles, labour relations, customer protection,
environmental and other rules. These differences will in many cases urge
EU entrepreneurs to separately incorporate as a subsidiary their per-
manent business activities in other member states. Thus they typically
will prefer or be de facto forced to organize their multi-state business
as a group of companies. This remains a disadvantage in comparison
with other large multi-state markets where a multi-state business can be
organized as a single entity headquartered in one state (province) and
operating through local branches in other states (provinces). Size does
22 Perspectiv es in compa n y l aw

not make a decisive difference: although the initial and marginal costs
of creating such a structure will be higher for SMEs, these have to be
offset against the continuous costs and management risks of operating
through branches in other jurisdictions.
An SPE Statute therefore should equally serve (the shareholders base
and governance of) a stand-alone SPE as an entity that enshrines incor-
poration of a single-person company, quasi-partnership or family com-
pany, as well as an SPE that (also) operates as the parent of a group of
SPEs (or other entities) and, moreover, looking from the perspective
of a subsidiary SPE in relation to its parent to preserve the coherent
and unified control of the parent over its operational and legal group
structure in its multi-state group strategy and management. Hence
the SPE Statute should explicitly take into account that expectedly an
SPE will often be used to create cross-border subsidiaries, quasi-part-
nerships and joint ventures for cross-border cooperation. The Statute
should envisage the use of an SPE as parent as well as at subsidiary level.
Therefore the eligibility of an SPE should not be limited to multi-state
cases.2 If the ‘European label’ should allow the enhancement of cross-
border marketing and business, also nationals should be able to ben-
efit from the SPE in pursuing cross-border activities. Evidently the plea
for flexibility and contractual freedom equally applies to the use of the
SPE as cross-border subsidiary and as a vehicle for start-ups and quasi
partnerships.
The main deciding elements for the initial selection of a business form
to be considered in designing a flexible SPE Statute remain:
a) to partition the business-related assets and liabilities (enterprise)
from the rest of his private property to enhance separate manage-
ment thereof as a propriety interest under full control of the entre-
preneur, e.g. distinct from matrimonial property and facilitating a
transfer thereof;
b) in cross-border activities: similarly to partition his business abroad
from that in his home country by creating a subsidiary to be party
to all contracts and transactions in the other member state and to
assume all the liabilities thereof;

2
It would require complicated requirements and enforcement rules if the promoter
should be resident in another member state and question the validity of the subsidi-
ary’s SPE form if he would be dissolved or acquire the same nationality as a subsidiary.
Unnecessary set-up of special vehicles to meet requirements of multi-nationality should
be avoided.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 23

c) to manage business activities and fully control strategy, policies and

management by a statutory off-the-peg organization model, which
will be most relevant in case of a cross-border subsidiary to incorpo-
rate a permanent organization of activities in one or more member
states;
d) to insulate entrepreneurial risks and protect non-scope private assets
from bankruptcy of the firm by shielding off liability for its liabilities
(again, also in case of subsidiaries in other member states);
e) to optimize taxation (corporate and personal income tax) under
national law and in cross-border relations;
f) to facilitate financing of the business (equity, loans, credit) and to
attract new business or financial partners by issuing (transferable or
non-transferable) shares or rights thereto (this again relates both to a
parent as to a subsidiary in other member states). In case of creating a
quasi partnership or joint venture decisive factors may be:
(i) flexibility to enter into enforceable agreements with one or
more partners/shareholders (including venture capitalists
and private equity firms) on the internal control and exercise
of formal shareholder rights and obligations within the firm
and
(ii) contractual freedom to arrange for or – alternatively – fall back
on flexible and cost-effective default rules on internal disputes,
sell out, buy out and appraisal.
While these elements focus on the initial selection of a single
business vehicle, the dynamics of business activities urge the pro-
moter/entrepreneur also to consider the possibilities and degree of
flexibility to re- organize the legal organization of the firm and its
activities. Initially the question arises whether a business can be
incorporated as going concern uno actu by operation of law. In the
life cycle of the firm other reorganizations may present themselves
and it should be considered whether and to what the extent the SPE
Statute offers flexible opportunities for, amongst others, extension
of the shareholders base to (new) partners or financiers, conversion
into another business form, merger, split, takeover transaction and
also going public.
An SPE typically would offer the additional advantage of a European
label in cross-border activities. Th is may become more important in
view of the increased multi-cultural character of the EU after the
24 Perspectiv es in compa n y l aw

extension of the EU to – at present – twenty-seven member states with

their different legal traditions and company law.
In the selection from the menu of business organizations (home state
and other member states) the above elements should be balanced against
constraints to full control and costs of incorporation (initial and con-
tinuous) both under national law (parent) as under the law of the other
member states involved:
a) costs of incorporation: procedures, notarization, registration, profes-
sional advice (legal, tax, accountancy);
b) initial and ongoing taxation (as well as possible choice between
income and corporate tax);
c) administrative burdens of formalization of internal procedures (for-
mal division of powers as – single or joint – shareholder(s) and man-
ager; need for formal resolutions, e.g. on instructions/approvals of
shareholders meeting; 12th directive);
d) constrains to control over strategy and management of the parent
and ‘foreign’ subsidiaries respectively;
e) initial and ongoing administrative costs, fees and levies of
registration;
f) costs of disclosure duties and audit services as provided for under the
1st, 4th and 7th EU directive or other statutory requirements; con-
tractual monitoring requirements set by banks or other financiers
(venture capitalists); again, both at the level of the parent and its ‘for-
eign’ subsidiaries;
g) costs of legal and other advice in the ongoing operations and any sub-
sequent internal and external disputes at the level of the parent as
well as of its ‘foreign’ subsidiaries.
Evidently the success of the SPE Statute will largely depend on its abil-
ity to shape an effective group organization consisting of an SPE-parent
that will be in full control of its ‘local’ SPE-subsidiaries.
The EC’s synthesis of the comments on the consultation document on
a possible statute for an EPC3 largely reflects the above elective elements
both implicitly and explicitly. Asset partitioning and limited liability
are apparently assumed, but the responses do not clarify the position on
the ‘price’ in terms of (national or EU) protection of third parties, like
capital protection, statutory disclosure of accounts and audit, liability of
directors and shadow directors or wrongful trading rules.

3
See: http://ec.europa.eu/internal_market/company/epc/index_en.htm
 Societas Pr ivata Europaea : basic r efor m of EU l aw 25

The most remarkable observations are in line with the earlier rec-
ommendations of the High Level Group of Company Law Experts
(November 2003, Ch. VII) and can be summarized as follows:
a) The diversity of company laws and regimes are a significant source
of costs and legal uncertainty. The existing legal framework is insuf-
ficient for cross-border activities. Providing a European label is
regarded to be helpful as a marketing tool in a global environment.
An SPE would allow significant costs savings by using the same legal
form across the EU;
b) The SPE statute should be as open as possible and offer maximum
flexibility. Even though a majority would still support a single
shareholder SPE, most consider that the SPE should be open to
single and multiple shareholders (legal and natural persons alike)
and be allowed to have headquarters and registered office in dif-
ferent member states. A single shareholder model, however, would
allow for a more simple and uniform SPE statute. A majority clearly
favours a stand-alone and exhaustive SPE statute without reference
to national law to provide for a set of unambiguous rules, prevent
high legal costs and the emergence of twenty-seven different rather
than one single EPC. Th is would be the real added value of the
statute.
c) In a single shareholders SPE statute more matters could be left to
the articles of association than in a multiple SPE; many matters per-
taining to the management of an SPE should be left to contractual
freedom.
d) Respondents’ reactions were split on the issue of employee participa-
tion regimes, some opting for uniform rules and others believing that
opting for the rules applicable in the member state where the SPE has
its seat would be the only feasible solution.
Since the Lisboa ambitions, as rephrased, are formulated in a glo-
bal, rather than internal European perspective, we should compare
with developments in other important jurisdictions. Since the aims for-
mulated by the EC to consider an SPE Statute evidently closely resem-
bles those that lead to the introduction of the very successful business
organizations of the LLC and LLP in the US and other jurisdictions,
a closer comparative analysis of these regulatory innovations seems
highly relevant for the design of a brand new SPE as a European busi-
ness organization. These business forms offer starters and entrepre-
neurs a flexible business form in a start-up to incorporate their business
26 Perspectiv es in compa n y l aw

activities. The check-the-box rules allow a choice between corporate and

income taxation.

III. Overall regulatory approach by the EU and

starting conditions
The preamble of the EPC Statute should clearly lay down the legal basis
for the nature of the Statute and its purpose in the socio-economic frame-
work of our societies as reflected in the European Treaty for Human
Rights, the Roman Treaty (as amended), the Social Charter (2000) and
the Lisbon statements. Freedom of enterprise and association and protec-
tion of property shall be respected and undue state interference shall be
avoided. Similarly the freedom of establishment (and recognition of pseu-
do-foreign corporations) as established by the ECJ in Centros, Überseering
and Inspire Art shall be reflected. These basic concepts and policies should
guide EU regulatory action to enhance entrepreneurship and private ini-
tiative as indispensable generators of wealth and innovation. The design of
the Statute should strengthen the competitiveness of the EU business cli-
mate and environment in the global competition. Present but sometimes
ineffective concepts to prevent and sanction abuse and fraud should be
reconsidered in close connection with insolvency law since the ultimate
test of such corporate behaviour emerges practically always in bankruptcy/
insolvency. Capitis deminutio and mort civile may have been abolished
but lifelong stigmatization replaced these sanctions and the approach of a
‘fresh start’ after insolvency is not common in Europe.
The constitutional starting points and freedoms can be summarized
as follows:
a) the basic constitutional freedom of entrepreneurship as the autonomy
of persons (citizens) to become and operate as an entrepreneur by
starting, organizing, financing and operating a business under own
control and discretion, accrue and receive earnings (salary and prof-
its) therefrom and create value on top of the net asset value, which
can be disposed of as a propriety interest by sale to third parties, by
will or otherwise;
b) the constitutional freedom to associate with others (entrepreneurs
and/or fi nanciers) to pursue a joint enterprise by contract, partner-
ship or any other form of joint ownership and association, and to
share propriety interests (control, earnings and the accrued value of
the joint firm);
 Societas Pr ivata Europaea : basic r efor m of EU l aw 27

c) the freedom to select without state intervention (or concession)

any business form available within their own or any other (EU)
jurisdiction;
d) the freedom to re-incorporate a business in another EU jurisdiction;
e) the freedom to organize the ‘internal affairs’ of the business organiza-
tion as they think fit for their firm and resolve on matters concerning
the firm upon the agreed upon scheme;
f) the freedom to reorganize the firm’s business form and/or the mem-
bers relationship thereto by changing its internal affairs, merger, split,
conversion or any other such mechanism, including going public by
issuing (tradable) securities in the market;
g) the freedom to dissolve the firm with or without continuation of the
business.
These basic freedoms are guiding principles in our free market econ-
omy based on liberal democracy. On the other hand the general and pub-
lic interest of our complex societies urges proper regulation of amongst
others economic activities of entrepreneurs. They have to pay direct and
indirect taxes, observe strict quality and safety standards in manufac-
turing and sale of products and services under public oversight, e.g. pro-
duction/sale of food and drugs, banking, insurance, traffic, all kinds of
professionals services, environmental risks. Regulators thus discharge
their public tasks with respect to much more: care for personal health,
quality of drinking water, food, medical and other professional care,
personal and general safety and security, prevention and reduction of
environmental risks et cetera.
However, such rules on market activities of entrepreneurs should
be sharply distinguished from those on the organization of their busi-
ness form as such, i.e. the law on business organizations. It is here that
we encounter (diverging) historical roots that until today do influence
our concepts and – often unveiled – assumptions. Free entrepreneur-
ship was restricted by the medieval guilds, that were abolished in/after
the French Revolution. Today membership of professional organiza-
tions is required for certain regulated professions only. Restrictions to
free association did occur throughout history and recognition of asso-
ciations as legal persons in The Netherlands required until 1976 Royal
Approval which regularly was withheld. Cooperative associations were
long distrusted for their ‘political’ aims. In commercial law over time
contractual joint enterprises developed for cooperation between entre-
preneurs and/or fi nanciers in the form of (limited) partnerships giving
28 Perspectiv es in compa n y l aw

the (general) partners joint control and ownership and limited liability
to ‘silent’ partners. Companies emerged as continuous partnerships with
fi xed capital divided in (tradable) shares and limited liability for the
holders thereof. The Dutch East Indian Company (1602), created by Act
of Parliament, received a concession to trade ‘with the East’ to act ‘in the
common wealth’ under public oversight. Only after more than a century
such a concession was gradually replaced by ‘free covenant’: promoters
themselves without such approval could create a company-legal person,
but the Napoleonic codification re-introduced a moderated form of state
approval (non-objection). In the UK the South Sea Bubble caused par-
liament (in 1720) to ban public companies altogether, which remained
effective until 1840. German ‘Konzessionszwang’ and public interest
objectives were replaced in the 1892 Aktiengesetz by a set of detailed
mandatory substantive rules (‘materielle Normativbestimmungen’) to
protect shareholders, creditors and others. While the flexible and sober
Netherlands statute also allowed the NV to be tailored for flexible closely
held NVs, Germany created next to its strict AG statute a separate ‘light’
contract-based GmbH statute, which was copied in many countries.
In The Netherlands such a separate BV form was only introduced as late
as 1971 to avoid mandatory disclosure of accounts for closely held NVs
as still allowed by the 1st EU directive.4 The statute was copy pasted from
4
Until 1976 company and partnership law were integrated in the Commercial Code (no
separate form for private companies). ‘Public’ companies were ‘corporate species’ of part-
nership, essentially based – at least its internal organization – on contract, albeit that a
notarization and a ministerial decree of non-objection were required (public oversight).
The statute was very flexible and at the start of the EU The Netherlands were feared to
become the Delaware of Europe. In 1971 the BV, i.e. the ‘close’ corporation, was intro-
duced to enable privately held companies to be exempted from the duty of the 1st Directive
to disclose audited annual accounts. Its statute was, however, copy-pasted from the then
modernized and institutionalized NV with employee participation for ‘large’ companies.
NV and (!) BV were disconnected from partnership law and enacted in Book 2 Civil Code
under the heading Legal Persons (together with public entities, churches, associations,
cooperatives and foundations) and with overall general rules. Hence, until today, even
single-owned BVs and quasi-partnership BVs are characterized as ‘institute’ and legal
person in the first place. The original notion of contract is absent, but a broad rule estab-
lishes that all directly related parties should observe rules of equity. Anti-abuse provisions
against acts contravening the ‘own interest of the company’ have been piled up in com-
pany law (minimum capital, capital protection, disclosure of accounts, directors’ liability
for non-compliance with disclosure duties also in bankruptcy, the duty to properly resolve
and record resolutions in case of related party transactions and conflicts of interest also
in one-man companies). Case law shows that non-observance of company law rules are
used by receivers to hold directors and shadow directors liable in bankruptcy. The pend-
ing Bill to reform the BV deletes some rules on minimum capital and capital protection,
but leaves many others in place and adds a new solvency test in case of distributions.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 29

the NV statute and hence the BV inherited the influx of the stakeholders
approach that characterized the amended 1970 NV statute.
The ‘Rheinland’ (stakeholders) model is well known from the
debate on the governance of public issuers. It regards companies as an
institution with a variety of stakeholders and interested parties, rather
than as an instrument of entrepreneurs and/or shareholders. Creditors
should be protected not only by means of general private law and spe-
cific insolvency law provisions, but also by company law itself (inter alia
protection of capital, rules on external liability of directors and disclosure
of annual accounts to allow assessment of the solvency of the company
as – potential – debtor). After World War II, Germany and various other
countries introduced rules on participation and co-determination of
employees (not only at shop floor, but also at board level).
Thus close companies became a derivative of ‘public’ companies rather
than of contractual ‘partnership’ or of sole ownershipship. So the stake-
holders concept over time influenced close companies as well, including
schemes of participation of employees. Creation of close companies as legal
persons providing limited liability to shareholders in The Netherlands
until recently required a ministerial declaration of ‘non objection’ and it is
still subject to notarization. The latter requirement will be even extended
to partnerships that elect to be ‘legal person’ (a status that thus be attrib-
uted rather than recognized). Moreover the close company law statute
over time has been filled with strict mandatory rules to prevent abuse
and fraud, not the least to protect collection of taxes. Further, companies
regulation follows the regulatory concept of ‘associations’ of capital pro-
viders (universitas personarum) rather than that of contractual coopera-
tion (societas) between entrepreneurs and financiers or a universitas iuris
with particular beneficial interests (incorporation of sole ownership).
The ‘institutional’ concept of companies shifts regulatory concern to the
variety of stakeholders and mandatory rules to protect their interests.
Applied to ‘private’ businesses it constrains their contractual character.
The regulatory claim of this legislative approach necessarily tends to a
closed shop (numerus clausus) of business organizations with mandatory

Co-determination for large BVs will not be changed. The Explanatory Notes to the Bill
specifically state that the ‘institutional’ character of (also) the BV remains the guiding
principle for reform. No contract, no split between memorandum of incorporation and
articles of association, shareholders agreements remain non corporate contracts, still
quasi-NV rather than quasi-partnership, mandatory law. Faced with requests to con-
sider a Netherlands LCC and LLP the Minister of Justice recently responded in the same
way. It illustrates the importance of going back to basics.
30 Perspectiv es in compa n y l aw

regulations, resulting in restrictions to the menu of possible reorgani-

zations (conversions, mergers, splits, transfer etc.). The recent ECJ deci-
sions (Centros, Uberseering, Inspire Art and Sevic) does however breach
such ban.
Thus the statutory concepts and objectives for different ‘legal
persons’–business organizations – raises the basic question whether
these forms are instrumental to the entrepreneur or rather institutional.
This is not a soft, philosophical issue, but one that is highly relevant to
guide regulation on a number of issues. Prevailing answers indeed form
part, also in reform debates in member countries, of path-dependent
directions and should therefore be unveiled. Th is is also true for the
present debate on the SPE Statute.
Netherlands company law is framed in a broad regulation of ‘legal
persons’, disconnected from partnership and commercial law. Also
other jurisdictions do not have a coherent statute for business organiza-
tions but rather a dispersed variety of codes and statutes. Belgium and
Austria did recently integrate their regulation.5
Overlooking EU company law the picture is not different. To achieve one
common market the Roman Treaty established the freedom of establish-
ment (arts. 42–49). Cross-border corporate mobility was hardly existent
and regulatory competition restricted by the aim to harmonize corporate
law (art. 44(g)) which reflects a broad ‘institutional’ and ‘stakeholders’
concept of companies/entities/legal persons (art. 48–2 and art. 44(g)).
The 1st (and for branches: the 11th) directive created a EU-style corporate
disclosure system to facilitate access to basic data of ‘companies’: instrument
of constitution (incorporation) and amendments, (powers of) managers,
subscribed and authorized capital and annual accounts as required by the
4th and 7th Directive (audited single and consolidated accounts). Initially
‘private’ companies were exempted, but were later included by extending
their scope. The 2nd Directive introduced mandatory rules on protection and
maintenance of capital and assets (minimum capital, evaluation and audit
of contribution in kind, mandatory reserves, limits to distributions of profit
and reserves; some member countries extended these rules to ‘private’ com-
panies to prevent fraud and abuses of limited liability. The 4th and 7th direc-
tive require all companies (incl. private and one-man corporations; see 12th
Directive) to draft single and consolidated annual accounts (balance sheet,
P&L account and management report) in accordance with its standards,

5
Belgian Wetboek van Vennootschappen and Austrian Unternehmensgesetzbuch
(2007).
 Societas Pr ivata Europaea : basic r efor m of EU l aw 31

statutory audit and disclosure (filing with the commercial register/registrar).

They thus typically reflect an institutional (stakeholder- rather than share-
holder-oriented) approach. Specific disclosure rules are applicable in case
of changes of capital and other incidental corporate reorganizations: (cross-
border) legal mergers and splits (3rd, 6th and 10th Directive). The system
focus at disclosure of accounts (and specific reports) to serve the public at
large. The draft 5th Directive intended to harmonize corporate governance
of ‘large’ formal public companies: board structure, co-determination, divi-
sion of powers between management, non executive directors and GMS
and other governance issues, but no agreement was reached on the choice
between shareholder and employee orientation. The 9th Directive on the law
on groups of companies,6 inter alia providing for a special report on related
party transactions between parent and a public type subsidiary, did not even
reach the status of an official draft. Most of the scope and subject matters
of the directives and regulations focus on the type of public companies and
issuers. The directives are implemented into national corporate law, some-
times with voluntary extension to close and pseudo-foreign corporations.
The EU did not itself develop a clear concept of, nor a coherent statute
for, private companies or partnerships (the EEIG resembles both part-
nerships and (cooperative) associations). It allows the EU to make a fresh
start, deviate from and set aside the ‘acquis communautaire’ that largely
originated as a top-down (from large enterprises to SMEs) rather than as
bottom-up design, i.e. starting with small and medium-sized enterprises
and building on such rules towards larger and big firms. The present EU
company law in fact is very dispersed in concept as well as in substance.
It reveals the opportunity to create a new, flexible and innovative SPE
that avoids the petrification of existing EU company law.7

6
Th is subject was covered in paras. 291–328 of the new Aktiengesetz (1965) and was copied
into the first drafts for the SE Statute (Title VII of the 1970 draft). The text of the provi-
sional draft for a directive was published in M. Lutter, Europäisches Unternehmensrecht,
Sonderheft Zeitschrift für Unternehmens- und Gesellschaftsrecht (1991), 279–289.
7
The societal and, hence, legal extension of the concepts of entrepreneur and enterprise
caused a gradual linkage of traditional private and classical commercial law regulation.
The basic ‘entity’, the sole ownership, in which the entrepreneur ‘owns’ his enterprise
and acts as party to all contracts and transactions, is not generally but only incidentally
addressed (e.g. EU Directive protection of employees in case of transfer of business).
‘Civil’ and commercial partnerships may be regulated in civil and commercial codes
and/or in separate statutes, sometimes as specimen of joint ownership, sometimes as
specific contracts and yet in other times as separate entities. Similarly corporate busi-
ness organizations are sometimes linked to ‘associations’, sometimes to partnership or
to trustlike devices or simply to artificial persons (e.g. Book 2 DCC), each time – though
not necessarily exclusively – addressee of all assets and liabilities.
32 Perspectiv es in compa n y l aw

The overriding question for the SPE statute – and more generally for
the development of the EU and national law on business organizations –
appears to be how it can contribute to enhancing economic and innova-
tive strength of EU enterprises in the rapidly changing global economy.
At the level of regulatory design an equally relevant question is how in
this changing reality of our EU market and society the primary freedoms
and proprietary interests of entrepreneurs shall be respected and bal-
anced against the interests (an appropriate protection) of other interested
parties. The most promising approach seems to be to think bottom-up
or – as was the device in the UK – to think small first.
Entrepreneurship should be enhanced, its imminent entrepre-
neurial risks should be acknowledged and divided properly, acquired
and accrued value in business should be properly protected as a pro-
priety interest, creditor self-help should in business be the lead theme,
not accumulation of statutory protective rules that are ineffective and
burdensome.
If these elements are taken as starting points for drafting the statute it
allows a sharper view on where and to what extent such specific corporate
law protection should be provided for. It would also urge a reassessment
of concepts and substantive rules of prevailing EU company law direc-
tives and regulations to allow a fresh view on the regulatory function
and border zones between company and insolvency law. Taking another
route may result in piling up or even cherry picking rules without assess-
ing their ratio and effectiveness. Protection of associates, members and
third parties should be based on contractual freedom to agree on the
‘internal affairs’ between them as associates, not as anonymous inves-
tors. General private law (contract and property) should be tested on
their ability to cope with fraud and abuse of the corporate device, e.g.
by distributing funds causing the company to become unable to pay its
tax and other bills without recourse for creditors in bankruptcy. It urges
to seek borderline solutions between strict company law and general
private and insolvency law (like the actio Pauliana). Prevailing regula-
tions should be meticulously assessed (e.g. asset and capital protection,
disclosure of accounts, statutory audits, mandatory division of powers,
general and specific (insolvency law) liability of directors and shadow
directors, derivative or direct actions of creditors and other enforcement
mechanisms. At least in the Netherlands case law reveals that receivers
in bankruptcy did (successfully) attempt to construe directors’ liability
on alleged non-observance of internal company law rules.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 33

IV. Basic issues to be addressed in the SPE Statute

Thinking bottom-up – like the ULLCA did – would cause the basis for the
SPE Statute to be the freedom of enterprise and contract and the protec-
tion of propriety interests to enshrine the economic and legal organiza-
tion of single-owned enterprises (incl. subsidiaries), quasi-partnership,
firms financed with venture capital and family holdings with ‘dispersed’
ownership. The Statute should focus on minimum mandatory require-
ments and provide as well – in one form or another – off-the-peg models
and solutions (default rules) for different, also more complicated firms
like family holdings. It should allow partnership-like patterns for coop-
eration between business partners and tailor-made fi nancing by venture
capitalists and merchant banks. It should be apt to become a stand-
ard form in its own right. State concessions and similar requirements
(‘birth control’) should be avoided and formal requirements (notariza-
tion) be minimized. Regulation of internal affairs (to protect sharehold-
ers) should be left to contractual freedom of promoters/partners and
shareholders. In view of the many single-person companies and quasi-
partnerships the statute should not be overloaded with superfluous rules
that de facto address patterns with a multitude of ‘outside’ shareholders.
The SPE should be recognized as a legal person the internal affairs of
which are regulated by contract. The ‘owners’ of an SPE (shareholders)
will have limited liability. Protection of employees, creditors and other
interested third parties should be addressed primarily by non-corporate
law rules, like contract and labour law, that can provide more effective
and tailor-made tools for the protection of their interests. Tort victims
are usually not specifically protected by the law on business organiza-
tions. (Future) Creditors should be more clearly confi ned to the principle
of creditor self-help. Trust is indispensable in the business community,
but should not be – at least not primarily and exclusively – be gained by a
multitude of detailed and complicated statutory rules that later may and
often do appear to be costly but ineffective.

A. The character of the SPE Statute

The choice for an SPE from the available menu(s) of business organiza-
tions should offer a reliable, cost effective business organization. The SPE
Statute should therefore be drafted – in contrast to the SE Statute – as a
real stand-alone statute. A Regulation would provide the proper instru-
ment. It should be comprehensive and exhaustive, i.e. without references
34 Perspectiv es in compa n y l aw

to national law to fi ll gaps and without additional national requirements.

Disputes are to be resolved by applying the rules of the statute in accord-
ance with their ratio. Official comments should offer guidance. Ultimate
interpretative questions will be submitted to the ECJ. Arbitration and
mediation should be recognized as appropriate means which partners or
shareholders can freely select to resolve their disputes. To prevent petri-
fication of the Statute an official experts committee should be appointed
to monitor practice and advise the EC on amendments or additions that
may become necessary or desirable.

1. The character of the SPE

The focus on SMEs implies a bottom-up approach. Hence the SPE should
be instrumental rather than institutional to enable and facilitate incor-
poration of small and medium-size sole ownerships, partnerships, fam-
ily holdings and venture capital financed firms. The SPE should not be
designed as a derivative of ‘public’ companies, but rather build on the
contractual and proprietary concepts of partnership and sole ownership
(see S. 202 ULLCA). Complicated internal governance and shareholder
protection rules for public type companies should be avoided. The SPE
should offer a simplified company form which is recognized as a sepa-
rate legal entity (see S. 112, 201 and 501 ULLCA), grant limited liability
to its owner(s)/shareholder(s) (see S. 303 ULLCA) and allows contractual
freedom to organize its internal affairs. To prevent uncertainty and legal
costs the Statute should provide for proper default rules and attach vari-
ous off-the-peg models for the internal organization. Transfer of shares
need not be excluded; the main rules can be adapted to those applicable
in partnership law.
To enable the reality of SPE-patterns to be reflected the Statute should
enable an SPE to be structured as ‘shareholders managed ’ or as ‘manage-
ment managed ’ corporations.

2. Eligibility of an SPE
Perhaps the major advantage of an SPE in the enlarged and culturally
diversified EU will be its European label, particularly in cross-border
business activities developed from the home state. A requirement of
being ‘international’ (or – like an SE – to be created by promoters from
different member states) would unnecessarily limit the eligibility of
the SPE. Promoters should not be forced to create artificial, ‘formal’
cross-border structures. An SPE should rather be eligible for every
EU citizen-entrepreneur or firm, irrespective of the nature of their
 Societas Pr ivata Europaea : basic r efor m of EU l aw 35

activities: merchants (Kaufleute), providers of professional services

(lawyers, auditors, docters), securities industry, farmers and others,
including existing companies or other entities (also other than an SPE). A
plurality of promoters will not be required (12th Directive). Limitations
to the objects and operations like art. 3 of the EEIG Regulation should be
avoided (S. 112 ULLCA).

B. The creation of an SPE

An SPE should be created by signing a memorandum of incorporation
and fi ling that memorandum with the Commercial register (Registrar
or similar national agency) which fi ling will vest legal personality (see
S. 202 and 205–7 ULLCA and art. 1 EEIG). The Statute should – like
the EEIG Statute – provide its own rules without reference to the 1st
Directive. The creation will not be subject to any (form of) state consent
or approval, nor quasi-public oversight like notarization of documents.
Registration of the memorandum will inform and protect the business
community and disclose its existence, scope, whether it is shareholder
managed or management managed, the identity of the promoter(s),
the power of managers – or in case of a shareholder-managed SPE, of
shareholders to represent the SPE (see S. 202/203 and 301 ULLCA). The
contractual internal organization and division of powers need not be
disclosed. An SPE may also be created by conversion of existing corpo-
rate entities and partnerships without limitation to ‘companies’ as meant
in art. 1 of the 1st Directive (as suggested in art. 5 EPC) and by a ‘going
concern’ contribution in kind of a sole ownership (transfer by operation
of law and therefore a quasi-conversion).

1. Capital and shares

The capital of the company will be divided in shares and the rights
attached thereto will be laid down in the agreement between promot-
ers. Shares may vary in terms of nominal value, control, income and
value. Whether shares are transferable or may be pledged will depend
on the operation agreement. The ULLCA takes another approach and
explicitly provides that members are not co-owners of nor have a trans-
ferable interest in an LLC’s property. It avoids the qualification ‘share’
and uses the term ‘transferable interest’ distinct from any (further)
rights members in the organization of an LLC. Only that transferable
interest may be transferred and the transferee consequently will not be
a member (S. 501–3 ULLCA). That transferable interest may be pledged
36 Perspectiv es in compa n y l aw

or be the subject of a lien ordered by the court. In case of dissociation of

a member in a continuing LLC only this interest will be purchased by
the LLC against its value as agreed upon or fi xed by the court (see 504,
602–3, 701 and 702 ULLCA).

2. Contribution
The SPE rules on contribution shall not be governed by the 2nd Directive
and no minimum capital will be required. They should rather focus on
partnership like rules and hence allow movable and immovable assets,
money, but also services of any kind to be contributed (S. 401 ULLCA).
The obligation to contribute will be governed by the agreement and be
enforceable on behalf of the company (derivatively) by every sharehold-
er-promoter and – in case he relied upon the obligation to contribute – a
creditor (see S. 402 ULLCA). Since SMEs very often start as sole owner-
ships, contribution is in kind as a ‘going concern’ by operation of law and
thus preserving its ‘identity’.

C. Internal organization
The Statute’s rules on internal organization should offer both the free-
dom to members to lay down such rules by (operating) agreement, off-
the-peg choices and default rules. To reflect and follow the reality of
single-owned companies, quasi-partnerships, subsidiaries and family-
owned structures the Statute should follow the ULLCA example and
allow SPEs to be organized both as a shareholder-managed SPE and as
a management-managed SPE. The latter could serve cases with a wider
circle of shareholders or delegated organizational structures. Mandatory
provisions on the creation of and the division of powers between bodies
corporate become obsolete; default rules on the consequences of such a
choice do not. Because the choice directly affects the authority of mem-
bers/managers to represent the SPE the choice should be disclosed in the
memorandum of incorporation. An operating agreement regulates the
affairs of the EPC and the conduct of its business and governs the rela-
tions among its members, managers and the company. It should include
the following elements.
A member-managed SPE would effectively operate as a quasi part-
nership with each member having power to represent the SPE in its nor-
mal course of business, but also – as ‘partner’ – to be accountable to his
fellow members and to observe duties of care and loyalty vis-à-vis the
SPE (S. 103 and 404 ULLCA). Therefore the operating agreement cannot
 Societas Pr ivata Europaea : basic r efor m of EU l aw 37

unreasonably withhold information and inspection rights of members,

duties of loyalty and care, eliminate obligations of good faith and fair
dealing, vary the right to expel members in specified events or to wind
up an SPE, as specified. It may specify the procedure to be observed
in case of conflicts of interest (S. 103 ULLCA). Each member is agent
of the SPE for the purpose of its business. He binds the SPE unless the
third party with whom he was dealing knew or had notice of the lack of
authority. In case of acts outside the ordinary course of business will be
binding only if all other members did authorize such act. The SPE will be
bound by wrongful acts in the ordinary course of the SPE’s business (S.
301–302 ULLCA). Liability solely by reason of being or acting as mem-
ber (or manager) is excluded. Members may by consent and disclosure
assume liability for the debts of an EPC (S. 303 ULLCA).
With respect to the management each member would have equal
rights and, unless otherwise provided, matters relating to the business of
the SPE could be decided by majority vote (S. 404 ULLCA).
Each member shall properly account for his management to the com-
pany and its members. Each member has the right to be informed and
access to the records of the company (S. 408 ULLCA). The 4th and 7th
Directives would not be applicable to the SPE. Public disclosure would
be limited to the memorandum of incorporation, irrespective specific
information duties to tax authorities and other public agencies or con-
tractual rights of financiers or other third parties.
Fiduciary duties of members in a member-managed SPE would be
limited to the following duties of loyalty: to account to the SPE and hold
as trustee assets and business opportunities; to refrain from self-dealing
in case of a conflict of interest; refrain from competition with the SPE.
Duties of care would be limited to refraining from engaging in grossly
negligent or reckless conduct, intentional misconduct or a knowing vio-
lation of law. His assignment should be exercised with the obligation of
good faith and fair dealing. These duties are not violated merely because
the member’s conduct furthers his own interest (S. 409 ULLCA).8
In a management-managed SPE managers will be elected by (a major-
ity of) the members. The rules on binding the SPE would follow muta-
tis mutandis for a member-managed company and the same would be
the case for the management-managed company. Management would
exclusively decide on any matter related to the business; major matters

8
See for the position of a member-non-manager in member-managed company: S. 409 (g)
ULLLCA.
38 Perspectiv es in compa n y l aw

concerning the organization of the EPC would require approval by the

members (S. 404 ULLCA).
Payments made by members made in the ordinary course of the
business will be reimbursed and indemnified for any liability so incurred
(S. 403 ULLCA). Accounting and information to the company and its
members follow mutatis mutandis the rules for a member-managed SPE.

D. The limits of limited liability

The limits of limited liability are a delicate and heavily ‘path depend-
ent’ topic since regulators – also at EU level – over time have designed a
series of general and detailed rules to prevent and sanction abuse of lim-
ited liability (and non-liability of directors) by mandatory company and
also private or insolvency law provisions. In draft ing a ‘light’ SPE Statute
a fresh analysis is needed of the relationship between recognition/grant
of corporate personality as such, the conditions for limited liability, the
allocation of the per se existing entrepreneurial risks between entrepre-
neur and third parties, the ability of the latter to protect their risks by
contract (banks, suppliers/customers, tax collectors) and the entrepre-
neurial assignment of managers. Prevention of fraud and criminal use
of the corporate device (e.g. for laundering) should be addressed sepa-
rately in the context of crime prevention and penal sanctions.
The EU 2nd Directive for ‘public’ companies aims to protect the com-
pany’s capital by a series of detailed and complicated rules (which were
extended by some member states to ‘close’ companies). Non-observance
of internal organization rules (often copied from public company stat-
utes) have sometimes been interpreted as to cope with agency problems
in close corporations as well and hence be extended (derivatively, by
tort law or otherwise) to protection of third parties, thus blurring bor-
der lines between (internal) corporate and insolvency law. The 4th/7th
Directives require ‘private’ companies to prepare and disclose audited
single and consolidated accounts to enable (potential) creditors to assess
their solvency.9 As stated above an LLC is not subject at all to such duties

9
Non-observance of these requirements under Netherlands law (art. 2:248 Civil Code)
vest an assumption of causation in case of bankruptcy and hence liability of (shadow)
directors for the company’s deficit. Th is is far from rational and reality although these
ongoing requirements are costly and burdensome. They tempt receivers to out-of-context
interpretations. Starting from the inherent risk of any business venture, the crucial test
should rather be whether shareholders in the face of insolvency risks divert assets from
the company or managers knowing/intending to induce new creditors to fi nd recourse.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 39

of draft ing, auditing and disclosure of its accounts. The directives in their
‘institutional’ approach thus deviate from the mere traditional account-
ing to members who evidently can design their own rules for accounting
and inspection of records (with proper default rules). Since the ultimate
test materializes in insolvency the variety of specific insolvency rules10
developed in various member states have to be taken into account as well
and preferably the SPE Statute should provide exhaustive rules.11
The focus should be (again) on the basic issue of withdrawing (by
whatever technique) assets from the SPE’s patrimony causing the SPE
to be or become unable to pay its debts as becoming due in the ordinary
course of its business or the SPE just becoming insolvent. This is the core
of many existing rules and it should preferably be the core provision in
the Statute as well. Its application would involve directors’ liability vis-à-
vis the SPE to be also enforceable derivatively.
For the LLC the following rules have been established. S. 406/407
ULLCA prohibit distributions to shareholders if (a) the company would
be unable to pay its debts as they become due in the ordinary course
of business. be made and liability for unlawful distributions or – in
summary – (b) total assets would be less than total liabilities upon disso-
lution of the company. Members/managers failing to meet the standards
of conduct and vote for or assent to unlawful distributions will be per-
sonally liable for the portion of the distribution that exceeds the maxi-
mum amount that could have been lawfully distributed. The recovery
remedy extends to the company only, not to creditors.

E. Dissociation and expulsion of members

Regulation of dissociation and expulsion of members in SPE’s with more
than one member would be primarily subject to the operating agree-
ment between the members. For quasi-partnerships and joint ventures
members should envisage that the basis of personal cooperation and
commitment (affectio societatis) may disappear and result in frustration
of the operations of the company or even a deadlock in its management
and strategy. Members may provide for dispute resolution but if unsuc-
cessful dissociation should be allowed. They therefore should explic-
itly provide for – like in a partnership – the terms and conditions for
expulsion and for voluntary dissociation and, equally important, for the

10
E.g. wrongful trading and thin capitalization.
11
S. 807–8 ULCCA: procedures to settle claims against dissolved LLC.
40 Perspectiv es in compa n y l aw

settlement of the exit price. In view of possible incomplete contracts or

a change of the shareholders base, the Statute should provide for default
rules to be applied in such case. Although continuity of the SPE’s busi-
ness should be the guiding principle, complete dissolution of the SPE
will follow upon occurrence of an event or consent of (number/percent-
age of) members as specified in the operating agreement, inability to
pursue the business or on a substantiated application of a member or
transferee of a member’s interest (S. 801 ULLCA).
The default rules providing the reasons and grounds for dissociation
should include a (lawful)12 notice of a member to withdraw, agreed upon
event, expulsion according to the operating agreement or by unani-
mous vote under substantiated circumstances, dissolution of a corpo-
rate member or partnership, judicial expulsion, bankruptcy, death or
appointment of a guardian or conservator (cf. S. 601 ULLCA).
The effect of dissociation of a member is that his ‘organizational’
rights as most of his fiduciary duties ceases to exist and that he becomes
entitled to a purchase by the LLC of his transferable interest against the
agreed-upon value or – upon application – as being fi xed by the court
(S 603, 701–2 ULCCA).

F. Corporate reorganizations
Corporate reorganizations are important for SPEs as they are for other
business forms. The 3rd, 6th and 10th Directives harmonized (cross) bor-
der mergers and splits and the SEVIC decision of the ECJ extended the
reach of facilitating national rules, like German Umwandlungsgesetz to
‘foreign’ firms wishing to use these. Seat transfer, conversion and cross-
border merger are also addressed in the SE Statute.
The dynamics of SMEs equally require a flexible regime for corpo-
rate reorganizations which should be addressed separately in the SPE
Statute by extending the existing facilities to include SPEs. In view of
the very nature of the LLC, allowing contractual cooperation between
its members as quasi-partnership, it would be important to also allow
for conversion of partnerships into an LLC and vice versa as well as to
convert an LLC in other forms, including a ‘public’ company, e.g. in view
of going public of a successful start-up of a firm financed with venture
capital. Apart from the existing EU rules reference is made to the flexible
rules as provided by Article 9 ULLCA on conversions of partnerships

12
S. 602 ULLCA.
 Societas Pr ivata Europaea : basic r efor m of EU l aw 41

into an LLC and merger of entities with or resulting in an LLC. For com-
pleteness sake it should be noticed that an amendment of an SPE from a
member-managed into a management-managed SPE does not constitute
a conversion of business form in the strict sense.

V. Concluding remarks
The main purpose of this article in honour of Eddy Wymeersch was to
address the possibility of combining corporate and contractual (part-
nership-like) notions into one and the same statutory business organiza-
tions. Faced with the intention of the European Commission to come up
with an innovative design of an SPE to facilitate SMEs and taking notice
of the desires as expressed in the consultation, the danger should be
faced and addressed that the project will stand on the dogmatic resist-
ance of combining what according to some scholars can simply not be
combined: contract and corporation. Th is idea seems to be definitely
outdated but continues its life as ‘unveiled assumption’. Since my 1976
PhD thesis on joint ventures I have been fascinated with the question
whether one can be a partnership inter sese and a corporation to the rest
of the world. The question was positively resolved in the US at the begin-
ning of the last century and the LLC, the highly successful offshoot of
this development, provides us with a statutory example how to combine
contract and corporation. I sincerely hope that Eddy Wymeersch will
continue to enrich the academic debate as he did so devotedly for so
long!

Post scriptum
After completion of this article the European Commission published a
draft Statute for a European Private Company (SEC/2008/2098/2099).
Time and space only allow a very brief overview. The Statute largely
follows the ‘standard’ form for private companies in the EU. Its forma-
tion is free and includes transformation/conversion of an existing busi-
ness as well as merger/division (art. 5). Registered office and real seat
may be in different states (art. 7). Articles of association shall be pub-
lished, not only a memorandum of incorporation; legal personality will
be acquired upon registration (art. 8–11). Capital divided in shares, no
minimum capital required, contribution in kind allowed (art. 14–15,
19–21). Transfer regulated by articles; expulsion and withdrawal of
shareholder envisaged (art. 16–17). Solvency certificate required before
42 Perspectiv es in compa n y l aw

distributions to shareholders (art. 21). Preparation, fi ling, auditing and

publication of accounts according to art. 25 follow applicable national
law, i.e. essentially the 4th and 7th Directives. The Statute does not envis-
age a shareholder-managed EPC and sticks to the model of centralized
management acting in the interest of the EPC (art. 30/31) albeit with
broad collective powers for the AGM (art. 27). Individual (group) rights
of information and calling a meeting are covered by art. 29/29. Transfer
of registered office is regulated separately (incl. employee participation).
Transformation, merger, division and dissolution follow national law
(art. 39–40). The Statute should be in force by July 1, 2010.
The draft takes an important step towards a stand-alone ‘federal’
business form for all member states. In view of its focus on SMEs and
its use as cross-border subsidiary further simplifications as allowed by
ULLCA should be considered.
 3

Ius Audacibus. The future of EU company law1

Ja ap Winter

An Elf shall go
Where a Dwarf dare not?
Oooh, I will never hear the end of it.
Gimli in Lord of the Rings, Tolkein

I. Introduction
The European Union originally was conceived as creating an economic
community between Member States. A key pillar of the European
Community is the principle of free movement as expressed in the free
movement of persons, goods, services and capital. Together with the EU
rules on competition they form the European Community’s economic
constitutional law.2 Part of the free movement of persons is the freedom
of establishment. This freedom includes ‘the right to take up and pursue
activities as self-employed persons and to set up and manage undertak-
ings, in particular companies or firms…under the conditions laid down
for its own nationals by the law of the country where such establishment
is effected, subject to the provisions of the Chapter on capital’ (Article
43 Treaty of Rome). In order to attain freedom of establishment the
Council and the Commission are required to ‘co-ordinate to the neces-
sary extent the safeguards which, for the protection of the interests of
members and others, are required by Member States of companies or
firms…with a view to making such safeguards equivalent throughout
the Community’ (art. 44 (2) (g)). This Treaty provision is the basis for
the harmonization of company law in the European Union. It is a rather

1
Th is contribution is an adaptation of my inaugural lecture at the University of Amsterdam
held on 14 April 2007.
2
J. Baquero Cruz, Between Competition and Free Movement. The Economic Constitutional
Law of the European Community (Oxford: Hart Publishing, 2002).

43
44 Perspectiv es in compa n y l aw

peculiar basis. It takes a specific angle to the harmonization process:

the protection of shareholders and others which is required by Member
States’ company laws. The protection of shareholders and others, in par-
ticular creditors, was very much in the minds of the original authors of
the Treaty. There was a concern among Member States in those days,
we speak of 1957, that shareholders and creditors would not invest in
companies from other Member States or do business with them, as they
would not be familiar with the company laws to which such companies
would be subject and particularly with the protections afforded to them
under these company laws. In addition, Member States feared that with-
out a rigorous harmonization programme, Member States would race
to the bottom by creating company laws with ever-reducing protection
for shareholders and creditors in order to compete with other Member
States for the incorporation or registration of companies in their juris-
dictions. The Netherlands were seen as Europe’s bottom in those days,
not only geographically but also in terms of company law. Dutch com-
pany law was very flexible in those days, with a minimum of mandatory
rules. Regulatory arbitrage that would lead other Member States to race
to that same bottom was to be avoided. I will not go into the question
whether such a race to the bottom would have ever occurred without
article 44 (2) (g) and the harmonization programme. For now I just note
that approaching company law legislation with the primary objective to
make protections for shareholders and creditors equivalent across the
EU is indeed a peculiar approach to company law. I will come back to
this at the end of this chapter.
On the basis of article 44 (2) (g) in the meantime eleven directives
have been adopted. They primarily deal with formalities of company
law such as incorporation, publicity, capital formation and protection,
(cross-border) legal mergers and split-ups, accounting, branches etc.
Some call the resulting EU company law trivial.3 Member States have
discovered fundamental differences of opinion on such core issues as
the organization of the board, the role and rights of shareholders, group
relationships, employee co-determination and corporate control. In
these areas nothing of substance has been agreed by Member States,
projects were either abandoned (the fi ft h Directive on the structure of the
company dealing with board structures and the rights of shareholders,

3
L. Enriques, ‘EC Company Law Directives and Regulations: How Trivial Are They?’, in
J. Armour and J. McCahery (eds.), After Enron, Improving Corporate Law and Modernising
Securities Regulation in Europe and the US, (Oxford: Hart Publishing, 2006), 641–700.
 Ius Audacibus . The futu r e of EU compa n y l aw 45

and the ninth Directive on group law) or Member States have agreed to
disagree and to leave it to Member States individually (e.g. the Statute for
the Societas Europea on board structures and the thirteenth Directive
on takeover bids).

II. Political process

In light of the political decision making in the EU process we should
perhaps be surprised that so many directives have actually made it to
their adoption. The right of initiative lies with the Commission which
has a primarily, but maybe not exclusively European agenda. But the key
decisions are made by the Council of Ministers. The Council consists
of representatives of the current twenty-seven Member States’ govern-
ments. Decisions in the Council are often, perhaps more often than not,
driven by each Member State’s government negotiating to preserve and
further national Member State interests. They are doing this on a num-
ber of fi les which are discussed simultaneously and which should all lead
to some form of regulation or action at EU level. Member States find it
difficult to suppress the inclination to make deals across fi les, to agree
to certain other Member States’ wishes, say on an agricultural issue,
in order to get their agreement on a company law issue. The compro-
mises that follow often have little to do with the merits of the issues dealt
with. Directives then require approval from the European Parliament.
The Parliament functions mainly along party lines, but MEPs sometimes
are sensitive to national issues and particular concerns of the Member
States they are representing. In some cases all MEPs from a particular
Member State vote in a certain direction to protect perceived national
interests, as is said did the German MEPs from left to right when voting
down the Takeover Bids Directive in June 2001.
A complicating factor in this political process is that on many fi les the
question is raised whether it is really for the EU to regulate or whether
regulation should be left to Member States. Member States have become
sensitive to this question when after some decades they witnessed that
many of their powers had effectively been transferred to the EU and
would need to be shared with other Member States. In the Maastricht
Treaty of 1992 article 5 was introduced, providing that in areas which
do not fall within its exclusive competence, the Community shall take
action, in accordance with the principle of subsidiarity, only if and
insofar as the objectives of the proposed action cannot be sufficiently
achieved by the Member States and can therefore, by reason of the scale
46 Perspectiv es in compa n y l aw

or effects of the proposed action, be better achieved by the Community.

The words ‘cannot be sufficiently achieved’ and ‘be better achieved’ leave
ample opportunity to challenge EU interference in almost any area.
Subsidiarity is an argument often heard and used when Member States
do not like the possible outcome of an EU regulatory process.
Linked to these factors troubling the political decision-making
process is the fact that Member States’ governments also make up the
key decision maker at EU level, the Council of Ministers. This has the
effect that these governments, but also everybody else who has a role or
an interest in the subject matter to be regulated, can and often needs
to play chess on two chess boards: national level and EU level. If for
example a certain national legislative development is not desired by a
Member State government, or by those who lobby that government, it
or they can argue that this is a matter for the EU to regulate and not for
any single Member State. Th is often serves as an efficient delaying tactic
as agreement at EU level is difficult to achieve. Or, vice versa, a deadlock
at national level can sometimes be broken by forging an agreement with
other Member States at EU level. Playing simultaneous chess on two
boards is what the vast lobbying industry in Brussels is all about.
All these factors contribute to the political decision-making process
in the EU being highly complex and its outcomes highly unpredictable.
The focus and efforts of the EU to improve its legislative process through
the Better Regulation initiatives4 are not suited to dealing with these
fundamental complicating factors, which lie at the root of the politi-
cal structure of the EU. They have caused three somewhat overlapping
trends in EU legislation of company law in this century.

III. Three trends

The first trend is a strong emphasis on subsidiarity. This trend can be
seen from abandoning the fi ft h and ninth Directives on the structure of
the company and on group law, which are now no longer issues where
the EU seeks a legislative role for itself. Th is trend is also clear from the
efforts to simplify current directives, in particular the second Directive
on capital maintenance. The thrust is to remove from the Directives any-
thing which is not really necessary or clearly helpful.5 Finally we see this

4
See http://ec.europa.eu/enterprise/regulation/better_regulation/index_en.htm.
5
See Directive the European Parliament and of the Council of 6 September 2006 amend-
ing Council Directive 77/91/EEC as regards the formation of public limited liability
 Ius Audacibus . The futu r e of EU compa n y l aw 47

trend from the development to not impose certain elements of legislation

on Member States but to either give them options to apply or not apply
certain EU rules (see the thirteenth Directive on Takeover Bids and the
opt-outs that Member States have been given from the rules on defence
against takeovers, provided they give opt-in rights to companies)6 or to
leave out of an EU legislative instrument core elements of regulation (see
the SE Statute, leaving anything contentious to Member States to regu-
late themselves in their legislation implementing the SE Statute).7
The second trend is the privatization of company law. This trend is
visible at national and at EU level. The SE Statute for example leaves the
choice for a one-tier board structure or a two-tier board structure to
those incorporating the SE themselves, see articles 39 and 42 SE Statute.
Similarly, companies have the right to opt-in to application of articles 9
(board passivity) and 11 (break-through) of the thirteenth Directive on
Takeover Bids, if the Member State does not impose application of these
rules, see article 12. Finally, and perhaps most importantly, the regula-
tion of corporate governance to a large extent is left to companies and
their shareholders. Codes of corporate governance are to be adopted at
Member State level and in most if not all Member States these codes have
been drafted by committees consisting of representatives of companies,
shareholders and other private entities. Furthermore, these codes are not
binding upon companies, but companies must explain to what extent
and for what reasons they do not comply with the code to which they are
subject, see article 46a (1) (a) and (b) of the fourth Directive on annual
accounts, as amended by Directive 2006/46/EC, L 224/1. The enforce-
ment is primarily in the hands of shareholders.8

companies and the maintenance and alteration of their capital 2006/68/EC [2006] OJ
L 264/32. See for the general thrust to simplify company law, the report on the public
consultation on the future priorities of the company law action plan, http://ec.europa.
eu/internal_market/company/consultation/index_en.htm.
6
G. Hertig and J. McCahery, ‘An Agenda for Reform: Company and Takeover Law in
Europe’, in G. Ferrarini, K. Hopt, J. Winter and E. Wymeersch (eds.), Reforming Company
and Takeover Law in Europe, (Oxford University Press: 2004), 21–49, who advocate the
option-approach for EU company legislation. My concern with this approach is that
the design and effects of the options to be given to Member States will be subject to the
same political factors I described above and are likely to be used particularly to protect
national interests.
7
See L. Enriques, ‘Silence is Golden: The European Company As a Catalyst for Company
Law Arbitrage’, Journal of Corporate Law Studies (2004), 77.
8
See the Statement of the European Corporate Governance Forum on the comply-or-
explain principle of 22 February 2006, see, http://ec.europa.eu/internal_market/
company/ecgforum/index_en.htm.
48 Perspectiv es in compa n y l aw

The third trend is that where Member States do reach an agreement

in spite of conflicts between national interests and perceptions, the out-
come is typically an ugly compromise creating problems for companies
that have to apply the resulting rules. The Directive accompanying the
SE Statute on the involvement of employees, in particular the rules on
participation of employees in a board of the company, are a fine example.
The Directive is wrought with provisions whose only purpose is to avoid
that by merging into an SE a German company subject to German co-
determination rules could escape those rules. The rules create a complex
set of provisions detailing what majorities of employees of participating
companies can in different circumstances outvote German employees
to not apply the German co-determination rules to the SE. If no agree-
ment is reached a set of standard rules apply, the interpretation of which
would be a tough challenge for the European Court of Justice and some
of which actually are mutually conflicting.9 Another example is offered
by the opt-out and opt-in rules combined with the reciprocity rule of
article 12 of the thirteenth Directive on takeover bids. These rules result
in preserving the existing situations in Member States with respect to
takeovers and defence instead of creating a level playing field for takeo-
ver bids, which is the stated objective of the Directive. They also create
rules which are either easy to circumvent and manipulate or incredibly
difficult to apply and which are possibly in breach of the Treaty itself and
with the EU’s obligations under the WTO as they by definition exclude
non-listed and non-EU companies from obtaining as good as a position
as a bidder as EU-listed companies can obtain.10

IV. EU’s legislative remit in company law

In light of all this, I believe the remit of the EU’s involvement in company
law should be modest, at best. In line with the principle of subsidiarity,
it should focus on those issues where individual Member States cannot
provide solutions, and, in addition, on those issues where the evidence of
a benefit of a solution at EU level over a solution by individual Member
States is clear. These issues are most likely to arise with companies whose
shares are listed on a regulated market. The securities laws to which these
listed companies have become subject in Europe are to a very large extent

9
See J. Winter, ‘De Europese Vennootschap als sluis voor in- en uitvoer van vennoot-
schapsrecht’, Nederlands Juristenblad (2002), 2034–40.
10
J. Winter, ‘You must be joking’, Ondernemingsrecht (2004), 367.
 Ius Audacibus . The futu r e of EU compa n y l aw 49

harmonized, if not uniform across the EU following the many far-reach-

ing Directives and secondary regulations that have been adopted under
the Financial Services Action Plan. A key aspect of the new rules is to
ensure that companies in Europe have efficient access to capital markets
across Europe and that their investors are offered equivalent protections
on these markets. As a result, a key feature of listed companies, i.e. their
relation to the capital markets, is regulated practically uniformly across
the EU. It is more likely that there are issues for these companies that
require EU solutions or where EU solutions are clearly preferable over
Member States solutions than for non-listed companies.
Finally, the subject of corporate governance warrants EU attention.
Not in the traditional way of trying to regulate the substance of corpo-
rate governance at EU level, as was intended with the fi ft h Directive,
but in a more distanced way. The substance of corporate governance is
linked directly to the core of company law: the structure and operation of
boards of companies and the relationship with their shareholders. As this
core of company law is designed differently across Member States, based
on different legal, social, financial and cultural traditions, it is unlikely
that Member States at EU level will reach agreement on a single model
to be applied across the EU. It is also very doubtful whether creating and
imposing such a model would really be efficient. But the EU can coordi-
nate the efforts of Member States to protect and where necessary improve
the integrity of their corporate governance models. This is particularly
so because of the warm reception the so-called comply-or-explain model
has received in Member States. This model avoids mandatory legislation
on the substance of corporate governance by implementing corporate
governance codes, compliance with which or proper explanations for
non-compliance are to be enforced primarily by shareholders. The High
Level Group that I chaired and the European Corporate Governance
Forum recommend this model as a means to create and improve corpo-
rate governance in the EU.11 But if we are honest, we should admit this
is one big experiment. There is little or no experience with corporate
governance codes and comply-or-explain in most Member States. There
is also little understanding of what type of regulatory environment is
required for such a system to function properly. What can or should

11
See the report ‘A Modern Regulatory Framework for Company Law in Europe’ of
November 2002, http://ec.europa.eu/internal_market/company/modern/index_en.
htm#background. See also the Statement of the Forum on comply-or-explain, (note 8,
above).
50 Perspectiv es in compa n y l aw

be done to ensure sufficient explanation for non-compliance? The sys-

tems assumes that shareholders can exercise certain rights effectively
in order to enforce proper compliance or explanation, but it is not clear
that shareholders actually have these rights in all Member States and
it is certainly clear that most shareholders cannot exercise their rights
efficiently across borders. The Directive on Shareholders Rights, which
has been adopted to solve problems of cross-border voting in the EU, is
precisely not doing that.12 There are also questions in cases where the
company is controlled by a major shareholder and the (non)compliance
with the code fulfi ls the major shareholder’s wishes (possibly to the det-
riment of minority shareholders), particularly if the major shareholder
is able to exercise more control rights than are proportionate to his own-
ership of share capital. Comply-or-explain works fundamentally differ-
ently in those circumstances.13 These are issues where the EU should
at least coordinate the efforts of Member States. By using instruments
such as the Recommendation the Commission would create a sort of
comply-or-explain environment for Member States, which may create
incentives to actively improve the national corporate governance system
while retaining some flexibility between Member States.14

V. A new avenue for progress: the free movement of capital

The legislative remit for the EU in company law may be limited; this does
not mean to say that the EU will not have an important impact on the
company laws of Member States in different ways. The European Court of

12
Directive of the European Parliament and of the Council of 11 July 2007 on the exercise
of certain rights of shareholders in listed companies 2007/36/EC [2007] OJ L 184/17;
see also the recommendations made by the European Corporate Governance Forum
on solutions for cross-border voting, see statement of 24 July 2006, http://ec.europa.eu/
internal_market/company/ecgforum/index_en.htm.
13
After having called for substantial research into whether there is a need to regu-
late structures which create disproportionate control rights, EU Commissioner
McCreevy abandoned this in October 2007. See for the reports on disproportion-
ality http://ec.europa.eu/internal_market/company/shareholders/indexb_en.htm.
The European Corporate Governance Forum did recommend several measures to be
taken, including a higher level of disclosure of disproportionate control structures,
see the statement of the Forum and the paper of the Forum’s working group on pro-
portionality on
14
See for example the Commission’s Recommendations on the role of independent direc-
tors and on director remuneration, http://ec.europa.eu/internal_market/company/
independence/index_en.htm and http://ec.europa.eu/internal_market/company/
directors-remun/index_en.htm.
 Ius Audacibus . The futu r e of EU compa n y l aw 51

Justice has proven to be a particular driving force, with its judgments on

the freedom of establishment. The Centros, Überseering and Inspire Art
judgements15 have established that, where Member States have not agreed
on harmonization of certain aspects of company law, a Member State
may not impose barriers to the freedom of establishment merely because
a company with an establishment in that Member State is incorporated
in another Member State in which it does not perform any real business
activities. Restrictions imposed on such a company, such as not allowing
registering the establishment in the Member State, denying legal stand-
ing in court and imposition of additional administrative and substan-
tive legal burdens, are not justified by the fact that the company does not
adhere to the same capital maintenance rules as companies incorporated
in the Member State itself. This case law has had at least three effects: (i) an
increased trend to use English limited liability companies instead of the
national form of limited company for doing business in other Member
States, in particular Germany,16 (ii) a fundamental discussion on whether
the real seat theory is still a viable theory on the basis of which to apply
company law of a Member State to a company incorporated in another
Member State,17 and (iii) some Member States have initiated proposals
to deregulate their laws on limited companies, like the Netherlands and
Germany.18 This may lead to a convergence of company law from the bot-
tom up, by incorporation choices of companies and by legislative actions
by Member States without any EU legislation.
The case law on freedom of establishment is now well understood and
its effects are becoming clear. The question is whether the other freedom

15
Case C-212/97, Centros Ltd v. Erhvervs- og Selskabsstyrelsen, [1999] ECR I-1459 Case
C-208/00, Überseering BV v. Nordic Construction Company Baumanagement GmbH,
[2002] ECR I-9919 Case C-167/01, Kamer van Koophandel en Fabrieken voor Amsterdam
v. Inspire Art Ltd, [2003] ECR I-10155.
16
M. Becht , C. Mayer and H. Wagner, ‘Where do fi rms incorporate? Deregulation and the
cost of entry’, ECGI Law/Working Paper 70(2006), http://papers.ssrn.com/sol3/papers.
cfm?abstract_id=906066.
17
E. Wymeersch, ‘The transfer of the company´s seat in EU company law’, ECGI Law/
Working paper 08(2003), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=384802.
18
In the Netherlands a proposal to simplify and make more flexible the law applicable
to the besloten vennootschap (limited company) has been submitted to parliament.
According to this proposal the minimum capital requirement of currently €18,000
will be abolished. See for the German proposal to change the law applicable to the
Gesellschaft mit beschränkter Haft ung www.jura.uni-augsburg.de/prof/moellers/
materialien/materialdateien/040_deutsche_gesetzgebungsgeschichte/momig/. The
German proposal does not abolish minimum capital altogether but reduces it from
€25,000 to €10,000.
52 Perspectiv es in compa n y l aw

relevant to company law will have similar effects. This is the free move-
ment of capital. The ECJ by now has established important case law based
on the free movement of capital in the area of so-called golden shares.
Golden shares refers to arrangements, either in law or in the company’s
constitution, made by Member States with respect to companies in their
jurisdiction, typically companies that have been privatized, and that con-
fer to a Member State certain powers of control over those companies, or
the ability to prevent certain shareholders to acquire control over those
companies. This is a crucial issue in the development of the EU. It is about
striking the right balance between the EU’s objective to create a single mar-
ket without artificial barriers imposed by Member States and the Member
States´ concerns about losing control over business that are crucial to their
economy and national infrastructure. The case law shows that the ECJ
leaves Member States only very little scope to fence off companies with
golden-share structures, which are quickly considered to hinder the free
movement of capital as they are liable to dissuade investors (either direct
investors interested in participating in control or portfolio investors not
interested in participating in control)19 from investing in the company. As
with the freedom of establishment, the ECJ accepts only limited justifica-
tions of any impediment to the free movement of capital.20
So far, the case law on the free movement of capital is related to Member
States and state actions, rather than to companies and citizens. However,
the recent Volkswagen case may open up new avenues for development
of EU company law on the basis of the free movement of capital.

VI. Volkswagen
The Volkswagen case21 deals with the so called Volkswagen Act, a special
Act of the German legislator dealing with certain governance arrange-
ments for Volkswagen AG. After World War II the trade unions had started
up the car-making business of Volkswagen, without it being clear who

19
The ECJ has repeatedly ruled that both types of investors, distinguished in the
Commission’s statement of 19 July 1997 relating to certain legal aspects of intra-Com-
munity investments, Pub nr C 220, are protected by the free movement of capital.
20
Case C-367/98, Commission v. Portugal [2002] ECR I-04731; Case C-483/99, Commission
v. France [2002] ECR I-04781; Case C-503/99, Commission v. Belgium [2002] ECR
I-04809; Case C-463/00, Commission v. Spain [2003] ECR I-4581; Case C-98/01,
Commission v. United Kingdom [2003] ECR I-4641; Case C-174/04, Commission v. Italy
[2005] ECR I-4933 and Cases C-282/04 [2006] ECR I-9141 and 283/04, Commission v. the
Netherlands [2006] ECR I-9141.
21
Case C-112/05, Commission v. Germany [2007] ECR I-8995.
 Ius Audacibus . The futu r e of EU compa n y l aw 53

actually owned the business. In 1959–60 the Federal German government

and the government of the state of Lower Saxony discussed and agreed
with the trade unions on the ownership of the business. It was decided that
Volkswagen was to be a publicly held company, an Aktiengesellschaft, in
which both the Federal State and Lower Saxony would each hold 20% of
the company’s share capital and the rest would be offered to the public.
To date, Lower Saxony has maintained a stake of approximately 20% in
Volkswagen, by subscribing for and investing in new shares whenever they
were issued by the company. The Federal State has sold its shares. Part of the
deal struck in 1959–60 was that minority shareholders would be protected
against a party trying to take control of the company without acquiring the
full share capital. At the same time this would protect employees against
a possible hostile bid that could lead to lay-offs in Germany. The parties
agreed to the adoption of three key governance provisions:
• the voting rights of each Volkswagen shareholder are limited to a
maximum of 20% of the total votes that can be cast, even if the share-
holder holds more than 20% of share capital;
• special resolutions of the general meeting of shareholders of
Volkswagen that require a 75% majority under standard German law,
require a majority of 80%;
• Germany and Lower Saxony may each, as long as they are Volkswagen
shareholders, appoint two members to the Volkswagen supervisory
board.
These provisions have not only been incorporated in the articles of asso-
ciation of Volkswagen AG, but have also been imposed on the company
and its shareholders by the Volkswagen Act. As a practical result, Lower
Saxony by maintaining its 20% in Volkswagen could veto important res-
olutions in the general meeting and no other shareholder could acquire
more voting rights than Lower Saxony.
Germany had argued that all of this was nothing more than a pri-
vate agreement between parties who had disputed the ownership of the
company, which private agreements have merely been confirmed by the
Volkswagen Act. The Court rejects this argument. The Volkswagen Act,
a state measure, imposes these arrangements on the company and its
shareholders and does not allow for the shareholders to decide to change
them.22

22
In the cases against the Netherlands, the Court considered putting certain clauses in
the articles of association granting it special rights in companies the Netherlands was
54 Perspectiv es in compa n y l aw

Germany then argued that the voting cap and the super-majority
requirement did not restrict the free movement of capital, because they
apply without distinction to all shareholders, including Lower Saxony,
and work both to the benefit (reduced chance of a third party acquiring
cheap control with a relatively low percentage) and detriment (reduced
ability to exercise control yourself with a relatively low percentage) of
all shareholders, including Lower Saxony. The Court rejected this argu-
ment as well. But in doing so and by arguing that the Act does restrict the
free movement of capital, the Court took a new turn. The Court basically
argued that the 80% super-majority requirement created an instrument
for Lower Saxony, as an approximately 20% shareholder, to procure for
itself a blocking minority allowing it to oppose special resolutions on the
basis of a lower level of investment than would be required under gen-
eral company law. The 20% voting cap supplements this legal framework
and enables Lower Saxony to exercise considerable influence on the basis
of such a lower investment. The combination of the 80% super-majority
requirement and the 20% voting cap, the Court ruled, diminishes the
interest in acquiring a stake in the capital of Volkswagen as it is liable to
limit the possibility for other shareholders to effectively participate in the
management and control of Volkswagen. By arguing in this way, the Court
made instrumental to its reasoning the investment Lower Saxony held in
Volkswagen and continued to maintain at around 20% by subscribing for
newly issued shares. The Court uses vague words in this respect. It does
not rule that the provisions of the Act as such are liable to deter investors,
but states: this ‘situation’, i.e. rules combined with a private investment by
Lower Saxony, is liable to deter investors from other Member States. This
raises at least two interesting questions: how would the Court have ruled
if Lower Saxony had not maintained its investment at around 20% and its
investment would have dropped significantly as a result of share issues to
others? Could the Volkswagen Act still be saved if Lower Saxony was to
sell a significant part or all of its shares in Volkswagen?23

privatizing, as taking a state measure. In Volkswagen the 20% voting cap and the 80%
majority requirement did not create special rights, but there was a clear state act in the
form of the Volkswagen. It would be interesting to see how the Court would rule if the
state acts as a shareholder to include certain restrictive clauses in the articles of asso-
ciation of a company, which do not grant special rights to the state. See on this J. van
Bekkum, J. Kloosterman and J. Winter, ‘Golden Shares and European Company Law:
the Implications of Volkswagen’, European Company Law (2008), 9.
23
Interestingly, Porsche, which in the meantime has acquired a 30% stake in Volkswagen
sought to get shareholder approval from removing the provision copying the Volkswagen
Act from the Articles of Association of Volkswagen in the Volkswagen annual general
 Ius Audacibus . The futu r e of EU compa n y l aw 55

By drawing Lower Saxony’s investment decisions into its reasoning,

the Court at least conceptually opens the door to applying the free move-
ment of capital to the private sphere. In Volkswagen the Court did not
have to dwell on this, as the Volkswagen Act itself is clearly a state act.
But broadening the scope of the free movement of capital by bringing it
into the private sphere would not be surprising, in light of the trends in
the case law of the Court on the other Community freedoms. The free
movement of capital case law has traditionally trailed the case law on
the other freedoms but has picked up quite a bit over the last decade.
And recent case law shows only few differences between the doctrinal
features of this freedom compared with the others.24

VII. Free movement and the private sphere

For the other freedoms, the Court has already addressed the question
whether and to what extent they could be applied to private person. In
particular the free movement of workers has triggered Court rulings
that apply the freedom into the private realm. In cases such as Walrave25
and Bosman26 the Court held that provisions limiting the free movement
of workers were adopted in a collective manner (e.g. by international
cyclist and football organizations), these provisions should be caught by
Article 39 and 49 EC and should be subjected to the same standards
applicable to state measures. In Ferlini27 the Court went a little further
by arguing that the discrimination prohibition of article 12 EC also
applies to a case where an organization (in this case an organization of
Luxembourg hospitals) exercises a certain power over individuals and is
able to impose conditions upon them as a result of which the exercise of
fundamental freedoms guaranteed under the Treaty is made more dif-
ficult. And in Agonese28 the Court ruled that the requirement imposed
by a private bank in Northern Italy for candidates applying for a job
at the bank to prove their bilingual capabilities (Italian–German) by a

meeting held on 24 April 2008. The resolution was rejected as ‘it did not obtain the
required majority’ (i.e. still 80% under the Articles of Association), the Volkswagen
website announces, see http://www.volkswagenag.com/vwag/vwcorp/info_center/en/
news/2008/04/AGM.html.
24
L. Flynn, ‘Coming of Age: the free movement of capital case law’, Common Market Law
Review (2002), 773–805.
25
Case C-36/74, Walrave and Koch [1974] ECR 1405.
26
Case C-415/93, Bosman [1995] ECR I-4921.
27
Case C-411/98, Ferlini [2000] ECR I-8081.
28
Case C-281/98, Angonese [2000] ECR I-4139.
56 Perspectiv es in compa n y l aw

diploma that can only be obtained in one province of Italy, constitutes a

prohibited discrimination on the basis of nationality. The precise extent
of this case law is not yet clear. One interpretation is that the prohibition
against discrimination may be applied against any person (as shown in
Angonese), while the prohibition against restrictions on the free move-
ment of workers only applies to measures of a collective character with
semi-public implications (Walrave, Bosman, Ferlini).29
For the free movement of goods, the Court traditionally takes the
view that articles 28 and 29 only apply to measures taken by Member
States and not by private persons.30 There is backdoor, however, through
which even this freedom may have its effects on the actions of private
persons. In Commission v. France 31 French farmers repeatedly and vio-
lently obstructed Spanish farmers from selling their strawberries in
France. The Court ruled that the actions undertaken by the French gov-
ernment were manifestly inadequate to ensure freedom of intra-Com-
munity trade in agricultural products on its territory by preventing and
effectively dissuading the perpetrators of the offences in question from
committing and repeating them. It is for the Member State concerned to
adopt all appropriate measures to guarantee the full scope and effect of
Community law so as to ensure its proper implementation in the inter-
ests of all economic operators. The actions of the French farmers were
extreme, but the case may provide the basis for a more general rule that
if private persons repeatedly and consistently obstruct the exercise of the
Treaty freedoms by others, Member States may have to take measures to
guarantee that these freedoms can be exercised.

VIII. Let’s speculate: cross-border voting

There is no reason why the extension of the Treaty freedoms to the pri-
vate sphere as follows from the case law referred to above could or should
not also apply to the free movement of capital.32 Speculating about the

29
P. Oliver and W.-H. Roth, ‘The Internal Market and the Four Freedoms’, Common Market
Law Review (2004), 423.
30
Oliver and Roth, ‘The Internal Market’ (note 29, above), 422, with references to relevant
case law.
31
Case C-265/95, Commision v. France [1977] ECR I-6959.
32
Oliver and Roth refer to the complication of the justifications that may be available
for Member States under the Treaty may not be available for private persons. In par-
ticular, private autonomy, protected by national constitutions and the very essence of
the European market economy, does not show up as a justification, see note 28, above,
423. The justification for private persons to restrict the Treaty freedoms is indeed
 Ius Audacibus . The futu r e of EU compa n y l aw 57

application of the free movement of capital into the private realm, one
example comes to mind where this could have a salutary effect.
Europe is struggling with the exercise of voting rights by sharehold-
ers in companies located in another Member State. Today, shareholders
typically hold their shares through securities accounts with intermedi-
aries such as banks and brokers. When holding shares in a company in
another Member State usually a chain of intermediaries in various juris-
dictions exists between the shareholder and the company, each hold-
ing shares for the next intermediary until the ultimate shareholder is
reached. It is often not clear legally and practically whether the ultimate
shareholder, as the person who has invested in the shares and, in princi-
ple holds the economic risks attached to the shares, is entitled and able
to vote the shares. The chain of intermediaries leads to multiple contrac-
tual and ownership claims in various jurisdictions and there is no EU
or other rule clarifying that the entitlement of the ultimate shareholder
at the end of the chain allows him to control the exercise of the voting
rights. And practically, the securities intermediaries do not have systems
in place allowing for the swift identification of ultimate shareholders, or
the passing on of voting instructions or powers of attorney along the
chain. For the intermediaries, facilitating the exercise of voting rights by
their clients is a burdensome service to their clients and most intermedi-
aries simply do not provide the service, or at least will not ensure that the
next intermediary down the chain will also provide the service.33

problematic. But in this respect the free movement of capital is no different than the
other freedoms where the Court has brought them into the private sphere. For a different
view, B.J. Drijber, ‘De Dertiende Richtlijn tussen Europese politiek en Europees recht’,
Ondernemingsrecht (2004), 140, holding that art. 56 EC does not have any horizontal
effect. See for further speculation into the possible horizontal effect of the free move-
ment of capital I. van der Steen, ‘Horizontale werking van de vier vrijheden en van het
discriminatieverbod van artikel 12 EG’, Nederlands tijdschrift voor Europees recht (2001),
8, relating to the effect the free movement of capital on the ability of companies to defend
against hostile takeover bids. See also the report of the European Corporate Governance
Forum working group on proportionality, referring to cases in which foundations hold
control over listed companies through mechanisms that allow for control rights dispro-
portionate to the investment made by the foundation to further different stakeholder
and societal interests. The report suggests that the free movement of capital may offer a
fruitful avenue that can be explored to restrict the use of disproportionate mechanisms
by such foundations to situations which are acceptable and justified under the Treaty,
see p. 19 of the report of June 2007, see the posting on the website of 12.09.2007 http://
ec.europa.eu/internal_market/company/ecgforum/index_en.htm.
33
See for a description of the problems underlying cross-border voting J. Winter, ‘Cross-
border voting in Europe’, in K. Hopt and E. Wymeersch (eds.), Capital Markets and
Company Law (Oxford University Press: 2003), 387–426.
58 Perspectiv es in compa n y l aw

A typical cross-border problem is one that cannot be solved by Member

States individually and therefore calls for an EU solution. The EU has
identified such problems and sought to address them. The Shareholders
Rights Directive34 is aimed at solving problems of cross-border voting.
Recital 11 states:

Where financial intermediaries are involved, the effectiveness of voting

upon instructions relies, to a great extent, on the efficiency of the chain
of intermediaries, given that investors are frequently unable to exercise
the voting rights attached to their shares without the cooperation of
every intermediary in the chain, who may not have an economic stake
in the shares. In order to enable the investor to exercise his voting rights
in cross-border situations, it is therefore important that intermediaries
facilitate the exercise of voting rights.

But then, typically for EU Member States not agreeing and the
Commission for whom agreement on a Directive is often preferable
over a Directive which makes sense, the Directive completely fails to
provide any useful content that would allow shareholders to effectively
exercise their voting rights along a chain of intermediaries. Securities
intermediaries are not required to exercise voting rights according to
the instruction of their clients or to pass on such voting instructions
to the next intermediary in the chain or to provide powers of attorney to
their clients to vote directly.35 Instead, the real issue is moved to a pos-
sible Recommendation from the Commission to Member States, which
in itself, by definition, will not be able to solve the problem as Member
States can choose to ignore it and to not impose any obligation on secur-
ities intermediaries.
What good could the application of the free movement of capital do
here? Banks and brokers are instrumental to the holding of shares by
investors today. The vast majority of investors, big and small, hold
their shares through securities accounts with these intermediaries.
As a result, investors generally fully depend on these securities inter-
mediaries to facilitate the exercise of their voting rights. Without the

34
Directive of the European Parliament and of the Council of 11 July 2007 on the
exercise of certain rights of shareholders in listed companies 2007/36/EC [2007] OJ L
184/17.
35
The European Corporate Governance Forum had recommended to include such obliga-
tions for intermediaries in the Directive, see its recommendation of 24 July 2006, see
http://ec.europa.eu/internal_market/company/ecgforum/index_en.htm.
 Ius Audacibus . The futu r e of EU compa n y l aw 59

banks and brokers no investor can identify themselves as shareholders

to the companies in which they own shares and provide evidence of
their share ownership. In chains of intermediaries, voting instructions
or powers of attorney to vote need to be passed on by all intermediaries
in the chain until they reach the company or the investor in question.
Th rough their essential role in the international system of sharehold-
ing in book-entry form banks and brokers have become indispensable
for the exercise of voting rights by investors. In the words of the Court
in Ferlini the banks and brokers exercise a certain power over individ-
uals and are able to impose conditions upon them as a result of which
the exercise of fundamental freedoms guaranteed under the Treaty is
made more difficult. Th is is precisely what banks and brokers do by
not facilitating the exercise of voting rights by their clients through
the chains of intermediaries across borders. The resulting inability to
exercise voting rights across borders is liable to dissuade investors to
invest in companies in other Member States and therefore a restriction
on the free movement of capital. A different approach, based on the
Commission v. France ruling, could be that Member States, allowing
that banks and brokers in their jurisdiction facilitate the exercise of
voting rights of their clients in their own jurisdiction but consistently
refuse to facilitate (i) the exercise of voting rights by their clients on
shares held in companies in another Member State, and (ii) the exercise
of voting rights by investors from other Member States on shares in
companies within the jurisdiction of the banks and brokers, failing to
adopt all appropriate measures to guarantee the full scope and effect of
the free movement of capital so as to ensure its proper implementation
in the interests of all economic operators. The fi rst, Ferlini-based rea-
soning, would allow for a case against the banks and brokers directly
by investors, with the possibility of the national court to request the
European Court to give a ruling on the interpretation of art. 56 EC on
the basis of art. 234 EC. The second, Commission v. France-based rea-
soning, would allow for the Commission to adopt a policy not unlike
its policy on golden shares, directed at ensuring that Member States
require their banks and brokers to facilitate cross-border voting by
their own clients and by investors from other Member States. Where
a Member State fails to do so, the Commission could bring an action
against that Member State with the European Court. Both avenues
would allow for creating solutions to the problem of cross-border vot-
ing without legislation at EU level.
60 Perspectiv es in compa n y l aw

IX. Ius audacibus: company law and EU law

Capitalism isn’t for the faint hearted, it is said. It is based on people who
are willing to take risks in order to reap the fruits if they succeed. This is
what produces wealth and wealth allows us to prosper as a society.
Both company law and EU law are instrumental to this objective.
Company law first of all facilitates entrepreneurship, the risk-taking by
business in order to generate profits. But it also seeks to protect those
who are affected by companies against careless exploitation.
EU law creates a European space for entrepreneurship, where people
and capital can move freely to create optimal results without artificial
restrictions. Company law and EU law therefore have a common charac-
teristic: they are both law for the brave, ius audacibus. It is only natural
that they meet, for example in the free movement of capital.
Eddy Wymeersch has made numerous contributions to both these
fields of law. It is always a delight to discuss, write and work with him
and it is an honour for me to contribute to this book of his friends.
 4

Free movement of capital and protectionism after

Volkswagen and Viking Line
Jonathan R ickfor d 

I. Introduction
It is a particular honour to provide an essay in tribute to Eddy Wymeersch.
Just ten years ago I was appointed, after over fifteen years without involve-
ment in company law matters, as project director of the UK Company
Law Review.2 Very shortly thereafter I received a generous invitation3
from Eddy (whom I had never met) to attend a very high powered inter-
national corporate law conference convened by him in Siena. The con-
trast between the European approach of fifteen years before and those
discussions was remarkable: the former mechanical, ideological harmo-
nization per se, with the law of one Member State at its core; the new
approach scientific and openly comparative, heavily law-and-economics
in style, and purposive, concerned for efficiency and economic welfare.
Soon afterwards I found this now generally characterized Commission
and Brussels work. The responsibility for that change lay very much with
Eddy and a group of colleagues4 successfully dragging EU company law
into enlightenment.5

1
The paper develops thoughts offered at a conference marking the Finnish presidency of
the EU in October 2006.
2
Now largely embodied in the Companies Act 2006.
3
The generosity extended to my wife also!
4
Perhaps most notably, if another name is to be mentioned, Professor Klaus Hopt.
5
The Siena papers were published as K. Hopt and E. Wymeersch (eds.), Capital Markets
and Company Law (Oxford University Press, 2003). There is much more: perhaps
most significantly K. Hopt, H. Kanda, M. Roe, E. Wymeersch (eds.), Comparative
Corporate Governance, the State of the Art and Emerging Research (Oxford University
Press, 1998); G. Ferrarini, K. Hopt, J. Winter and E. Wymeersch (eds.), Reforming
Company and Takeover Law in Europe (Oxford University Press, 2004); K. Hopt,
E. Wymeersch, H. Kanda and H. Baum (eds.), Corporate Governance in Context
(Oxford University Press, 2005) and G. Ferrarini and E. Wymeersch (eds.), Investor
Protection in Europe, Corporate Law Making, the MiFID and Beyond (Oxford
University Press, 2006).
61
62 Perspectiv es in compa n y l aw

Two years later there emerged proposals at the highest political level,
for opening up European law and related corporate service markets to
free competition and restructuring.6 The objective was an efficient struc-
ture and financial base for European business, exposed to open market
forces, with a view to global competitiveness – the right objective for our
law of business organization.
Ever since Siena I have derived enormous pleasure and satisfaction
from cooperative work with Eddy, friends and colleagues met there, on
occasions too numerous to enumerate. So I write in both admiration and
gratitude.
However, while over the intervening decade enormous strides, both
legislative7 and jurisprudential,8 have been made in developing EU law
in that direction, recently problems have emerged at market, Member
State and Community level. Member States pursued protectionist poli-
cies at community level in the Directive on Takeover Bids,9 and imple-
mented them with protectionist effects at market level. The Commission,
too, seems to have lost confidence in new legislative projects addressing
closed markets, notably on ‘shareholder democracy’, pre-bid takeover
defences and proportionality.10
But the biggest concern is that the objectives of Member State govern-
ments have become more widely and overtly, and no doubt also covertly,
protectionist – to achieve a ‘national solution’, ‘economic patriotism’, and

6
Lisbon European Council Presidency Conclusions 23, 24 March 2000 EU see Press
Release library at www.europa.eu.
7
Including: Statute for a European Company: Directives on Employee Involvement; Cross
Border Mergers and Takeover Bids; Regulation on International Accounting Standards;
Directives on Company Accounts, on Audit and on Shareholder Rights; Corporate
Governance Recommendations; and Financial Services Action Plan initiatives opening
markets in fi nancial services and capital.
8
Cases C-212/97, Centros, [1999] ECR I-1459; C-208/00, Ueberseering, [2002] ECR
I-9919; C-167/01, Inspire Art, [2003] ECR I-10155; C-411/03, SEVIC, [2005] ECR
I-10805.
9
Directive of the European Parliament and the Council 2004/25/EC [2004] OJ L142/12 –
see article 12 (optionality for neutrality and pre bid defences).
10
In October 2007 Commissioner McCreevy abandoned further action on ‘share-
holder democracy’ (1 share:1 vote) and on the 14th Directive (corporate migration).
In February 2008 he also abandoned work on capital maintenance (2nd Company Law
Directive) reform. The original announcement relied on a false analogy between inter-
national best practice on binding balance sheet tests and EC law and a misrepresenta-
tion of the ‘Rickford’ Report on Reforming Capital, European Business Law Review,
(2004), 919. The errors were corrected in March 2008, but the conclusion was main-
tained nevertheless.
 Fr ee mov ement of capita l a n d protection ism 63

so on.11 This is particularly worrying, even distressing, for an observer

from a Member State with open markets. One sees domestic businesses
being acquired from foreign states (perfectly acceptably if the mar-
ket so concludes) but then locked into closed corporate and national
legal structures which lock out subsequent open restructuring – not so
much the notorious ‘unlevel playing field’, of the football metaphor, as
a kind of tilted billiard board where the balls are progressively sliding
off the table and into pockets where they are destined to remain out of
play. This irreversible progression of the market from open to closed
represents not only a stifling but a reversal of the spirit of Lisbon.
In the face of this Member State hostility to basic principles of the
European economic constitution, and the current unwillingness of
the Commission to pursue its responsibilities, this paper considers
the extent to which a reversal of these trends, and even progress, can
be looked for from the Court of Justice, as champion by default of
Community principles. The paper will focus on the impact on state
interventions in the market for corporate control of the developing
law on free movement of capital, mainly in the ‘Golden Shares’ cases
and in particular the recent Volkswagen12 decision, on the one hand,
and the relevance in that context of the developing jurisprudence in
the area of horizontal application of the fundamental freedoms,13 on
the other.
The paper thus falls into four parts:
• first, a selective survey of the free movement of capital as a constraint
on state interference in the market for corporate control, based on the
case law before Volkswagen;
• second, an examination of the implications of Volkswagen;
• third, examination of recent cases on the horizontal effect of funda-
mental freedoms and their implications for such state interference,
beyond the traditional golden share public law mechanisms, and also
for private law managerial entrenchments, which often complement
state protectionism; and
• fourth, some conclusions and a proposed solution.

11
Too frequently reported in the fi nancial pages to require enumeration. Similarly K. Hopt,
‘Concluding Remarks, ECFR Symposium on Cross-border Company Transactions’,
European Company and Financial Law Review, 4 (2007), 169.
12
Case C-112/05, EC v. Germany, [2007] ECR, I-8995.
13
Viking Line and Laval Cases (notes 88 and 89, below).
64 Perspectiv es in compa n y l aw

II. Free movement of capital

Free movement of capital ranks equally with the other three freedoms
as a fundamental principle of Community14 (soon to be EU)15 law and
as a component of the internal market which is the foundation of the
Community. In many respects it corresponds in shape and effect to
those freedoms (of goods, persons and services). But it presents special
problems, because of the detail of the text and because capital transac-
tions tend to be engaged in for ulterior or connected purposes (such as
in pursuit of investment transactions – a service – or company control
transactions – establishment), rather than in their own right.
As for the text, Article 56(1) EC simply states:
Within the framework of the provisions set out in this chapter all restric-
tions on the movement of capital between Member States and third coun-
tries shall be prohibited.

Unlike freedoms of establishment or services,16 for capital the benefici-

ary of the obligation need not be a community national. The transaction
itself is required to be free regardless of the parties, as for free movement
of goods.17 But goods applies only to inter-State transactions: the territo-
rial scope of the capital prohibition applies also to transactions between
Member States and third countries. The capital freedom thus has a wider
range than the others both as to beneficiaries and territorial scope.
Second, there are also issues about the transactions which fall within
the prohibition – what is a ‘movement of capital’? In particular what is
the distinction between such a movement (which, as we shall discover,
includes an investment in a share and the exercise of the managerial
rights attaching to a share) and an exercise of freedom of establishment,
which includes ‘the right to … set up and manage undertakings, in
particular companies or firms’?18

14
EC Treaty Articles 2, 3(1)(c) and 14 (abolition of obstacles to free movement of capital,
one of the four freedoms characterizing the common market, as a means for achieving
the Community task).
15
The Reform Treaty, agreed in October 2007 but not yet ratified, renders the internal mar-
ket an aim of the Union – Treaty on European Union, article 3(2) and defines it in article
22a, Treaty on Functioning of the European Union (which replaces the EC Treaty), sub-
stantially restating article 14, EC. Article 3(1)(c) EC is repealed. The ECJ’s approach to
the fundamental freedoms should be unaffected.
16
Articles 43, 49 EC.
17
Restrictions are prohibited ‘between Member States’ – articles 25 (customs duties) and
28 (quantitative restrictions and their equivalents).
18
Article 43, 2nd paragraph EC.
 Fr ee mov ement of capita l a n d protection ism 65

Third, where a capital transaction is engaged in as an ancillary part

of another transaction governed by a fundamental freedom, such as a
movement of goods, the provision of a service, or an exercise of a right of
establishment, to what extent is the right in question constrained by the
limits which attach to those other rights?19
A fourth, perhaps most significant, area of difficulty is the need to
characterize the kinds of Member State intervention in the markets
for corporate control which are likely to fall foul of the prohibition on
restricting capital movement.
All these issues are of concern for my purpose, which is to determine
the extent to which Member States and others are and should be con-
strained by article 56 in their ability to engage in protectionist policies
and operations.

A. Beneficiaries and territorial scope

Evidently on its face the capital freedom extends to non-Member State
nationals and to transactions between third countries and Member
States as well as to the normal scope of the EU freedoms (inter-state
trade).20 Also, since the beneficiary need not be a national, the qualifi-
cations (community incorporation, commercial character and perhaps
additional requirements) for companies and firms as beneficiaries of
freedoms of establishment and services21 do not apply.22 Such extended
territorial, transactional and personal scope of the freedom would be
significant for state protectionism – different considerations apply to
protection against 3rd countries (as opposed to inter-State transactions
and those done by Member State nationals). This might argue for a less
extensive scope for the freedom in other respects. However it will be
argued below that this is not justified.

19
Further uncertainties arise as to the interference with the freedom prohibited in terms of
the means used and the nature of the obligees, whether public, semi-public, private but
performing some public law function, or private.
20
Thus covering some ground normally within the common commercial policy – Article
113 EC.
21
As explained in Ueberseering (note 8, above). Quaere also whether even a nationally
incorporated firm must have a real economic link with a Member State economy – a
concept originally developed in the General programme on Establishment and reserved
in Ueberseering (note 8, above) at 74, 75.
22
Thus a charitable body has the benefit of the freedom for an investment in land, Case
C-386/04, Centro di Musicologia v. Finanzamt Muenchen, [2006] ECR I-8203 – article 48
applies only to ‘profit-making’ bodies.
66 Perspectiv es in compa n y l aw

B. Movement of capital
The treaty does not define ‘movement of capital’ but it has been estab-
lished since 199923 that the nomenclature in Annex I (including impor-
tant clarifications in its explanatory notes) to the Capital Directive of
198824 is ‘indicative’. This, in brief, makes it clear that investments in
companies whether direct (i.e. to establish or maintain lasting economic
links) or portfolio (i.e. broadly speaking passive) investments are cov-
ered. Direct investment includes the power ‘to participate effectively in
the management of the company or its control’.25

C. Ancillary character of capital movements

It is clear, as already noted, from this definition that free movement of
capital in some cases (but not all) covers transactions also subject to
freedom of establishment: the right to ‘set up and manage an under-
taking’, under article 43 EC, necessarily involves and coincides with,
subscription for or purchase of shares.26 So, so far as the defi nition of

23
Case C-222/97, Trummer and Mayer [1999] ECR I-1661, para 20, 21. Repeated in all
the Golden Share cases (see below) most recently in C-112/05 Commission v. Germany
(‘Volkswagen’) [2007] ECR at para 18.
24
Council Directive 88/361/EEC [1988] OJ L178/5, providing for direct implementation
of the original capital provision, old article 67 EC, which was not directly effective in
itself. Remarkably, old article 67 was materially different from article 56 EC enacted by
the Treaty of Amsterdam; it applied only to ‘movements of capital belonging to persons
resident in Member States’ – repeated in article 1 of the Directive.
25
For a company share a rigid distinction between direct and portfolio investments is
unsatisfactory since any share carries rights of control and influence and an investment
which is intended to be passive may at any time become active, for example in a public
offer – a good reason for rejecting (as the Court did) the arguments of Maduro AG in EC
v. UK (‘BAA’) and EC v. Spain, (note 34, below), that direct investment issues should be
resolved solely under the establishment chapter – but not of direct concern here, as in the
context of state protectionism only direct investments are relevant.
26
The Capital Directive Annex I nomenclature specifically includes in direct invest-
ment ‘establishment of branches or new undertakings belonging solely to the person
providing the capital and the acquisition in full of existing undertakings’ as well as
more limited participation – para I, 1 and 2. This is ‘to be understood in its widest
sense’, explanatory note para 1. It has been suggested, relying on Baars, C-251/98
[2000] ECR I-2787 at para 21, 22, that acquisitions of shares providing a ‘definite
inf luence over a company’ and allowing the shareholder to ‘determine its activi-
ties’ are a matter for freedom of establishment and not for capital – see C-208/00
Ueberseering v. Nordic Construction (note 8, above) at 77. But this now seems unsus-
tainable. Baars decided that inf luence was required for establishment, not that it
was a disqualifier for capital. The alternative question on capital in Baars was not
reached.
 Fr ee mov ement of capita l a n d protection ism 67

movements of capital is concerned, the chapter would extend to the

control transactions in companies which are of concern to protection-
ist Member States and would in that context extend the freedom to
third country transactions and to non-nationals and companies and
fi rms which do not qualify as nationals for establishment purposes.27
However article 58(2) provides that the chapter is to be ‘without preju-
dice to the applicability of restrictions on the right of establishment
which are compatible with this Treaty’. Apparently28 that exemption
will allow Member States to deny a right of direct investment under
the chapter to individuals and fi rms which could not take advantage
of the chapter on establishment – a position confi rmed by dicta in the
Volkswagen case.29
It seems therefore that in spite of its wider territorial and personal
extent the capital freedom does not extend, for transactions which
involve establishment, to persons and territories beyond the establish-
ment chapter. Therefore there is no need, in determining the appropri-
ate scope of the capital freedom, to take account of the need of Member
States in developing their mercantile policies to take special precautions
against transactions involving third countries.30
As already noted, it is sometimes argued that where capital move-
ments are ancillary to other transactions (e.g. investment services,
such as life insurance, collective investment or brokerage, or lending,
or establishment, as discussed above) it is appropriate to treat the cap-
ital right as no more extensive than the ‘primary’ right under consider-
ation. It may be argued similarly that third country nationals who seek
to make direct investments in a Member State are exercising their right
of establishment as a primary matter and free movement of capital is
really secondary in relation to that. Th is is an alternative route to the
27
Article 48 EC – also article 55 for services.
28
Unfortunately the argument is not completely free from doubt – article 57(1) pro-
vides that article 56 is without prejudice to certain restrictions which exist under
national or community law on 31 December 1993 on capital movements to or from
third countries involving direct investment, establishment, financial services and
admission of securities to listing. But this specific transitional derogation must be
without prejudice to the later general derogation for establishment restrictions in
article 58(2).
29
Case C-112/05, at para 17: ‘article 56(1) generally prohibits restrictions on movements of
capital between Member States’, citing C-282/04, EC v. Netherlands (KPN) [2006] ECR
I-9141 at para 18, which introduced this qualification.
30
Centro di Musicologia, (note 22 above), which applies capital ratione personae beyond the
beneficiaries of the establishment and services chapters, did not involve direct invest-
ment or establishment.
68 Perspectiv es in compa n y l aw

conclusion above. The Court has recently made such a finding for credit
services provided in Germany from Switzerland.31
However that line seems precarious. It may (perhaps) be possible by
the light of nature to conclude that in a credit transaction the receipt
of the service by the borrower predominates in importance over the
making of the investment by the lender. But how is it to be determined,
in the case of the acquisition of a share conferring control powers, where
the acquisition of the share and of the rights that go with it is both a cap-
ital right and an establishment right, which of the two predominates?
Moreover the Golden Share cases, to which we now turn, are not con-
sistent with this approach. They were generally decided on the basis that
both establishment and capital were in issue, but determined in practice
on the basis of capital, either because the Court regarded it as unneces-
sary also to decide on establishment, or because the Commission failed
to press that charge.32

D. Nature of the prohibited state interventions

Having characterized a capital movement for Treaty purposes as includ-
ing direct investment in companies, at first impression it seems easy
enough to identify the obligation of Member States – surely any kind
of state measure, legislative or administrative, which has the potential,
object or effect of restricting the enjoyment of the freedom should be
prohibited, on the analogy of the other freedoms?33 Matters are however
not so simple. The cases so far have focused on Member States’ reserva-
tions of control powers over companies on privatization by means of
so-called ‘Golden Shares’ powers.34

31
Case 452/04, Fidium Finanz, [2006] ECR I-09521. The Court concluded that where one
of the freedoms is ‘entirely secondary in relation to the other and may be considered
together with it’ then the state measure will be considered in relation to that other free-
dom only (at 34); the effect on cross-border fi nancial traffic was ‘merely an unavoidable
consequence of the restriction on the freedom to provide services’ and ‘the predominant
consideration is freedom to provide services rather than the free movement of capital’ (at
48, 49).
32
As in Volkswagen C-112/05 (note 23, above) at para 14, 15.
33
See the familiar jurisprudence on goods based on Case 8/74, Dassonville, [1974] ECR 837
at 5: ‘all rules … which are capable of hindering, directly or indirectly, actually or poten-
tially, intra community trade’.
34
Key cases are: Cases C-367/98, EC v. Portugal, [2002] ECR I-04731 (privatization of
a wide range of enterprises); C-483/99, EC v. France (Elf Aquitaine), [2002] I-4781;
C-503/99, EC v. Belgium (Distrigas) [2002] ECR I-4809, (‘1st generation cases’); similar
is Case C-463/00, EC v. Spain (petroleum, telecommunications, banking, tobacco and
 Fr ee mov ement of capita l a n d protection ism 69

Typically such powers attach to special shares giving Member States

rights enabling them to retain control over such enterprises in order to
prevent their operation contrary to national interests and/or prevent
undesirable persons obtaining control. Member States may accordingly
take powers to veto certain strategic transactions, such as disposals of core
assets, and certain acquisitions of shareholdings and/or of voting pow-
ers by persons, or groups of persons, above a percentage ceiling. In some
cases they also take powers to nominate board members, so as to secure
influence over ongoing operations, or at least to provide information.
Such powers may be acquired under public law provisions, or under
public law provisions authorizing or requiring issue of shares to Member
States conferring ostensibly private law powers to the same effect, or
through issue of such shares under private law.
In 1997 the Commission, viewing such measures as liable to infringe
Community law, issued a Communication to that effect35 and took legal
proceedings.

1. First generation Golden Share cases – powers

under public law
36
The first three cases all involved public law provision. The issue was made
simpler because the powers in question were conceded to amount to restric-
tions on capital. France and Portugal did argue that the provisions were not
discriminatory and did not involve any particularly restrictive treatment of
nationals of other Member States; but the court ruled that they were ‘liable
to impede the acquisition of share in the enterprises concerned’ and ‘as a
result to render free movement of capital illusory’ thus restricting the right
to make direct investments as defined by the capital directive.37 The court
thus, implicitly at least, refused to accept the argument that the provisions
were not prohibited restrictions because they did not bear differentially on
investors from outside the home Member State, i.e. inhibit ‘access’ to the
state market.38 So there were restrictions conflicting with the freedom.

electricity) [2003] ECR I-4581; C-98/01EC v. UK (BAA) [2003] ECR I-4641; C-463/00,
and C-282/04 and -283/04, EC v. Netherlands (KPN/TPG), [2006] ECR I-9141 (‘2nd
generation’).
35
Communication of the Commission On Certain Legal Aspects Concerning Intra-EU
Investment [2007] OJ C 220/15, 19.7.1997.
36
I.e. the first generation cases cited at footnote 34 above.
37
EC v. Portugal (note 34, above) at para 30 and 45–46; EC v. France (note 34, above) at para
37–42.
38
See the discussion in P. Oliver and W. Roth, ‘The Internal Market and the Four Freedoms’,
41 (2004), Common Market Law Review, 407.
70 Perspectiv es in compa n y l aw

The issue then turned on whether these (to the extent they were not
actually discriminatory)39 were justifiable by reference to the ‘rule of
reason’ or ‘general interest/proportionality’ tests familiar from the other
freedoms.40 The Court made three important rulings on what could be
regarded as legitimate general interests and proportionate protection
thereof: first, such interests would include protection of the national
petroleum and gas supply or other vital public services such as tele-
communications and electricity but did not include retention of state
controls over other enterprises such as banking, or tobacco41; second,
national economic policy could not be invoked as a general interest, so
an attempt to uphold restrictions, as necessary to secure that national
industry was restructured satisfactorily after the mass privatizations,
could not be sustained42; and third, where the powers were discretion-
ary, procedural safeguards were required to ensure transparency of the
grounds on which the powers were exercised and recourse to legal chal-
lenge to secure this. This is an important point – even where such powers
constraining or encumbering investment are exercisable on legitimate
grounds they may in fact be abused. Transparent grounds and legal
recourse must be available to meet this risk.
The effect of this first generation of cases was that where special pow-
ers to intervene in strategic decision making or to disallow acquisition of
strategic stakes were conferred by or under public law on Member States,
then if the effect was to render investment less attractive (inevitably so
given the operational constraints and limits on realisation of invest-
ment, e.g. in takeovers), the provisions would be prohibited restrictions
and not justifiable except in defence of such vital national interests as the
protection of energy supply, and then only if the powers in question were
transparent and subject to judicial scrutiny.

39
As some of the restrictions in EC v. Portugal were.
40
E.g. Case C-55/94 Gebhard, [1995] ECR I-4165 – restrictions to be justifiable must be
imposed in order to serve a (sc legitimate) general interest, must be non-discriminatory,
must be appropriate for the purpose, and must impose no greater restriction than is nec-
essary to achieve the objective.
41
EC v. Spain (note 34, above), at para 70; but in Volkswagen the Court seems to have
accepted that the general interest could be served in the context of a particular manufac-
turing company – see below.
42
EC v. Portugal (note 34, above) at para 52, 53. ‘It is settled case law that economic
grounds can never serve as justification for obstacles prohibited by the Treaty’. Portugal
claimed the powers were necessary to enable it to ensure appropriate strategic part-
ners, to strengthen the competitive market and to modernise and increase efficiency of
production.
 Fr ee mov ement of capita l a n d protection ism 71

2. Second generation Golden Share cases – powers

under private law
However the powers in these cases were conferred by or under public
law provisions and created special exceptions to the normal company
law provisions. In two later cases the powers were conferred by vesting
the special share in a government official under private law, these powers
were consistent with general company law and their legal source was the
company’s (private law) constitution.
The first of these was the BAA case, concerning a Golden Share in the
company owning the major UK airports.43 The UK government made
two important arguments:
• First, that the constraints in question (which conferred a prior
approval power on Government for disposals of major airports and
for acquisitions of more than a 15% voting stakes) could not amount
to restrictions because they bore equally on all shareholders and
thus did not constrain access to the market.44 The court responded,
following the Commission, that the restrictions ‘affected the posi-
tion of a person acquiring a shareholding as such and are thus lia-
ble to deter investors from other Member States and, consequently,
affect access to the market’. Th is amounts to an assertion that any
deterrence of other Member States investors amounts to an effect on
access regardless of whether it is greater than the effect on domes-
tic investors; this is difficult to follow and open to challenge.45 Any
provision of a company’s constitution, or indeed any provision of
mandatory company law, may deter an investor – for example a limi-
tation on the company’s objects or a provision which restricts the
extent to which the constitution can be changed or which enables
directors to be removed. If the provision is there for private purposes
then ex hypothesi there will be no general interest to be invoked
by way of justification. If it is there for public purposes it will also

43
Case C-98/01, EC v. UK (note 34, above). BAA is now wholly owned by the Spanish com-
pany Ferrovial SA.
44
At 24–7, citing the well known cases on goods, Cases C-267 and 268/91 Keck and
Mithouard [1993] ECR I-06097.
45
In EC v. Netherlands (KPN Case) (note 34, above). Maduro AG at para 24 suggested that
where any shares confer special rights they are likely to inhibit access because those
rights are likely to be vested in nationals, thus deterring investment by non-nationals.
Th is point clearly applies a fortiori to cases where the shares are vested in national gov-
ernments. It suggests a way forward – see below.
72 Perspectiv es in compa n y l aw

require justification; but does all mandatory company law require

justification?
• Second, the UK argued the powers were private-law powers, compat-
ible with UK company law (albeit unusual) and thus not ‘repugnant
to company law’. The Commission responded that this made no dif-
ference because the powers were exercisable exclusively by the UK
Government qua State. The Court rejected the UK argument on some-
what different grounds: that the articles ‘do not arise as the result of
the normal operation of company law’ but had to be approved under
the privatization Act; the UK thus acted ‘in its capacity as a public
authority’.46
The ruling on access was not a surprise.47 Although the issue had been
obscured in the previous cases by the concessions by the Member States
the Court had found a restriction in each case in spite of equal applicability.
This point apart, the decision turned on whether there was a state meas-
ure.48 This was resolved on the basis of the statutory authorization. But
that was essentially an accident: the same result could have been achieved
by the UK as shareholder adopting the relevant articles before privatiza-
tion, exercising normal shareholder powers. While the method of restric-
tion would have been different, the effect would have been the same.
This issue presented itself in the second of the cases about the use of
private law powers, EC v. Netherlands. Shortly before their privatization
the Netherlands postal and telecommunications companies resolved49
to issue to the Dutch government special shares which enabled it to
require prior approval of a wide variety of transactions, including share
issues and repurchases, distributions, mergers and demergers, and art-
icles changes, but not acquisition of shares; the government also agreed
that it would not use its powers to defeat a hostile takeover. It argued that
these provisions did not result from exercise of public power but from

46
Ibid. 47. The Commission itself suggested a ‘derogation from company law’ test in 1999
(note 35 above).
47
Although Colomer AG protested, arguing that in the interests of uniformity of applica-
tion of all the freedoms the Court ‘should temper the rigour with which it applied its
principles on restrictions applicable without distinction … as it did … in Keck’, opinion
at para 36 footnote 10.
48
The restriction on acquisition of more than 15% of voting rights bore equally on all
shareholders (except the Government which had powers to allow its removal) but noth-
ing was made of this in the case. Compare the discussion of Volkswagen below.
49
The resolution was carried by the Dutch government as shareholder – see the following
footnote.
 Fr ee mov ement of capita l a n d protection ism 73

its powers as a shareholder, as a market operation, and did not therefore

fall within article 56.50 The court had no difficulty, following established
jurisprudence, in finding that the provisions constituted restrictions on
capital, as likely to deter investors. To the argument that they were not
public measures, it responded that they were ‘state measures’, because
they were ‘the result of decisions taken by the Netherlands state in the
course of the privatization of the two companies with a view to reserving
a certain number of special rights under the companies’ statutes’.51 But,
unlike the UK case, the Court found it necessary to go on to add two
points: that the special shares conferred on the State important powers
and a disproportionate influence – i.e. one ‘not justified by the size of
its investment and greater than that which an ordinary shareholding
would normally allow it to obtain’52 and thus ‘limited the influence of
other shareholders in relation to the size of their holding’; and that they
created a risk that the Netherlands might pursue interests which did not
coincide with the economic interests of the company, thus discouraging
direct (and portfolio) investors.53
Thus the ruling turned on three points, apart from the familiar point
that the powers attached to the shares deterred investors (albeit equally
applicable as between those from the Netherlands and other Member
States): i.e. that they:
• constituted a ‘state measure’ because they were taken for privatization
purposes,
• conferred disproportionate powers at the expense of other sharehold-
ers; and
• created a risk of state interference with operation of the company in its
own best economic interests.
This deserves closer examination. The argument alleging existence of a
state measure amounts to one that use by a Member State of private law
powers may be regarded as a state measure where the purpose for their
use is a public purpose of a certain kind – in casu a privatization policy.
Such a ‘public purpose’ test will probably be satisfied whenever a state
takes a shareholding with a view to exercising influence. Only where the
state is investing as a portfolio investor is it likely that it is not exercising
50
See speech of Maduro AG at para 19; cf. the ruling at para 16, characterizing the argu-
ment as that the powers were ‘not State measures’.
51
EC v. Netherlands (note 34, above), at para 22.
52
Ibid. 24.
53
Ibid. 28.
74 Perspectiv es in compa n y l aw

some industrial or other public policy objective. So the state measure

requirement looks weak – it is likely always to be satisfied.
The nature of the disproportionality test is obscure. It may rely on
some idealized vision of what level of shareholding entitles a com-
pany member to any particular level of influence. But, as the UK
Government pointed out in BAA, national company law often allows
shareholders autonomously to determine the allocation of powers
between them, a freedom allowed by the Community legislators to
continue in the context of the Takeover Bids Directive. A subsequent
Commission study led in turn to the conclusion that departures from
proportionality could not on the evidence be regarded as contrary to
the general interest and that no further work should be done on the
issue. 54 So the idealized view of proportionality is neither defined nor
agreed.
An alternative view of proportionality, not open to these objections
and conceivably what the Court had in mind, would be by reference to
the default rules of the national company law applicable; a departure
from these being not ‘normal’. 55 It is true that default rules in all Member
States seem to provide for a ‘one share: one vote’ rule and a standard
level of minority blocking power in relation to decisions of major impor-
tance. However the decisions which require special majority approval
(and thus confer a disproportionate blocking power on dissenters) are
by no means uniform in their nature in all Member States, nor are the
majorities required the same. Moreover ordinary default rules are by
no means uniform. So reference to departure from such rules would
produce different results in different Member States. Again, it by no
means follows from the existence of a default rule that it is ‘normally’
followed – a conclusion which would require a statistical examination of
national practice. So this ‘non-idealized’ version of the proportionality
rule would have a subjective effect as between Member States, produc-
ing an absence of uniformity in the measures permitted to deter capital

54
Commission announcement of October 2007 (note 10, above) referring to a Report by
KPMG.
55
EC v. Netherlands (note 34, above), at para 24. Compare the Commission assertion in its
Communication of 1999 that even provisions of general application allowing state veto
of certain operational decisions and state board nominations for that purpose are offen-
sive as ‘in derogation of company law’. This however seems to posit some single Platonic
ideal, so to speak, of company law, rather than one that varies between Member States.
Of course no such ideal model exists and special veto or nomination rights for particular
shareholders or others are quite lawful under general law in many States.
 Fr ee mov ement of capita l a n d protection ism 75

movement as between different States.56 It is not evident why company

law rules should have this differential effect on the operation of a fun-
damental freedom, nor why national rules should determine whether
capital movement is restricted.
The third test, relating to risk of abuse, is of course the heart of the
matter. The concern is always the risk that powers may be exercised for
purposes contrary to EU principles, particularly in pursuit of economic
policies designed to achieve nationalist industrial policies and protec-
tionism. The Court puts this argument in different terms however –
i.e. of the risk that the State will depart from the economic interests of
the company – following the Advocate General, who suggested that the
principle should be that once the state places an enterprise in the market
place it must live by the laws of the market place and in consequence
must respect the company’s economic autonomy, justifications by ref-
erence to security of public services apart.57 But this is too wide – it is
not in fact a universal principle of States’ company laws that sharehold-
ers’ powers must be exercised in the economic interest of the company
(whatever that means) and even when such a principle operates it is no
part of the competence of the Community to ensure that it is upheld. On
the other hand, exercise of discretionary powers to impede the common
market is of course highly offensive to Community principle and this is
the risk of abuse which should be considered here.
Two further comments can be made about this risk test (whether or
not the narrower scope for it argued for here is accepted):
• First, it will be satisfied in all cases where a Member State holds pow-
ers conferred by a company constitution or by public law to determine
or influence a company’s control, operations or strategy. Thus, while
vital, it does not provide a useful criterion for determining which
powers amount to a restriction – it suggests that all do.
• Second, the essence of the matter is the risk, or potential, for abuse. This
suggests that, short of outlawing all such powers, the appropriate response
is to outlaw those that conflict with community principles on the face of it
and to ensure that the remainder are not abused in that way.
56
The same can be said of reference to departures from mandatory, as opposed to default,
company law rules, not in issue in the BAA or KPN cases, but which may be implicit in
the first generation cases and as we shall see below were relevant in Volkswagen.
57
ECJ at para 27–28, Maduro AG at para 27–30. Cf. D. Wyatt, A. Dashwood and others,
European Union Law, 5th Edn. (London: Sweet and Maxwell, London, 2005) 860–1,
suggesting that this is the meaning to be attached to the Commission’s ‘derogation from
company law’ test.
76 Perspectiv es in compa n y l aw

It was with this in mind that the High Level Group on Company Law
and Corporate Governance (‘Winter Group’) in its first report, recom-
mended that Golden Share powers should be subjected to public law due
process principles – i.e. transparency and judicial review. 58 This calls to
mind the approach to discretionary powers conferred by public law and
the concern about the assertion of Member States’ ‘economic policy’,
considered by the Court at the level of justification in the first genera-
tion cases, discussed above. The Court there required that discretionary
powers should be subject to due process and seems to have rejected eco-
nomic policies contrary to the market.59
This is a key to the problem. But it is appropriate, before developing it, to
complete the picture by considering the recent Volkswagen case and cases
suggesting community freedoms apply to private law measures, whether
or not states (or other bodies with public law functions) are involved.
A further question arises from the Netherlands (KPN) case. To what
extent are the three grounds in the case independent? Would it have
been decided the same way on the basis of any one or more, or are all
three required, at least in cases where private law powers are in play? Is
it enough that investment is deterred either by state measure, or by ‘dis-
proportionate’ powers conferred on a state, or by powers which create
a risk (whether to the company as the Court asserts or to the common
market, as is argued here)? This question too is best examined after con-
sidering Volkswagen.

III. The effects of Volkswagen60

The notoriety of this case is such that it is likely to be much relied
upon. But it does not give clear guidance to Member States and inves-
tors concerned with the liberty of investment across frontiers in the
Community.
Volkswagen was founded in the 1930s to manufacture the people’s
car. It was largely controlled by government and trades unions and
financed by deposits from prospective car purchasers. After World War
II it fell to the German government to determine how the enterprise

58
Report of the High Level Group of Company Law Experts, Report on Issues Related to
Takeover Bids, Brussels 10 January 2002, 34.
59
The scope of the ECJ’s economic policy objection is vague. For a similar suggestion as to its scope
see Wyatt and Dashwood, European Union Law (note 57, above). Compare Case C-174/04, EC v.
Italy [2005] ECR I-04933 (‘golden share’ to achieve interstate competition policy).
60
Case C-112/05, EC v. Germany (‘Volkswagen’), [2007] ECR I-8995.
 Fr ee mov ement of capita l a n d protection ism 77

(now essentially bona vacantia but with various moral claims on its
ownership) was to be owned and controlled. Under a historic compro-
mise, after long debate between Federal Government, the Land of Lower
Saxony (where the enterprise and its factory was based), the trades
unions and other claimants, the matter was settled by federal legislation
in 1960 privatizing Volkswagen. Th is Act incorporated the statutes of
the new Volkwagen AG, and enabled 60% of the shares to be sold to the
public while 20% each were retained by the Federal Government (sold at
the time of the proceedings) and Lower Saxony.61
The legislation contained three provisions which the Commission
argued were unlawful restrictions on free movement of capital and free-
dom of establishment:62
• a voting rights cap of 20% – i.e. provision that any holding in excess of
20% was disenfranchised to that extent;
• special board nomination powers – i.e. power for The Federal
Government and the Land of Lower Saxony each to appoint two mem-
bers of the supervisory board;
• a 20% enhanced blocking minority power – i.e. special company reso-
lutions normally requiring a 75% majority were to require 80%.
Two general arguments were dealt with by the court for all three
restrictions:
• First, Germany argued that this was not a state measure as required for
liability by previous cases. The Court assumed that such a measure was
needed but had no difficulty in concluding the restrictions, as imposed
by legislation were ‘a manifestation par excellence of State power’.63
• Second, the Court concluded that the provisions satisfied the require-
ment that they deterred investors from other Member States by restrict-
ing their ability to participate effectively in management. This conclusion
was reached for the board appointment power independently;64 for the
enhanced minority and voting cap provisions it was taken in combina-
tion – i.e. that the two provisions taken together had this effect.65

61
Th is settlement has been widely regarded in Germany as epitomizing the German post-
war ‘economic miracle’ and its ‘social market’ model. For a fuller account see Colomer
AG, footnote 47.
62
The Commission failed to pursue the establishment charge which was on that ground
dismissed by the Court, at paras 13–16.
63
Volkswagen para 27.
64
Ibid. para 66.
65
Ibid, paras 51–5.
78 Perspectiv es in compa n y l aw

However apparently these two conclusions were not enough to settle

the case.
On the board appointment provisions, the Court noted that these
enabled the Land and Federal Government to appoint more members
by such special powers than was permitted under general law (which
limited such rights to one third of shareholders representatives)66.
This was thus a specific right which derogated from general company
law, enabling the two governments ‘to participate in a more signifi-
cant manner in the … supervisory board than their status of share-
holders would normally allow’. This possibility would continue even
if they held only one share each. So the provision gave these authori-
ties ‘the possibility of exercising influence which exceeds their levels
of investment’.67
It is not clear whether the two points – that the appointment powers
(i) were greater than normally allowed (i.e. conflicted with general man-
datory company law) and (ii) ‘exceeded the level of their investment’ (i.e.
were disproportionate to the potential level of shareholding which con-
ferred them) – were separate points. If the Land had only been entitled
to appoint one of the ten shareholder members would this have been dis-
proportionate, albeit company law would have allowed it, or would the
provision have needed to require that the Land should for this purpose
retain 10% of the share capital (corresponding to 10% of the shareholder
members) to satisfy the proportionality criterion? The decision indeed
reads on first impression as if the Court regarded a level of representa-
tion corresponding to shareholding (‘proportionate’) as both necessary
and sufficient,68 but this is by no means a principle of the generality of
community law. In many EU states, including the UK and Ireland (and
I believe France and Belgium), directors can only be securely maintained
66
Art. 101(2) AktG (which makes express exception for Volkswagen). German law sets
the size of the supervisory board (which appoints and dismisses the management board
and thus ultimately controls both strategy and operations) for companies of this size
at twenty, with ten to be appointed by or on behalf of employees (art. 7 MitbestG). The
maximum number of shareholder representatives allowed to be appointed by such spe-
cial appointment powers was therefore three. The effect of the power even when exer-
cised only by Lower Saxony was to confer a blocking majority on a combination of Lower
Saxony and the employee representatives thus creating an effective veto on takeovers for
Lower Saxony.
67
Volkswagen, paras 61–4.
68
A position adopted by Colomer AG at 72 ‘this exclusive power is totally detached from
the importance of their respective shareholdings … and ruptures the symmetry between
the power of capital and the possibilities of management’ (author’s translation, emphasis
added).
 Fr ee mov ement of capita l a n d protection ism 79

in office by a simple majority.69 It is also unclear whether if the power had

been proportionate but had conflicted with mandatory company law
it would have been acceptable. For example, suppose that the case had
arisen in the UK, would it have been sufficient for the law to have allowed
a power of appointment proportionate to the holding, even though this
would have confl icted with the normal UK mandatory provision allow-
ing a bare majority to dismiss ad nutum?
It may be argued that this ruling creates a Community proportional-
ity principle, in the generally recognised sense, for shareholder powers
exercisable by states by virtue of state measures.70 This seems doubtful in
view of the above points. Nor does the test seem apt to address the mis-
chief in hand. The proportionality of the powers held by a state by refer-
ence to the size of its holding bears no relation to the risk that the powers
held will (be used to) deter investors. The mere fact that a holding is
proportional to the powers of a state can hardly be regarded as allowing
those powers to be exercised in a discriminatory fashion. Why should
such proportionality allow powers to be used to impede access by inves-
tors from other Member States? Yet if satisfaction of this test renders a
power no longer a restriction its potential or actual use to hinder access
to the State market is presumably not open to challenge.
The remaining two provisions in question, the voting cap and the
enhanced minority provision, the Court considered together, as the
Advocate General had done. Germany argued that these provisions
could not amount to restrictions because, unlike all the earlier cases,
they bore equally on all shareholders conferring burdens and (allegedly)
benefits on all, rather than conferring special privileges on the two state
authorities. While the voting cap was contrary to mandatory German
law (which imposes a ‘one share, one vote’ rule for listed companies),71
nothing in Community law prevented Germany from adapting this rule
for particular companies. This was a formidable line of argument. If pro-
visions which bear equally on all shareholders are objectionable, where
is the limit to the powers exercisable by Member States as shareholders
which are objectionable? Any normal company law power could be so.
The Advocate General considered the two provisions together, maintain-
ing that it was their combined effect which was to be considered (without
69
Companies Act 2006 sections 168, 169.
70
As argued by J. van Bekkum, J. Kloosterman and J. Winter, ‘Golden Shares and European
Company Law – the Implications of Volkswagen’, European Law Review, (2008)
(forthcoming).
71
Art 134(1) AktG.
80 Perspectiv es in compa n y l aw

explaining what special effect the combination achieved) and relied on two
points (apart from the general deterrent effect of the provisions on investors
seeking to exercise management control): that the provisions were imposed
by a special law by the Government itself and that the special minority posi-
tion entrenched the Land by virtue of its particular shareholding, which
conferred the very blocking minority required to secure its use.
The Court accepted the German assertion that the cap provision was
applicable without distinction to all shareholders and was a ‘recognised
instrument of company law’,72 but noted that it was an infringement of
German mandatory company law. However, it clearly did not regard this
as sufficient to outlaw it. So it turned, like the Advocate General, to con-
sider the cap and the enhanced minority provisions together.
The relevant German special resolution provisions to which the special
minority rule applied were those on various key strategic issues including
amendment of the statutes and certain decisions relating to capital and
financial structures.73 While the 75% majority was the default rule nothing
prevented companies from adopting articles with a higher requirement.
However the Court noted that for Volkswagen the provision had been
made mandatory by legislation and could not be revoked by the sharehold-
ers.74 The provision was thus an exception to mandatory German company
law in that sense; however the Court did not explicitly take that point.
But the critical aspect in this connection seems to have been that at
the time of the enactment both state authorities, and still at the time of
judgment the Land, held an approximately 20% holding – i.e. perfectly
fitted to take advantage of the blocking minority provision – and were
thus able to ensure, once the legislation was enacted, that no structural
changes of the relevant kind could ever take place without the consent
of each of them – a position which was bound to deter direct investors
and particularly takeover bids.75 This enabled the court to hold that the

72
Case C-112/05, EC v. Germany, (note 60, above), paras 42, 38. German law allows voting
caps for unlisted companies and they are common in certain other European states: see the
Report of Institutional Shareholder Services on Proportionality between Ownership and
Control in the EU, EC Brussels April 2007, 31. Note that the Court accepted this argument
although the cap infringes any ‘ideal’ notion of proportionality of holding to voting power.
73
Th is is all that is mentioned by the Court but a 75% majority is required for a number of
other matters including mergers and voluntary dissolution.
74
Case C-112/05, EC v. Germany, (note 60, above), para 45.
75
The Court noted that takeover bids were in issue, though somewhat curiously, it mentions
this in the context of the establishment issue, at paras 14, 15. For Porsche SE’s current
attempts to acquire control, see G.-J. Vossestein, ‘Volkswagen, The State of Affairs of
Golden Shares’, 5:1 (2008), European Company and Financial Law Review, 132.
 Fr ee mov ement of capita l a n d protection ism 81

provision thus enabled the Federal and State authorities ‘to procure for
themselves a blocking minority on the basis of a lower level of invest-
ment than would be required under general company law’.76 In other
words on the facts the effect of the provision was to confer a special right
on Lower Saxony (and allegedly on the Federal Government, which was
true at the time of the legislation but was however no longer true). While
the court did not say so, and perhaps implies otherwise,77 a further
shareholder could take a 20% holding (or a smaller one sufficient for the
necessary blocking minority de facto) and would in so doing be able also
to exercise the same right of veto; but in practice such a second right of
veto would be of little value given the first mover advantage of the Land
and would depress the value of the shares generally.
What of the voting cap? The Court held that ‘by capping voting rights
at the same level of 20% [the cap] supplements a legal framework which
enables [these] authorities to exercise considerable influence on the basis
of such a reduced investment (i.e. 20%)’ and this situation (the combina-
tion of powers) was likely to deter investors.
This combined ruling is problematic. It clearly implies that each of
the two powers would have been lawful without the other, and that there
was some synergy between them which rendered them unlawful.
So apparently the Court did not believe that either provision, the cap
or the enhanced blocking power, were sufficient in themselves to con-
stitute a restriction. This was so although the former was contrary to
German mandatory law (and clearly made the company a less attractive
target for direct investors seeking to exercise control or influence) and
the latter was contrary to default law (and excluded a mandatory consen-
sual power, though it would have been lawful as a consensual provision),
and also conferred on Lower Saxony de facto a special blocking power
over constitutional change and other strategic decisions based on a lower
than normal level of investment. The reason why the Court felt unable
to find against the cap seems to have been that it conferred no special
right on the authorities. The enhanced blocking power did do so de facto.
Why did the Court not regard this as sufficient to find against this power
in isolation? Perhaps the Court believed or assumed that a special legal
power was needed to do so, but the factual result was to confer a special
right which would be a wholly effective deterrent for strategic investors,
as the Court clearly recognised. That is the concern of European law.

76
Case C-112/05, EC v. Germany, (note 60, above), para 50.
77
Ibid. ‘enabling the authorities to procure for themselves’.
82 Perspectiv es in compa n y l aw

We need therefore in order to understand the Court’s objection to

the two powers in combination to understand the objectionable synergy
between them. In what way was the operation of the two powers in com-
bination offensive? Each provision deters direct investors, but separately –
the cap, because it makes it difficult for them to exercise influence outside
the field of the special minority decision – and the special minority provi-
sion, because it makes influence impossible (without state consent) within
that field. The Court drew attention to the fact that the cap and the minor-
ity provision both applied at 20%78 but that was incidental. There there-
fore seems to have been no legal synergy between the two provisions. One
conferred a veto on certain strategic decisions; the other made investment
less attractive in relation to the remaining, mainly operational, decisions
because it made collective action more difficult – a difficulty increased by
the Lower Saxony 20% holding, but there was no magic in that context in
the 20%. If there was no legal synergy we are driven to consider synergy
on the facts. The two provisions taken together did deter investors more
than each provision separately. Perhaps this point about the degree of
deterrence taken together founded the Court’s conclusion.
But this rationale is unsatisfactory. If the fact that provisions confer
no special powers on Member States excludes them, then how can two
such provisions be objectionable taken together? If on the other hand
the de facto special benefit of the enhanced minority provision rendered
it objectionable (as is strongly arguable if we accept the general rationale,
although an alternative approach will be suggested below) then why was
that provision (which absolutely barred direct investors from power over
the constitution, for example) not objectionable in isolation? Why was it
necessary that there should have been a voting cap as well? Finally, if the
objection to a power depends on the degree of deterrence de facto, then
how is the objectionable degree to be calibrated?
The Court would apparently have had little difficulty in finding against
the enhanced minority in isolation as a de facto special veto power con-
ferred on the basis of a lower shareholding than normal. It clearly felt
the need to find against the cap as well. But what was the real objection
to the cap? Surely that, although it applied equally to all shareholders,
in practice it made direct investment less attractive, thus enhancing the
control powers of Lower Saxony.79

78
Ibid. ‘at the same level’ paragraph 51 cited in full above.
79
The enhanced majority looks objectionable per se. It is reported at the time of writing
that the German government proposes relying on the combined nature of the ruling to
 Fr ee mov ement of capita l a n d protection ism 83

The case thus leaves us with the conclusion that for powers over com-
pany control and operations to be objectionable they must be:
i. likely to deter investors (perhaps particularly investors from other
Member States);
ii. be exerciseable by states; and
iii. be operable in pursuance of a state measure80 or state power81
(though how significant this is, is debatable).82
Further factors regarded by the Court as relevant are whether the
measure:
iv. creates a special power for the state authority;
v. infringes mandatory state law,
vi. departs from default state law; or
vii. infringes proportionality principles (which may be by reference to
state law or to some abstract ideal of proportionality).83
More sense needs urgently to be made of this catalogue. Items (i) to (iii)
seem to be necessary in all cases on the basis of the cases. But the extent
to which (iv) to (vii) are needed and in what combination is far from
clear. But before considering this task we need to examine the recent
jurisprudence on horizontal effect, which brings into question the extent
to which (i) to (iii) are required.

IV. Horizontal effects

There is no doubt that the obligation not to obstruct movement of capi-
tal, like the other freedoms, binds Member States and other state bodies.
It has for many years been debated whether these obligations also bind
private persons exercising autonomous private law powers.
Extension of the freedoms to bind private bodies exercising autono-
mous powers under private law would, if it applies to capital, exclude
a fortiori any requirement that Member States exercising such powers

leave this in place while repealing the cap and the appointment power, blocking Porsche
control. See Financial Times 26 January 2008, 19, and 15 March 2008, 21.
80
KPN (note 34, above), at para 22.
81
Volkswagen (note 60, above), at para 27.
82
See the discussion of the KPN case (note 34, above).
83
There is also an important (but beyond our purpose) ruling in Volkswagen that the
restrictions were not justified by protection of employees from strategic or control
changes, Volkswagen (note 60, above) at para 74.
84 Perspectiv es in compa n y l aw

must do so under a state measure or must be in some sense exercising

sovereign power.
A series of cases on free movement of workers and services have
imposed the obligation on bodies exercising rule-making functions
under private-law powers, including bodies making rules about sports84
and this case law has been applied to professional services and establish-
ment85. In one case (Angonese)86 freedom of movement of workers has
been held to bind a private employer, even though not exercising any
rule-making function,87 but only in respect of discriminatory practices.
This case law has been extended by two recent cases: Laval88 and
Viking Line89. Both involved trade union industrial action under pri-
vate law powers. In Laval Swedish trades unions sought, by ‘blockading’
Laval work sites in Sweden staffed by Laval, a Latvian company provid-
ing workers in Sweden to work on building sites operated by a subsidiary
of Laval, to force Laval to sign the Swedish building sector collective
agreement, and to pay a certain hourly wage. Laval claimed this was an
unlawful restriction of its freedom to provide services in Sweden and
sought a declaration and damages.90 The Court held compliance with
article 49 EC, on freedom of services ‘is also required in the case of rules
which are not public in nature but which are designed to regulate collec-
tively provision of services’ and applies to ‘exercise of their legal auton-
omy by associations or organizations not governed by public law’;91 so

84
Case 36/74, Walrave v. Union Cycliste Internationale, [1974] ECR 1405 (discrimina-
tory rules governing cycle racing – affecting workers and services); Case 13–76, Dona
v. Mantero, [1976] ECR 1333 (discriminatory rules of a football association affecting
workers and services); C-415/93, Union Royale Belge des Societes de Football Association
v. Bosman, [1995] ECR I-4921 (Belgian National football association imposing transfer
fees on cross-border transfers and discriminating on eligibility to play for other nation
clubs – affecting workers and services); C-51/96 C-191/97, Christelle Deliège v. Ligue
francophone de Judo et al, [2000] ECR I-02549 – to similar effect.
85
C-309/99, Wouters v. Algemene Raad van Nederlands Orde van Advocaten, [2002] ECR
I-1577 (professional rules on cross-professional partnerships for advocates – affecting
services and establishment).
86
C-281/98, Roman Angonese v. Cassa di Risparmio di Bolzano, [2000] ECR I-4139.
87
The practice was permitted but not required by a collective agreement so the decision to
apply it was that of the individual defendant employer, ibid. at para 11, 36, 37.
88
C-341/05, Laval un Partneri Ltd v. Svensaka Byggnadsarbefoerbundets et al, [2007] ECR
I – not yet reported.
89
C-438/05, International Transport Workers Union and Finnish Seamens’ Union v. Viking
Line ABP, [2007] ECR I – not yet reported.
90
The terms sought by the union went beyond those the host state was entitled to impose
on services operators under the relevant Community Directive.
91
Laval (note 88, above), at para 98.
 Fr ee mov ement of capita l a n d protection ism 85

that article precluded the union from forcing Laval to enter negotiations
on rates of pay and to sign the agreement.
In Viking Line Viking proposed to re-register in Estonia a ship regis-
tered in Finland, and thus crewed at Finnish rates of pay, in order to sub-
ject it to the lower Estonian rates. The unions sought by collective action
to prevent this. Viking claimed a declaration that this interfered with its
freedom of establishment, and injunctive relief. The referring court asked
the European Court if ‘article 43 has horizontal direct effect so as to confer
rights on private undertakings which may be relied on against another pri-
vate party and, in particular a trade union in respect of collective action’.
The Court ruled that it was clear from the case law that ‘abolition of obsta-
cles to free movement of persons and services would be compromised if
the abolition of state barriers could be neutralized by obstacles resulting
from the exercise by associations or organizations not governed by public
law of their legal autonomy [citing the cases mentioned above92]’.93 It added
that ‘it does not follow [from that case law] that that interpretation applies
only to quasi public organizations or to associations exercising a regula-
tory task and having quasi legislative powers. There is no indication in that
case law that could validly support the view that it applies only to [such
organizations and associations]’; but the court then added ‘furthermore it
must be pointed out that in exercising their autonomous power pursuant
to their trade union rights … trade unions participate in the drawing up of
agreements seeking to regulate paid work collectively’.94
Three questions are prompted by this body of case law in the present
context:
• Does the case law apply to freedom of capital?
• What are the implications for the restriction applied in the Golden
Share cases that, for the obligation to apply, the state must pursue a
‘national measure’ or exercise ‘state power’?
• What are the implications for private persons in the company law context
with powers which enable them to impede free movement of capital?
There can be no doubt that this case law applies to free movement of
capital. It applies to establishment and the two freedoms are consistently

92
Walrave, Bosman, Deliege, Angonese (note 84, above).
93
Viking Line (note 89, above), at para 57.
94
Ibid. at para 33 ‘articles 39, 43 and 49 [freedom of workers establishment and services] do
not apply only to the actions of public authorities but extend also to rules of any nature
aimed at regulating in a collective manner gainful employment, self-employment and
the provision of services’.
86 Perspectiv es in compa n y l aw

treated in the Golden share cases as subject to the same rules. Moreover,
since the cases of concern also involve establishment this case law will
apply by that route anyway.
On the second question, it seems strongly arguable that since the
case law applies to private persons exercising private powers it follows
a fortiori that it does to public persons exercising private powers. Th is
is wholly in conformity with community principles. As the Advocate
General pointed out in the KPN case, Member States are bound by
the treaties qua signatories and not qua state authorities.95 Moreover,
Member States are obliged by article 10 EC to ensure fulfi lment of the
obligations arising out of the Treaty, to facilitate the achievement of the
Community’s tasks and to abstain from any measure which could jeop-
ardize the attainment of the objectives of the Treaty. Where a State can
exercise a power in a way which has the object or effect of restricting a
fundamental freedom it is bound to comply with the treaty, whatever
the legal basis of that power. If a state may exercise powers by virtue of a
shareholding in a company then it must not do so in a manner which dis-
criminates, nor in a manner which restricts the fundamental freedoms of
others, however that share was acquired. Similarly if a share is acquired
with the object of restricting such freedoms or its acquisition would tend
to have that effect, that is a breach of the Treaty by that State.
It may be argued that this reasoning neglects the point that the cases
apply the law to private persons exercising quasi-regulatory functions.
Very considerable doubt at the least is cast on this by the ruling in
Viking quoted above (although it does then emphasize that the union in
question had powers to seek to draw up agreements that regulate work
collectively). But in any case this restriction is clearly intended to limit
the nature of the private bodies who are to be subject to the case law; it is
very doubtful that the court would apply it to a public body.96
On the third question, how far can private persons engaging in pro-
tectionist activity intended to inhibit free movement of capital be bound
by the horizontal effect of the freedom? This is more speculative. It is
doubtful whether where a private party engages for private purposes

95
‘Treaty provisions on free movement of persons services and capital impose obliga-
tions on national authorities regardless of whether these authorities act as public pow-
ers or private law entities’: Maduro AG in EC v. Netherlands (note 89, above), at para 22
(author’s translation) and again in cases C-463 and 464/04 Federconsumatori et al v.
Comune di Milano [2007] ECR I – not yet reported, at para 22.
96
Perhaps company constitutions, given the breadth of their effect, do regulate a matter
collectively.
 Fr ee mov ement of capita l a n d protection ism 87

in conduct which falls short of discrimination (which is probably out-

lawed by Angonese)97 the freedoms can be invoked. But there is room
for development of a principle, and some authority, that where such a
party engages in such conduct for public purposes, then on the analogy
of a trade union which is entrusted by private law with the function of
negotiating collective agreements with general effect, that party should
be subject to the obligation not to obstruct the operation of the freedoms
except in conditions permitted by community law. Where a private party
is entrusted with public functions under private law the treaty freedoms
apply to that party because he acts as a surrogate for the state.98
Two examples of the application of this principle in the context of pri-
vate persons exercising company powers impeding freedom of capital
come to mind:
• First, in the case of some companies a special shareholding is vested
in a private body entrusted with functions for the general good. A UK
example is the Reuters Trust which has the responsibility of ensuring
through a private law Golden Share that control changes in Reuters
plc do not endanger editorial independence. Similar is the position
of certain foundations in Nordic countries which hold voting shares,
often with enhanced powers, exercisable for the benefit of the com-
pany in the widest sense, including its continuity, the interests of the
employees and the community in which it operates.
• Second, the company laws of some States confer public functions on
company boards in the sense that their fidelity obligation requires that
they serve not only interests of shareholders but also a wider range of
constituencies and the public interest. Such boards are similarly act-
ing as surrogates for the state. A particular context is where boards
exercise powers to frustrate the success of takeover bids under author-
ity allowed them under the Takeover Bids Directive99 and in particular
the so-called ‘reciprocity’ power to block a bid from a company with
a less open structure than their own.100 It is clear from the legislative

97
Note 86, above.
98
Cases 266 and 267/87, The Queen v. Royal Pharmaceutical Society, [1989] ECR I-1295;
Case C-16/94, Édouard Dubois et Fils SA and Général Cargo Services SA v. Garonor
Exploitation SA, [1995] ECR I-2421.
99
Directive 2004/25/EC, article 12.
100
The legality of the Directive is beyond the scope of this paper – see J. Rickford, ‘The
Emerging European Takeover Law from a British Perspective’, European Business Law
Review, (2004), 1379, 1402 (‘contrary to well recognized Treaty principles’), devel-
oped in ‘Takeovers in Europe: a UK Perspective’, in T. Baums and A. Cahn (eds.), Die
88 Perspectiv es in compa n y l aw

history that this has a public purpose – to level the regulatory play-
ing field. Boards exercising such powers should be subject to Treaty
freedoms.

V. Conclusion – proposed way forward

How are the uncertainties attaching to Golden Share cases and horizon-
tal-effects cases to be resolved? As in every game it is important to keep
our eye on the ball. As Eddy Wymeersch has himself pointed out more
than once,101 it is not the concern of the Court of Justice or European
lawyer to create company law. Nor is it therefore to impose some ideal-
ized version of company law on Member States, nor their own company
law default rules, nor even their mandatory rules – it is to ensure that
States do not adopt powers or actions which conflict with Treaty prin-
ciples – i.e., here, which have the object or effect of deterrence of inter-
State investment.
We must address realities: it is notorious that Member States, in tak-
ing powers over companies, whether by public law or private law and
whether by special provision or by acquisition of shares in the mar-
ket place, often (perhaps always) intend to use those powers in pur-
suit of their industrial policies, frequently for protectionist or other
purposes confl icting with Treaty principles. The issue is not the legal
means by which those powers are obtained, nor the nature of legal
provisions under which they are exercisable, but the actual or poten-
tial effect of their existence and actual or potential use. It follows from
this reasoning, and, as we have seen, from the implications of the
Netherlands (KPN) case and the authorities on the horizontal effects
of the freedoms, that insistence that States are only subject to Treaty
principles if they are acting under State measures is unsustainable. It is
sufficient if they are pursuing political objectives. Or to put it another
way, the ‘state measure’ requirement in KPN is met wherever states have
or may have an industrial policy objective – privatization is merely an
example. Similarly insistence on qualifications by reference to actual

Umsetzung der Uebernahmerichtlinie in Europa (Berlin: De Gruyter, 2006) 88, 89; cf.
Wyatt, Dashwood and others, European Union Law (note 57, above), Chapter 20.
101
‘Cross-Border Transfer of the Seat of a Company’, Chapter 6 in J. Rickford (ed.), The
European Company (Antwerp: Intersentia, 2003) 83, 84; and again, E. Wymeersch, ‘The
Transfer of a Company Seat in European Company Law’, 40 (2003) Common Market
Law Review, 661, 674.
 Fr ee mov ement of capita l a n d protection ism 89

or ideal company law provisions would only be justifiable if compliance

with such provisions were an indicator of absence of the mischievous
effect (or even conceivably an indicator that it would be less likely). As
a matter of common experience, that is not so – whatever the character
of a State’s control power it has the potential for protectionist abuse; in
some states such abuse is very likely, not disguised and even publicly
paraded to deter unwelcome investors. Moreover what applies to States
also applies to bodies acting as surrogates of States, such as nationalized
industries and state investment banks.102
All this is wholly consistent with the general principles of the
European economic constitution and far from original. More difficult
is how to carry it through in terms of legal consequences in this sensi-
tive context. Clearly where States exercise such powers in ways which
are discriminatory or deter cross-border investment such exercises
are open to challenge. But, as the Court recognizes, the problem lies
deeper. The very existence of the powers carries the risk of abuse. Such
powers are objectionable as such unless they are subject to a transpar-
ent and enforceable regime at domestic level which ensures that they
are only used for legitimate purposes. If such a regime is in place then
investment will not be unlawfully deterred because there is an assur-
ance of the absence of abuse. The burden is on Member States to show
that such regimes are effective as the Court itself ruled in the France
and Belgium cases. In the absence of such regimes the powers exercis-
able by States should be void as contrary to Community law; if they
are attached to shares, the shares should remain valid, but be shorn of
control rights.
There will be strong political opposition to this proposal and the
Commission may well be unable to summon the necessary internal con-
viction to pursue it before the Court. But fortunately that is not neces-
sary. Any shareholder in a company subject to such powers may pursue
it. A suitable test case might be brought by such a shareholder wishing
to pursue or facilitate a takeover bid. A shareholders’ association has
already successfully challenged a Golden Share in this way.103 Damages
will be available, as well as enforcement orders.104

102
Such as the Caisse des Depots et Consignations in France.
103
Cases C-463 and 464/04 Federconsumatori et al v. Comune di Milano (disproportion-
ate, but lawful, control power reserved by local authority in articles under private law
powers).
104
As in the Laval and Viking cases (notes 88 and 89, above). Cases C-46 and 48/93,
Brasserie du Pecheur/Factortame III [1996] ECR I-1029.
90 Perspectiv es in compa n y l aw

Similar conclusions can be applied to company organs exercising

public law powers. It is often argued that private persons are subject to
Treaty principles even when exercising private powers. This seems a step
too far105 and one the Court deliberately did not take in Volkswagen,
Laval and Viking. It is not necessary for the purposes examined here.
And it is sufficient to leave the discipline of true market players to the
market, to autonomous regulation and to competition law.

105
See van Bekkum, Kloosterman and Winter, ‘Golden Shares and European Company
Law – the Implications of Volkswagen’, (note 70, above). Many contra, e.g. Wyatt,
Dashwood et al., European Union Law (note 57, above), 861–863; M. Andenas, T. Guett
and M. Pannier, ‘Free Movement of Capital and National Company Law’, European
Business Law Review, 16 (2005) 757, 775.
 5

Centros and the cost of branching*

Marco Becht, Luca Enr iques and
Veronik a Korom

Following the Centros, Überseering and Inspire Art decisions of the ECJ
a thriving market for incorporations has developed in the European
Union. Round-trip incorporation is competing with domestic incorpor-
ation. Entrepreneurs can set up a shell company in any EU jurisdiction
and branch back to their home country to operate a business. The UK
Limited is a popular choice in many countries because it is rapidly and
cheaply available online with minimum formalities. We develop a tax-
onomy for measuring the cost of Limited round-trip incorporation. The
cost of setting up a Limited is directly observable in the market while the
cost of branching is not. We run field experiments to measure the cost of
branching. Our analysis reveals that despite the ECJ rulings, branching
remains costly or impractical in many cases. Incorporation agents play
an essential role in overcoming the limitations to branching.

I. Introduction
To incorporate a business at a lower cost than required by domestic com-
pany law, a Danish couple set up a UK shell company, Centros Limited,
to operate a business exclusively in Denmark via a branch. Technically
this was achieved by registering Centros Limited with Companies
House in the United Kingdom and by applying for registration of a
branch with the Danish companies register. After the Danish companies
1

* We are very grateful to Thomas Bachner, Niklas Cornelius, Francesco Dagnino, Aniek
Hos, Michael Karakostas, Johanna Kumlien, Theo Lynn, Wilhelm Niemeier, Juan Pablo
Felmer Roa, Katarzyna Stuczynska and Beate Sjåfjell for participating in the country
experiments. Without them, this research would not have been possible. We are also
grateful to John Favaro, Paul Farrell, Vito Gianella and David Mitzman for comments.
Financial support was received from the Business Register Interoperability Throughout
Europe (BRITE) project under European Commission contract number 027190.
91
92 Perspectiv es in compa n y l aw

register refused registration of the branch, the case was brought to the
ECJ, which declared the refusal of registration as being against the EC
Treaty.1 Überseering2 and Inspire Art3 confirmed and strengthened the
Centros ruling. In all three cases the ECJ made it clear that the Treaty
grants entrepreneurs the right to choose where to set up their com-
pany within the EU and to use that as their business form in the coun-
try of operation. It also made it clear that the Court strictly scrutinizes
attempts to restrict that right.
These European Court rulings have created an active incorporation
market in the European Union. Especially in some countries, entrepre-
neurs are increasingly aware that they can freely choose among all the
limited liability vehicles in the Union to run a business in their home state.
In Germany, agents selling the UK Limited are omnipresent in newspa-
pers, on television and on websites. The Limited is discussed on television
and in parliament. Scores of legal self-help books on the Limited written
in German are on display in bookshops. Between 2003 and 2006 more
than 40,000 residents of Germany have incorporated a UK Limited.4
In this article we show that incorporation from a distance in the United
Kingdom is easy and the cost is the same, no matter in which EU coun-
try the founding directors of the UK Limited live. By contrast, the direct
and indirect cost of branching for a UK Limited company varies greatly
across countries, which helps explain why ‘Centros incorporations’ are
more frequent in some countries than in others.5

1
ECJ, Case C-212/97 Centros Ltd v. Erhvervs- og Selskabsstyrelsen [1999] ECR I-1459. See E.
Wymeersch, ‘Centros: A Landmark decision in European Company Law’, in Th. Baums,
K. J. Hopt and N. Horn, Corporations, Capital Markets and Business in the Law. Liber
Amicorum Richard M. Buxbaum (London, 2000), 629.
2
ECJ, Case C-208/00 Überseering BV v. Nordic Construction Company Baumanagement
GmbH, [2002] ECR I-9919.
3
ECJ, Case C-167/01 Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art
Ltd, [2003] ECR I-10155.
4
See M. Becht, C. Mayer and H. Wagner, Where do firms incorporate? Deregulation and
the cost of entry, ECGI Law Working Paper N°.70/2006, August 2007.
5
To be sure, Member States do not usually provide for stiff sanctions against foreign com-
panies that fail to register their branch in the country of operations. So, for instance,
in Austria, § 107 GmbHG (Austrian limited liability company act) requires registra-
tion of the branch of a foreign company in the Austrian companies register. § 24 FBG
(Company registry act) provides that in case of non-registration the court can impose a
maximum fi ne of €3,600. In Germany, § 13d HGB (German Commercial Code) provides
that a company, the seat of which is abroad, must register a branch in Germany. Under §
14 HGB, the penalty for non-registration is a maximum fine of €5,000. In the case BGH
14.03.2005 II ZR 5/03, the German Federal Court of Justice considered the question of
whether the sanction for the non-registration of the Limited branch could be to make
 Centros a nd the cost of br a nching 93

We make two contributions to the literature: one, we devise a new

experimental methodology that allows us to measure the actual cost of
branching, comprising the cost of incorporation in the United Kingdom
and the cost of branching;6 two, we conduct experiments and report the
empirical results.
Our experiments show that the total cost of Centros incorporation
differs considerably across countries. It cost a mere €551 to set up a
UK Limited and branch back to Ireland. Centros incorporation also
proved to be relatively cheap for entrepreneurs from Austria (€698),
the Netherlands (€759) and Norway (€947). In contrast the cost has
proved to be much higher in Poland (€1631) and Sweden (€2146), and
prohibitive in Italy (€5007).
The main driver of the cost differences is the cost of translation and of
certification. In the Italian case the cost exploded because Italy requires
additional UK documents that also needed to be translated, like a let-
ter of good standing and a decision of the board of directors of the UK
Limited to open a branch. In addition we detected country idiosyncra-
sies that were somewhat surprising, like Sweden requiring the appoint-
ment of an auditor before branch registration (€1062). Greece wanted
to impose Greek minimum capital requirements on the branch, simply
ignoring the existence of the Centros case law.
The cost of branching is substantially reduced by the presence of an
incorporation agent. Private intermediaries play a central role in over-
coming existing administrative hurdles. The ‘do-it-yourself’ cost of
obtaining an Apostille might require a trip to London. German agents
typically charge less than €30 for an Apostille that certifies the authen-
ticity of their standard incorporation documents. The agents can obtain
Apostilles for hundreds of documents at the same time. The agents can
also offer low-cost translations because they use a standard document

the director of the Limited personally liable for the company’s debts (as it was held by
the lower courts). The BGH held that in the case of non-registration only a fine under
§ 14 HGB could be imposed on the company and that in no case could the director be
made personally liable for the company’s debts, the directors’ liability being governed by
English law. No matter how little dissuasive sanctions for non-registration are, branch
registration is, however, de facto necessary to deal with banks, State offices or major
suppliers.
6
There are other projects measuring the cost of incorporation in different countries,
for example the World Bank’s ‘Doing Business (Washington, January 2008), www.
doingbusiness.org. At the moment this project only measures the cost of domestic, not of
foreign incorporation. Also, the cost measurement is based on a questionnaire fi lled out
by country correspondents, not on the actual cost of incorporating a real business.
94 Perspectiv es in compa n y l aw

with its standard translation. The marginal cost of translating their

‘boilerplate’ UK documents is almost zero. In contrast, the translation
cost in our Italian experiment was approximately €1800.
The results we obtain help explain why the UK Limited is widely
used in the Netherlands while it is practically non-existent in Greece,
despite the equal amount of paid-up minimum capital for national pri-
vate limited liability companies in the two countries (€18,000); or, again,
widely used in Norway while almost unheard of in Italy, again despite an
approximately equal amount of minimum capital in the two countries
(€10,000). The cost of setting up the UK Limited is the same in all cases,
but the cost of branching is not; branching to Greece or Italy from the
UK is very costly, branching to Norway and the Netherlands is not.
Despite the rulings of the European Court and flanking measures
adopted by the European Commission, branching to some EU coun-
tries is still more limited than to others. The results of our experiments
provide clear indications of where further public or private enforcement
of the freedom of establishment principle enshrined in the Treaties is
required and of what steps the Commission could take to make branch-
ing less costly.

II. Centros incorporation terminology

The Centros idea of using a legal vehicle in another EU member state to
run a local business is well established in the mutual fund industry.
Most ‘Undertakings for Collective Investment in Transferable Securities’
(UCITS) in the European Union are incorporated in Luxembourg or
Ireland, although the promoter of the fund resides in another Member State.
A fund set up by a Belgian promoter under Luxembourg law and intended
to be sold back into Belgium is referred to as a ‘round-trip fund’. We use
this travel-industry-inspired terminology for Centros incorporations.
An entrepreneur wanting to set up a UK Limited from outside the UK
to operate a business in his or her home jurisdiction through branching
is confronted with three options offered by incorporation agents: ‘full
round trip’, ‘incorporation and half-way back’ and ‘incorporation-only’.
The first two options are available in some Member States only.

A. Full round trip

The easiest way to set up a Centros-type Limited is to purchase a ‘full
round trip’ incorporation package. This service includes everything
 Centros a nd the cost of br a nching 95

from registration of the UK Limited to registration of the branch in the

entrepreneur’s home country.
The ‘Foratis Limited’ sold in Germany is an example of this service.
For €2,500 Foratis AG will create and register a UK Limited with a cap-
ital of £120, deliver a Certificate of Incorporation, Memorandum and
Articles of Association and a certified translation of these into German
with Apostille.7 Foratis will also take care of the branch registration in
Germany and open a German bank account. The Limited is registered
at an address in Birmingham and Foratis provides a Company Secretary
for one year. A one-year service package is included in the purchase price
and features an application to the UK Inland Revenue for the Limited to
be exempted from fi ling a UK tax return, a mail forwarding service from
the registered office of the Limited to an address in Germany (against a
supplementary fee of €2 per letter) and reminders for important dates,
like fi ling obligations with Companies House. After the first year an
extension of the service pack subscription is available for €250.8
The full round trip service is not widely available and some agents do
not offer it at all. Instead, entrepreneurs have to take care of the branching
themselves or they are brought ‘half-way back’ by the incorporation agent.

B. Incorporation and half-way back package

This package differs from the full round trip one in that it does not
include the branch registration in the home state and the opening of the
bank account. It does provide instead for the registration of a Limited
in the UK, plus the documents required to register the branch: the offi-
cial UK documents with certification (Apostille) and certified transla-
tions. When the package is offered by a local agent it usually includes
instructions. In the ideal case, the national entrepreneur simply needs to
take the documents and translations received from the agent to the local
companies register and apply for the branch registration.9

7
The UK is not a signatory of the Hague convention and the Apostille is required to certify
the authenticity of the UK documents.
8
www.foratis.com/thema/000130/foratis_deutsche_limited.html.
9
An interesting legal question arises when a Belgian resident uses the ‘half-way back’
service of an agent in the Netherlands to obtain the branch registration documents in
Dutch, but certified by an official translator from the Netherlands. Current practice
appears to be that the Belgian companies register will not accept official translations from
the Netherlands, Germany or France, although Dutch, French and German are official
languages in different parts of the country. For cost reasons we did not explore this issue
in our empirical research.
96 Perspectiv es in compa n y l aw

C. Incorporation-only package
In the worst case, neither the ‘full round trip’ nor the ‘half-way back’
option is available in the country of residence of the entrepreneur. We
found, for example, that this was the case in Hungary. A Hungarian
entrepreneur has to resort to the services of a UK agent to set up the
Limited company and take care of the branching herself. A variety of
incorporation services are offered by a broad spectrum of providers. A
fully-fledged offering again includes an incorporation package bundled
with one year of compliance services, including a ‘virtual’ registered
office, a company secretary and mail forwarding.
After incorporation via the UK agent the Hungarian resident receives
the UK documents and has to undertake the branching procedure on
her own. This means that she has to arrange for legal representation for
the registration procedure,10 for a board resolution of the Limited to set
up a branch in Hungary,11 the notarization of the signature specimen of
the branch representative(s),12 the payment of all fees13 and the transla-
tion of all required company documents into Hungarian.14 As one would
expect, the requirement to undertake ‘do-it-yourself’ branching poses
serious limits on the relative attractiveness of the UK Limited.

III. Experimental design

The total cost of Centros incorporation is directly observable for the ‘full
round trip’ package, but not in the other cases. To obtain a direct measure
of the cost of ‘Limited round tripping’ from countries where a full service
is not available we conducted field experiments with the help of country
correspondents. We supplied them with a ‘Guideline for country corre-
spondents’. The Guideline gave an explanation of the procedural steps

10
For the branch registration process legal representation is compulsory in Hungary,
§ 32(4) of the Law V of 2006; costs of the legal representation may range between €400
and €4,000, as our country correspondent found out during our experiment.
11
Appendix I, Law V of 2006.
12
Appendix I, Law V of 2006, notarization of the signature specimen is regulated by Law
XLI of 1991; the cost of notarization is a standard €6 per signature.
13
Under Law XCIII of 1990 the branch registration fee is 250.000 Ft (€200) and under
Law V of 2006 and Decree Nr. 22 of 2006 of the Minister of Justice the publication fee is
14.000 Ft (€56).
14
Appendix I, Law V of 2006; according to Decree Nr 24. of 1986 the ‘National Translation
and Translation Authentication Office’ has the exclusive right to produce official transla-
tions (the rate is approx. €17 per page).
 Centros a nd the cost of br a nching 97

of the branch registration as well as a checklist of information that we

required our correspondents to record.
We found country correspondents from ten EEA states: Austria,
France, Germany, Greece, Ireland, Italy, the Netherlands, Norway,
Poland and Sweden.15 We asked our country correspondents to put
themselves into the shoes of a small local entrepreneur who intends
to incorporate and branch back a UK Limited at the lowest possi-
ble cost. We thus instructed them to search for a local incorporation
agent selling the UK Limited online. In case they could not find local
agents we suggested they use Jordans, a reputable UK agent that had
been recommended to us. After incorporating the Limited, the cor-
respondents were asked to register a branch in the local companies
register and to record the number of procedures they had to undergo,
the costs incurred, the time it took them, and any obstacles they
encountered.

IV. Results
Of the ten experiments our country correspondents undertook, five
were performed until branch registration, while two were abandoned
at an early stage (France and Greece), one (Austria) was only recently
resumed to obtain registration after some difficulties had emerged, and
two were abandoned just before the fi nal steps for cost reasons (Poland
and Sweden).

A. Choice of incorporation agent matters

Our French correspondent decided to break off the experiment after
experiencing problems with his chosen incorporation agent (‘Agent
A’), one of the cheapest providers on the UK market with a website in
English, French, German, Polish, Italian, Spanish, Arabic and Chinese.
Our correspondent reported that incorporation of the private limited
company in the UK took place in March 2007. However, despite prom-
ises of a prompt delivery (within 10–14 days) of the French translations
of the company documents, Agent A posted the translations with a delay
of two months (the correspondent also complained about their poor
quality). When in May the correspondent tried to apply for branch reg-
istration, the French register refused to accept the company documents

15
Freedom of establishment extends to EEA countries. Hence the inclusion of Norway.
98 Perspectiv es in compa n y l aw

issued in March and asked for more recent certificates. Agent A was
ready to supply these, but requiring additional payment of course. At
this point, the correspondent broke off the experiment.

B. Further ECJ Rulings might be required

The Greek experiment was abandoned as soon as our correspondent
found out that under Law 3190/1955, for a branch of a foreign private lim-
ited liability company (Limited) to be registered in Greece, the foreign
company must meet the minimum capital requirements set by Greek
law for the Greek private limited liability company, i.e. have a minimum
paid-up capital of €18,000.
This requirement of course undermines the basic rationale behind
incorporation shopping and might explain why the number of
UK-incorporations from Greece is very low, although Greece ranks
close to the top of the list of countries in terms of minimum capital
requirements and length of incorporation procedures.16 This require-
ment constitutes a serious (and, in light of Inspire Art, illegitimate) bar-
rier to freedom of establishment, quite aside from the fact that it is also
in breach of the Directive 89/666/EEC of 21 December 1989 (Eleventh
Company Law Directive on Disclosure Requirements in respect of
Branches: hereinafter, the Eleventh Directive).

C. Italy – a case study in incorporation market closure

Of the other experiments, the Italian one proved to be of particular
interest, both in itself and for the entrepreneurial activity it inspired.
In fact, as the Appendix fully details, it uncovered what is probably one
of the most tedious and expensive branching procedures in Europe.
Further, it gave our country correspondent the idea of setting up an
Italian incorporation service provider, ‘Italian Limited’.17 So far, Italian
Limited has incorporated thirty Limiteds for Italian entrepreneurs,
and there seems to be high potential for further growth. In the face of
an actual cost of more than €5,000, Italian Limited offers the full round
trip service package for €2,490.

16
See Becht, Mayer, and Wagner, Where do firms incorporate? (note 4, above), 31.
17
See www.italianlimited.it.
 Centros a nd the cost of br a nching 99

D. Proving the existence of the branch

The Austrian experiment is also interesting. In fact, it was temporarily
broken off due to two problems raised by the Vienna Company Court
during the registration procedure. First, the Court required that evi-
dence of the actual existence of the branch in Vienna be adduced (e.g.
lease of business premises, website, business contacts, etc.) for registra-
tion to take place.
In fact, Austrian law provides that, in order for registration to take
place, evidence must be given as to the existence of the branch.18 Austrian
Courts have clarified in several cases involving Limiteds incorporated in
England under English law and applying for the registration of a branch
in Austria.19 According to this case law, evidence has to be produced that
an appropriate business structure is in place which permits the branch
to do business permanently and independently form the company itself.
The courts concede that also planned measures can be taken into account
when determining the existence of the branch, if their implementation
can be held to be highly likely in the given circumstances. Examples of
accepted evidence are a webpage of the branch, rented premises and
facilities, a bank account, the existence of funds, business contacts, etc.
In our case, since the branch was only to be registered for the purposes
of the experiment, its real existence was hard to prove. Incidentally, we
note that this point should not be a serious obstacle in the case of a local
entrepreneur who indeed intends to do business through a Limited.

E. Objects clause restrictions

More importantly, the Company Court also required the amendment
of the objects clause because the standard English objects clause which
the memorandum of the Limited contained included financial activities
which under Austrian law need specific authorization.
The Vienna Court of Appeal has held that in the absence of the
required authorizations by either the Financial Services Authority in the
UK or the equivalent body in Austria the registration of the branch has
to be refused.20

18
§ 12 Austrian Commercial Code (UGB).
19
OGH 29.4.2004, 6 Ob 43/04y; OGH 29.4.2004, 6 Ob 44/04w; OLG Wien 29.12.2006, 28R
233/06z.
20
OLG Wien 5.12.2003, 28 R 338/03m, OLG Wien 30.11.2004, 28 R 217/04v.
100 Perspectiv es in compa n y l aw

The objects clause was an obstacle not only in Austria, but also in
Poland and Norway. In these two countries minor amendments had to
be made to the objects clause to obtain registration.
Apparently, it is frequent for member states to require the disclos-
ure of the memorandum and articles of the foreign company, as Art.
2(2)(b) of the Eleventh Company Law Directive allows them to do.
Furthermore, under Art. 2(1)(b) the member states may require the dis-
closure of the ‘activity’ of the branch. How these two interact is unclear.
While Austrian courts seem to focus on the objects clause of the Limited
and pay no attention to the ‘activities’ of the branch, German courts
have come to the conclusion that it is solely the ‘activity’ carried out by
the branch and not the objects clause of the foreign company that the
German company courts are called upon to scrutinize when consider-
ing the registration of a branch.21

F. Agents reduce cost

In the case of Germany, the Netherlands, Norway and Sweden the
branching procedure ran fairly smoothly and our correspondents
encountered no major obstacles. In Germany the notary fees are heav-
ily regulated with a cap of €19 that can be charged for authenticat-
ing the signature specimen of the branch representative. Therefore,
although traditionally the application procedure was taken care of by
the notaries, with the maximum fee of €19 now applicable, they are
reluctant to get involved in branching procedures. Hence, the bur-
den of lodging the application documents at the court falls back on
the entrepreneurs. In the Netherlands our correspondent was ques-
tioned by the clerk at the Chamber of Commerce (the office in charge
of the branch registration) why she decided to use a Limited instead
of a Dutch legal form.
In respect of the Irish experiment it must be borne in mind that our
correspondent chose to order the ‘full round trip’ instead of the ‘half-way
back’ service, used by most other country correspondents. Both because
of this and because the foreign company concerned was a UK Limited,
the process was more straightforward than anywhere else. Of course, a

21
OLG Thüringen, 22.4.1999 – 6 W 209/99; LG Bielefeld, 8.7.2004 – 24 T 7/04; LG
Ravensburg, 14.2.2005 – 7 T 1/04 KfH 1; LG Kassel, 18.3.2005 – 13 T 13/04; LG Chemnitz,
24.3.2005 – 2 HK T 54/05; LG Chemnitz, 12.5.2005 – 2 HK T 427/05; OLG Hamm,
28.6.2005 – 15 W 159/05; OLG Frankfurt a.M., 29.12.2005 – 20 W 315/05.
 Centros a nd the cost of br a nching 101

cost advantage for the Irish entrepreneur is that no translation has to be

made of incorporation documents.

V. Conclusion
Our field experiments show that there are substantial differences in the
cost and feasibility of ‘round trip incorporation’ between Member States.
Incorporating a Limited company in the United Kingdom is cheap, fast
and can be done from a distance. When problems arise they stem from
branching.
In part, this is explained by the presence of incorporation agents in
only some of the Member States. By standardizing the procedural steps
that are needed they can cut down on the costs significantly, the most
telling difference being between the cost of the required translation
where incorporation agents offer this service (€30 in Germany), and
where they do not (€1,800 in Italy).
Once the document translation and certification hurdle has been
overcome, the ease of branching depends on national idiosyncra-
sies. Branching can be made more cumbersome and costly by requir-
ing, de jure or de facto, the intervention of a public notary, as in Italy
or Germany, or by insisting on evidence that the branch really exists
(a requirement that is absent from those the Eleventh Directive allows
member states to impose), as in Austria, or by meddling with the con-
tents of the object clause, as in various countries. In Sweden the require-
ment to appoint an auditor for the branch places an important extra cost
burden on branching (although to be sure a similar requirement also
exists for domestic companies), while in Italy, Hungary and Poland the
requirement to enclose a company resolution setting up the branch will
cause additional hurdles since this resolution does not form part of the
standard documents provided by incorporation agents.
Of course, such obstacles discourage incorporation agents to begin
with, because the arbitrage surplus to be gained by incorporating a busi-
ness as a Limited will be lower in countries where such obstacles exist,
making the supply of a standardized and less costly Limited product less
likely.
Our experiments have also highlighted patent violations of EC law, as
in the case of Greece, that requires a minimum capital for foreign com-
panies branching in Greece as high as that of a Greek company.
To conclude, our research shows that a lot could be done to facili-
tate freedom of establishment in the form of branching. First of all,
102 Perspectiv es in compa n y l aw

the 11th Directive should be revised, at the very least by introducing

mutual recognition of objects clauses: a given object clause should be
of no obstacle to branching, no matter whether it includes activities
for which an authorization is required in the state of branching. This
would not mean that the registered branch would be free to exercise that
activity, for which it would have to obtain the required authorization
anyway.
The ‘European Commission proposals for fast track administrative
burden reductions in 2008’22 presented on 10 March 2008 recognizes
that unnecessary and disproportionate administrative costs severely
hamper economic activity and aims at cutting administrative costs for
entrepreneurs. The Proposals are the second package of an overall pro-
gramme to reduce the administrative burdens for entrepreneurs in the
EU by 25% in 2012.
With respect to cross-border branching the Proposals contain two
important measures: one, the possibility of re-using translations of com-
pany documents that have already been certified in one member state
when the same language is used and second, the abolishment of the obli-
gation to publish business data in the national gazettes.23 Instead, com-
pany information will be made available online which not only saves
costs for entrepreneurs, but makes access to the information easier. As
a next step the planned integration of the national company registers in
the EU could ensure more clarity and easier registration procedures as
well as a more efficient information exchange between the register of the
country where the company was incorporated and that where it intends
to set up a branch.

A PPE N DI X  C OU N T RY E X PE R I M E N T R E P ORT S

I. Austria – START Unternehmensberatung Limited

A. Preliminary investigation
There is a vast number of online service providers that offer UK incor-
poration services in Austria. They are almost exclusively run from
22
MEMO/08/152, http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/
152&format=HTML&aged=0&language=EN&guiLanguage=en
23
For an example of a dispute on the cost aspect of publishing company information in the
Official Journal on the occasion of branch registration: see ECJ, Case C-453/04 Innoventif
Limited v. Landgericht Berlin, [2006] ECR 4929.
 Centros a nd the cost of br a nching 103

Germany. Given the fact that there are no language barriers between
Germany and Austria, and that the branch registration procedure is
very similar in the two countries, German incorporation agents have
expanded and now cover the Austrian market too.
The country correspondent for Austria spent approximately half
a day on the internet searching for the cheapest incorporation pro-
vider and decided to order the ‘half-way back’ package (‘Offi zielles
Deutschland-Paket’) and a one-year company secretary service from
Ganz Einfach Ltd.24 for €348. The package included the Certificate of
Incorporation, the Apostille for the Certificate of Incorporation, the
Memorandum and Articles of Association and their certified German
translations.

B. UK incorporation
The correspondent ordered the incorporation of the ‘START
Unternehmensberatung Limited’ on 12 February 2007 by fi lling in the
online order form of Ganz Einfach Ltd. On the same day, Ganz Einfach
Ltd. confirmed by email that the START Unternehmensberatung
Limited was incorporated. Attached to the email were the Certificate of
Incorporation and the Memorandum and Articles of Association.
The next day, Ganz Einfach Ltd. provided the country correspondent
with a detailed explanation of the incorporation procedure in England,
setting out which incorporation documents and translations were still
to be sent to the correspondent and when.
On 16 February, only four days after placing the order for the incorp-
oration service, the correspondent received hard copies of the certi-
fied translation into German of the Certificate of Incorporation, the
Memorandum and the Articles by ordinary mail. On 22 February
these were followed by certified copies of the original English language
documents.
On 15 March our correspondent received the Companies House
Certificate of Incorporation issued by the Officer of the Companies
Registration Office in Cardiff.
Unfortunately an error occurred in the mention of the subscriber
shareholder which had to be rectified, thus retarding the branch incor-
poration by more than two weeks. Had this error not occurred, the
Austrian correspondent would have had all the necessary documents,

24
www.yoffi.net.
104 Perspectiv es in compa n y l aw

translations and certifications ready for the branch registration within

three weeks. Even with the delay, the procedure took just over five
weeks.

C. Registration of the branch in the Austrian

Companies Register
The country correspondent called the Company Court in Vienna to fi nd
out about the required steps for the branch registration. In Austria, the
company director is entitled to undertake the registration of the branch
herself, there being no requirement for legal representation.
In order to prepare for the registration, our correspondent had to draft
an ‘application for registration’ and a ‘signature specimen form’.25 The
director’s signature on both these documents must be certified either by
a public notary or by the Company Court. Our correspondent chose to
have her signature certified by the Court for the cheaper €18/signature as
opposed to €30/signature charged by public notaries.
On 4 April 2007 our correspondent handed in the application form
for branch registration at the Viennese Company Court. Attached to
the form were the English language Certificate of Incorporation and the
Apostille, the Memorandum and Articles in English and their certified
translations into German. The application fee was €34.
On 10 April 2007 the Company Court informed our correspondent
by letter that in order to have the Limited branch registered in Austria
she had to: (i) prove that the branch was actually and factually estab-
lished in Austria; (ii) amend the objects clause or provide proof of spe-
cific authorization by a fi nancial regulatory authority, because certain
paragraphs of the objects clause contained activities which in Austria
fall under ‘regulated fi nancial activities’ and therefore need specific
authorization. Unless these requirements were complied with and evi-
dence of the compliance adduced to the Court within eight weeks of
the date of the Court’s letter, the application would be rejected.26
25
In order to do this, our correspondent relied on the following manuals: C. Fritz,
GmbH-Praxis I, Vertragsmuster und Eingaben, Mustersammlung für Gründung,
Geschäftsführung, Umwandlung und Auflösung (Wien: Linde, 2003); A. Kostner/M.
Umfahrer, Die Gesellschaft mit beschränkter Haftung. GmbH-Handbuch für die Praxis
(Wien: Manz, 1998).
26
It appears to be a general practice of the company courts in Austria to require both evi-
dence of the actual establishment of the branch and the amendment of the object clause
for branch registration in the case of UK Limiteds. It is hoped that thereby some con-
trol over the pseudo-foreign companies can be exercised. See OLG Wien 5.12.2003, 28
 Centros a nd the cost of br a nching 105

At this point the branching experiment was broken off. Had registration
taken place, a registration fee of €180 and a publication fee for publica-
tion in the Official Journal of approximately €100 would have been pay-
able (publication fees depend on the length of the published information
about the Limited branch).27

D. Summary

Cost item Cost

Incorporation service (incl. company secretary) €348
Certification of signature €36
Application fee €34
Registration fee €180
Publication fee €100
Total €698

Time spent Time

Search for an incorporation service provider 5h

Prepare application form for registration and signature
specimen 3h
Certification of signature and handing in application form at
the Company Court 5h
Total 13h
Estimated elapsed time in total for branch registration
(from first contact with incorporation agent until branch approx. 5
registration) weeks

R 338/03m; OLG Wien 30.11.2004, 28 R 217/04v; OGH 29.4.2004, 6 Ob 43/04y; OGH

29.4.2004, 6 Ob 44/04w.
27
In February 2008 we decided that the experiment should be resumed and full registra-
tion of the branch attempted to be attained. Therefore, our correspondent approached
the incorporation service provider she had previously used and asked for an amended
memorandum that would omit from the objects clause the specific fi nancial activities
that would have needed authorisation in Austria. The new memorandum of course had
to be translated into German as well. Furthermore, our correspondent took steps to
ensure that evidence of the actual establishment and existence of the branch could be
established. At the time of writing this part of the experiment is still in progress.
106 Perspectiv es in compa n y l aw

II. Germany – Weiler Unternehmensberatungs Ltd.

Our correspondent ordered ‘the incorporation and half-way back’ pack-
age from GoAhead Limited28 on 15 December 2006 and the branch was
registered on 3 May 2007. There were a number of factors that caused this
delay:

A. Delay in document delivery by agent

Our correspondent ordered the Limited on 15 December 2006 and
although the GoAhead website states that incorporation would take
a week normally, the notification of the incorporation together with
the electronic documents were only sent to our correspondent on 28
December. Our correspondent was on holiday until 16 January 2007 and
therefore did not receive the documents before that date.

B. Dispute with GoAhead over objects clause

When reviewing the documents, our correspondent discovered that
the company’s objects clause had not been drafted as ordered. Our cor-
respondent had specifically described the object as ‘strategic non-legal
advice in M&A’, whereas GoAhead used the standard form describing
the object of the company as being engaged in any trade. Our corre-
spondent requested a change of the articles and the memorandum, but
GoAhead refused and our correspondent let go. Th is dispute lasted from
18 January to 16 February 2007.

C. Notary
Next, our correspondent contacted his local notary for registration of
the branch, but the notary was not responsive and failed to provide a
draft of the application form to be handed in to the court in order to
register the branch. The correspondent therefore produced the draft
form himself and finally received the authentication of his signature on
the application form on 12 April from the notary.
While a German notary would normally then submit the applica-
tion to the court and deal with any inquiries the court might have,
the notary refused to do so for a Limited. His explanation was quite

28
www.go-limited.de/.
 Centros a nd the cost of br a nching 107

simple and telling. For the required authentication of the signature,

the legal cap for the fee would be approximately €19. For such a low
fee he said he would not take it upon himself to submit the applica-
tion to the court. Our correspondent therefore lodged the application
himself.
In our correspondent’s words, ‘the reluctance of the local notary to
handle the matter swift ly is not to be understood as an intention to dis-
criminate against foreign companies. It is mainly influenced by eco-
nomic factors, that is, the low fee the notary can charge’.

D. Court
The local court registered the branch within a relatively short period of
time (18 days).

E. Overall assessment
In our correspondent’s view, ‘from the four and a half months that
it took to register the Limited’s branch, more or less two could have
been saved had I not been on holiday, not entered into the dispute with
GoAhead and urged the local notary more actively’. One should also
add that our correspondent lives in the countryside and it is well known
in Germany that companies registries in the countryside are slower
than elsewhere.

F. Summary

Cost item Cost

Incorporation with ‘half-way back’ €694.00
service
Notary €19.56
Registration fee of Court €170.00
Total €883.56

After the company was registered, the local companies register charged
€408 as compulsory membership fees.
108 Perspectiv es in compa n y l aw

III. Italy – FRADA Limited

A. Preliminary investigation
After a three-hour internet search the country correspondent for Italy
discovered that there were no Limited incorporation service provid-
ers offering the ‘incorporation and half-way back’ or the ‘full round
trip’ services in Italy. He thus decided to choose the ‘one-way only’
service.
The correspondent then limited his search to the ten most popular
results in the internet inquiry (writing ‘uk limited companies’ in the
search engine). Prices ranged from £30 (incorporation only) to £340 (for
a full-compliance package). The entrepreneur decided to use Jordans
(£340 + VAT): although Jordans was slightly more expensive than its
competitors its service was more reliable.

B. UK incorporation
Our correspondent sent an order form to Jordans by e-mail. Within 24
hours, he received by e-mail a copy of the ‘certificate of incorporation’.
Three days later, our correspondent received a letter with: a) documents
certifying that the incorporation had taken place; b) the company sec-
retarial service agreement (which the correspondent had to sign and
return); c) a two-page form to be fi lled in and returned to the Inland
Revenue; d ) a request for the following documents: i) a certified copy of
the page of a current signed passport which contains the photograph of
the correspondent; ii) either a certified copy or original of a recent util-
ity bill (not more than three months old and not a mobile telephone bill)
or bank or building society statement (not more than three months old)
showing the correspondent’s current address. The copies of company
documents had to be certified, preferably in English, as a true copy of
the original and signed and dated by a lawyer, accountant, notary, bank
manager, doctor, teacher or embassy official, whose name, address, sta-
tus or capacity the correspondent had to supply together with the copy
documentation.

C. Registration of the branch in the Italian Companies Register

Once FRADA Limited was incorporated, the correspondent called the
competent company registry in order to gather information about the
registration procedure. According to the registry’s officer, the usual
 Centros a nd the cost of br a nching 109

procedure requires a notary deed in order for the branch to be registered

(although Italian law does not expressly assign a role to notaries for this
purpose).29
The entrepreneur then contacted twenty notaries in order to regis-
ter the branch. This part of the procedure was the most cumbersome.
Only six out of the twenty notaries were willing to send a cost estimate
(€1,500–2,000 on average). One of these six notaries required, in order
for the branch to be registered, an extraordinary general meeting con-
ducted pursuant to Italian law (thus ignoring the lex incorporationis
principle). The remaining five notaries asked for a translation of a board
resolution – adopted according to English law – establishing a branch in
Italy and appointing a representative in Italy (i.e. the single shareholder).
The resolution had to be deposited with Companies House by the com-
pany secretary of Frada Limited.
The resolution above, the statute of incorporation, a certification
attesting that the Limited still exists, the personal data of the board
members have to be deposited at a notary’s office in Italy. The docu-
ments also have to be translated into Italian by a sworn expert. The
notary then takes care of the registration at the company registry.
Most of the notaries also required that our correspondent apply for a
tax number for the Limited in Italy in order for the registration to be
accomplished.
In general, notaries were reluctant to undertake the registration of
a Limited branch in Italy. They were apparently not used to this proce-
dure. Since under Italian law a notary is struck off the register whenever
she commits two errors during her professional career, notaries may be
unwilling to bear the risk of making an error in a not particularly profit-
able procedure, such as a Limited branching.
After having gathered the above information, the entrepreneur went
back to Jordans to obtain the certification attesting that the Limited
was still in force and the company’s resolution establishing the Italian
branch. The next day he received en e-mail containing the resolution
which he had to return signed to the company secretary for the regis-
tration at Companies House. The cost of the resolution was £50. Ten
days later, he received the certificate attesting the Limited was still in

29
See L. Enriques, Società costituite all’estero, (Bologna-Roma: Zanichelli-Il Foro Italiano,
2007), 69–70 (according to whom the notary should not be involved if there is no similar
requirement in the state of incorporation, but also noting that the contrary view is dom-
inant among scholars and practitioners).
110 Perspectiv es in compa n y l aw

force. This procedure could have been shortened (two days overall) by
paying a £30 extra fee.
To obtain the certified translation of the documents for the reg-
istration required twelve days and cost €1,801. Our correspondent
decided to engage an authorized translator, but the Italian legislation
also allows a certified translation to be made by the person applying
for registration. In such a case, an €80 registration fee is required.
The tax number was obtained in a couple of days and involved a fee
of €251.
Our correspondent then contacted the first notary again. The notary
took five days to check that the documents were formally complete.
Another six days were spent on draft ing the application deed for the
registration. In the meantime, our correspondent had to convince the
notary that the whole procedure was lawful, since the notary apparently
was not aware of the Centros case law. The notary was eventually con-
vinced, but although his cost estimate had at first been €1,500, he asked
for a fee of €3,000 once he understood that the Limited was a ‘mailbox
company’.
Our correspondent therefore decided to contact another notary,
who prepared the application deed in five days for a fee of €2,014.
Under Italian law, the branch is formally set up as soon as the nota-
ry’s deed is registered in the Companies Register. The notary must
register the deed within forty-five days after issuing it, but this sec-
ond notary informally undertook to fulfil this obligation within
three days.

D. Summary

Cost item Cost

Incorporation service (incl. company secretary) €558.37
Documents provided by Jordans
for the registration €381.54
Translation costs €1801.22
Opening of tax position €251.36
Registration and notaries fee €2014.42
Total €5006.91
 Centros a nd the cost of br a nching 111

Time spent Hours

Obtaining information from the Companies’ Register 1
Finding a notary and assuming information on the
procedure to follow and the documentation required
under the Italian law 3
Obtaining from the agent the documentation
requested by the notary 1
Finding and dealing with the translator 2
Opening VAT in Italy 1
Meeting and dealing with the first notary 3
Meeting and dealings with the second notary 7
Others (emails, phone calls, post office etc.) 1
Total 19
Estimated elapsed time in total for branch
registration (from first contact with incorporation
agent until branch registration) 52 days

IV. Ireland – ECGIBRITE Limited

A. Preliminary investigation
The Irish correspondent performed a Google search and selected and
ordered a ‘full round trip’ service from ‘Company Bureau’,30 a service
which includes both the registration of a UK Limited and the registra-
tion of its branch in Ireland. Company Bureau charged €550 for this
package.

B. Ordering the ‘ full round trip’

incorporation service
Our correspondent ordered the package on 27 February 2007 by phone.
On the same day, Company Bureau emailed him a company formation
order form. Besides fi lling in the form, our correspondent was asked to
provide a second, UK-based director and a UK-registered address for the
ECGIBRITE Limited.

30
www.companyformations.ie.
112 Perspectiv es in compa n y l aw

Our correspondent completed and returned the form together with the
above mentioned additional documents on 5 March. Company Bureau
confirmed the incorporation of ECGIBRITE Limited in England on
8 March 2007. The Certificate of Incorporation, the Articles and the
Memorandum, the share certificate, minutes of the first board meeting
and the company seal were posted to the correspondent on 14 March. He
received them on 20 March.

C. Registration of the branch at the Irish Companies

Registration Office
On 7 March 2007 Company Bureau emailed the correspondent the
F12 Form (requiring personal details of the director). The corres-
pondent filled in the Form and returned it by fax and by post the
next day.
Company Bureau applied to the Irish Companies Registration Office to
register the Irish branch of ECGIBRITE Limited on 30 March 2007. It
had to hand in a certified copy of the Certificate of Incorporation, certi-
fied copies of the Memorandum and the Articles, a certified copy of the
recent accounting documents and the F12 Form.
The Companies Registration Office confirmed the registration of the
branch on 5 April 2007. However, the incorporation service provider
only informed our correspondent two weeks later, on 20 April 2007, that
the branch registration had taken place.

D. Summary

Cost item Cost

Incorporation service (‘full-round trip’)
service fee €300
registration fee and documentation fee €187
VAT €67
Fax and postage €1
Total €551
 Centros a nd the cost of br a nching 113

Time spent Time

Researching the internet and fi lling in various forms 40 min
Total 40 min
Estimated elapsed time in total for branch
registration (from first contact with incorporation approx.
agent until branch registration) 5 weeks

V. Netherlands – Expletus Limited

A. Preliminary investigation
The Dutch country correspondent spent approx. two and a half hours on
the internet searching and comparing incorporation service providers and
decided to order the ‘half-way back’ package from Haags Juristen College
(HJC’)31 for €600. The package included the Certificate of Incorporation, the
Memorandum and Articles, a certified Dutch translation of the Articles, the
Current Appointments Report and Companies House Forms 10 and 12.

B. Ordering the ‘half-way back’ incorporation service

Our correspondent made first contact with HJC on 31 January 2007. She
received the same day their order form by email which she had to fill in and
return by post together with a copy of her passport and a proof of residence
for herself (the director of the Limited) and for the company secretary.
Our correspondent posted the above documents on 5 February and
on 7 February she received by post the Memorandum of Association
of Expletus Limited and Forms 10, 32 1233 and 255.34 Due to some delay
in settling HJC’s invoice, our correspondent received the Articles
of Association with the certified Dutch translation,35 the Current
Appointments Report and once again the Memorandum and Forms 10
and 12 only on 16 March by email. Three days later the Certificate of
Incorporation arrived by post.

31
See www.hjc.nl; the Inspire Art case was initiated by this specialist in company law.
32
First directors and secretary and intended situation of registered office.
33
Declaration on application for registration.
34
Change of accounting reference date.
35
For branch registration in the Netherlands, only the Articles of Association have to be
translated to Dutch.
114 Perspectiv es in compa n y l aw

C. Registration of the branch at the Dutch Chamber of Commerce

On 19 March our correspondent contacted the Chamber of Commerce
of Tilburg to find out about the branch registration procedure and the
general requirements that have to be fulfi lled prior to registration. She
was informed that there were no particular requirements for the branch
registration and that she did not need an appointment to hand in the
registration documents at the Chamber of Commerce either.
Our correspondent thus went to the Chamber on 22 March to under-
take the registration. She handed in the Certificate of Incorporation, the
Memorandum and the Articles, the certified Dutch translation of the
Articles, the Current Appointments Report and Forms 10 and 12 along
with the registration form, which she downloaded from the website of
the Chamber of Commerce.
The branch registration went through fast and smoothly, taking
about one hour. The clerk of the Chamber of Commerce checked our
correspondent’s personal identity and carried out a search against the
company name ‘Expletus’. Upon the payment of the annual registra-
tion fee of €148 the branch was registered. Our correspondent had to
pay an additional €11 for the Dutch extract of the branch registration
of Expletus Limited. She then was given a ‘welcome package’ contain-
ing a welcome letter and a brochure with further information about the
Chamber of Commerce.
The registration of Limited branches is not published in an Official
Journal or Gazette in the Netherlands, but information about such
registrations can be obtained from the website of the Chamber of
Commerce.
After registration, our correspondent was advised to apply for a tax
identification number to the tax authority.

D. Summary

Cost item Cost

Incorporation with ‘half-way back’ €600.0
service
Registration fee €148.5
Company extracts €11.0
Total €759.5
 Centros a nd the cost of br a nching 115

Time spent Time

Research incorporation services provider
and fi ll in order form 3h
Registration at the Chamber of
Commerce 5h
Total 8h
Estimated elapsed time in total for
branch registration (from first contact
with incorporation agent until branch approx.
registration) 5 weeks

VI. Norway – Ringilihorn Limited

A. Preliminary investigation
There are a large number of agents offering UK Limited incorporation
services in Norway.36 Our country correspondent for Norway searched
the internet for an incorporation service provider and also consulted
online forums which rate and provide feedback on the agents. She then
decided to use Stron Group, 37 which offered the cheapest incorporation
service in Norway. For 3,234 NOK (approx. €400) Stron Group offered a
‘half-way back’ package comprising the Certificate of Incorporation, the
Memorandum and Articles of Association, the Current Appointments
Report and the certified Norwegian translation of these documents.
Furthermore, a board resolution setting up a branch in Norway and
appointing our correspondent as the director of the branch, as well as a
declaration by the director accepting the nomination were also included
in the package. These latter documents were supplied in Norwegian. The
one-year company secretary service was also provided by Stron Group,
at an additional cost of 2,313 NOK (approx. €247)

B. Ordering the ‘half-way back’ incorporation service

The correspondent ordered the ‘half-way back’ package by fi lling in the
online order form on 9 March 2007. On the same day as our correspond-
ent ordered the incorporation service, Stron Group confirmed that the
36
Our correspondent reported that the Limited is a popular means of avoiding the
Norwegian minimum capital requirements.
37
www.stron-group.com.
116 Perspectiv es in compa n y l aw

Ringilihorn Limited was incorporated and emailed all the necessary

documents for the branch registration, including the Norwegian trans-
lations, to our correspondent.

C. Registration of the branch in the Norwegian

Company Register
On 10 March the correspondent posted all the above documents together
with the registration form, which was also provided by Stron Group, to
the Norwegian Company Registry. She had to pay a registration fee of
2,500 NOK (approx. €300). The registration fee for a branch of a foreign
company is less than half of the fee (6,000 NOK,or approx. €726) payable
upon registration of a Norwegian limited liability company.
Although according to Stron Group the registration of a Limited
branch usually only takes about 7–10 days, our correspondent received
a letter on 22 March from the Company Registry informing her that
for the registration to go through, further information had to be sup-
plied to the Registry about the business objectives of the branch. In
accordance with the ECGI BRITE Experiment guidelines, our cor-
respondent had stated ‘consultancy; economics and business’ in the
objects clause of the Limited, which mention however proved to be
not specific enough under Norwegian law and had to be amended to
‘economics and business consultancy’. The amendment was faxed to
the Registry.
In little over a week the Norwegian correspondent finally received
a letter from the Company Registry confirming the registration of the
branch.

D. Summary

Cost item Cost

Incorporation with ‘half-way back’
service, including one year of
company secretary €647
Registration fee €300
Total €947
 Centros a nd the cost of br a nching 117

Time spent Time

Researching incorporation service
provider, fi lling in order form, 3h
registration 40 minutes
Total 3.66 h
Estimated elapsed time in total
for branch registration (from first
contact with incorporation agent
until branch registration) approx. 2.5–3 weeks

VII. Poland – Ksanta Limited

A. Preliminary investigation
Using the usual keywords ‘Limited’ and ‘UK incorporation’ in Google
search prompted no Polish results at first, so the country correspond-
ent for Poland decided to instruct Jordans and order the ‘one-way only’
package.38 However, our correspondent found out later that there exist
also Polish Limited incorporation service providers.39
Jordans charged £441 (approx. €581) for the ‘Annual Compliance
Package’ which included the incorporation of Ksanta Limited in
England, the one-year company secretary service and a board resolution
to set up the branch in Poland. Th is was needed because in addition to
the usual company documents a resolution of the foreign company set-
ting up the branch and appointing a representative is also required for
the branch registration in Poland.
The translation of the company documents was not taken care of
by Jordans and had to be arranged and paid for by our correspondent
herself.

B. Ordering the ‘incorporation

only’ service
Our Polish correspondent ordered the Limited incorporation on 31
January 2007. The next day Jordans confirmed that Ksanta Limited

38
www.jordans.co.uk.
39
E.g.: www.companyinuk.pl, www.form-online.net/_pl/index.php.
118 Perspectiv es in compa n y l aw

was incorporated and emailed the Certificate of Incorporation to the

correspondent.
On 5 February 2007, she received the certified copies of the Certificate
of Incorporation, the Memorandum and Articles of Association by post
together with a) the company secretarial service agreement (which the
correspondent had to sign and return); b) a two-page form to be fi lled
out and returned to the Inland Revenue in England; c) a request for the
following documents: i) a certified copy of the page of a current signed
passport which contains the photograph of the entrepreneur; ii) either
a certified copy or original of a recent utility bill (not more than three
months old and not a mobile telephone bill) or bank or building society
statement (not more than three months old) showing the entrepreneur’s
current residential address.
The Memorandum supplied by Jordans contained a mistake; the
authorized share capital was marked £1,000 instead of £100. This
had to be rectified before the registration process could begin. Our
correspondent received the correct Memorandum with three days’
delay.

C. Registration of the branch at the

Polish Company Court
The following documents are needed for the registration of the
branch of a foreign company in Poland: an application form, differ-
ent forms detailing the appointed representative(s) for the branch and
the trading activities of the branch, a board resolution establishing
the branch and appointing a representative together with its certified
Polish translation, the Memorandum and the Articles together with
their certified translations, the Certificate of Incorporation and its
certified translation, a signature specimen of the branch representa-
tive certified by a notary and the payment of the registration fee and
the publication fee.
Our correspondent had to search for a certified translator who would
translate the Certificate, the Memorandum, the Articles and the board
resolution into Polish. The translations were ordered on 9 February 2007
and cost 935.1 PLN (€266). They were ready by 23 February.
The correspondent also had to arrange for her signature specimen to
be certified by a public notary. The certification cost an additional 24.40
PLN (approx. €7).
 Centros a nd the cost of br a nching 119

On 4 April 2007 our Polish correspondent handed in the applica-

tion form for registration at the Polish Company Court together with
the required documents. As she had not received any documents from
Jordans confirming her as the director, she was advised by the Court
secretary to hand in her share certificate (plus certified translation)
instead.
Our correspondent had to pay in advance the registration fee of 1000
PLN (approx. €284) and a publication fee of 500 PLN (approx. €142) for
the publication of the branch registration in the Official Journal of the
Court.40
About three weeks later, the Court wrote to the correspondent
requiring her to present documents confi rming her status as the direc-
tor of the company within seven days or else the registration could not
take place. Furthermore, the correspondent was asked to make two
minor corrections in the application form, one relating to the method
of representation and the other to the business activity of the com-
pany, so as to bring them into line with the Memorandum of Ksanta
Limited.
The correspondent made the requested two changes and turned
to Jordans for help in connection with her status as the company
director.
Jordans offered to supply a certified extract from Companies House
(notarized and legalized for use in Poland) confirming our correspond-
ent as the director of Ksanta Limited for £ 275.
At this point, given the additional costs involved, the branching
experiment was broken off.

D. Summary

Cost item Cost

Incorporation service (incl. company £ 441
secretary service)
Certified translations PLN 935.1
Notarisation of signature PLN 24.40

40
The publication in the Official Journal is restricted to the name of the foreign company,
its registration number abroad, the Polish registration number of the branch, the activ-
ities and the name of the authorised representative of the branch; the Memorandum and
the Articles are not published in full.
120 Perspectiv es in compa n y l aw

Registration fee PLN 1,000

Publication fee PLN 500
Certified extract confirming director £ 275 (n.a.)
Cost of Polish translation for
director’s extract n.a.
Total €1631

Time spent Time

Completing the forms, scanning,
mailing, telephones, information,
visits to the notary, translator,
courts etc. 12h
Travelling – to and from notary,
court, translator 12h
Total 24h
Estimated elapsed time in total
for branch registration (from first
contact with incorporation agent
until branch registration) 9 weeks

VIII. Sweden – J&N Consultancy Limited

A. Preliminary investigation
The country correspondent for Sweden conducted a Google search on
the internet looking for Swedish Limited incorporation service provid-
ers. He found Consab41 that offered the ‘half-way back’ incorporation
service for 8,112 SEK (approx. €872).
Our correspondent ordered the incorporation package from Consab
which included the registration of the Limited in England and the doc-
uments needed for the branch registration in Sweden: a certified copy
of the Certificate of Incorporation and of the Articles of Association,
proof that the Limited had not been declared insolvent in the UK,
a power of attorney authorizing the director to act on behalf of the
branch and to receive service of process, and the one-year company
secretary service.

41
www.starta-aktiebolag.se
 Centros a nd the cost of br a nching 121

B. Ordering the ‘half-way back’

incorporation service
Payment to Consab was made on 31 July 2007. Consab confirmed the
same day that the J&N Consultancy Limited was incorporated. Our cor-
respondent received the documents needed for the Swedish branch reg-
istration within a week, on 6 August.
According to Swedish law, it is mandatory to appoint a certified audi-
tor for the branch.42 The auditor must be appointed officially after the
incorporation of the Limited in the UK and before the branch registra-
tion in Sweden. This usually takes a few days. The annual cost for an
auditor is approx. 10,000 SEK (approx. €1,062).

C. Registration of the branch at the Swedish

Companies Registration Office
The registration procedure is very simple and very flexible in Sweden.
No Swedish translation of any of the English company documents is
required for the registration of the Limited branch, only a short descrip-
tion of the business activity of the branch must be provided in Swedish.
The latter was taken care of by Consab.
According to our correspondent, normally all company documents
can be handed in to the Swedish Companies Registration Office in their
original language (documents in Danish, Norwegian, German, Spanish,
French are usually accepted if the handling officer is able to understand
them; however, she can at any time request that any of the documents be
translated into Swedish), and all communications with the Registration
Office can be in English.
The application for registration is made by email, but the company
documents must be sent by post to the Companies Registration Office.
It takes usually about a week or one and a half weeks before applications
for registration are processed by the Office. The registration fee is 2,000
SEK (approx. €212).
However, the Swedish experiment was broken off before the branch
registration could take place because of the high costs involved in the
appointment of a branch auditor.

42
Th is rule applies to all branches of all types of limited liability companies, i.e. to branches
of foreign companies (Limiteds) as well as to branches of Swedish companies.
122 Perspectiv es in compa n y l aw

D. Summary

Cost item Cost

Incorporation and ‘half-way back’
service (incl. company secretary
service) €872
Registration fee SEK 2,000 (~€212)
Mandatory Appointment of
Auditor SEK 10,000 (~€1,062)
Total SEK 20,112 (~€2,146)

Time spent Time

Search for incorporation service

provider 4h
Search for and appointment of an
auditor 8h
Total 12h
Estimated elapsed time in total
for branch registration (from first
contact with incorporation agent
until branch registration) approx. 4 weeks

Table 1. Summary of country results

Total cost of
incorporation, one Total time spent Time in total until
year service and by correspondent branch registration
Country branching (in hours) (in weeks, approx.)
Austria € 698 13.00 5
Germany € 1,302 n.a. 10
Italy € 5,007 19.00 7.5
Ireland € 551 0.66 5
Netherlands € 759 8.00 2
Norway € 947 3.66 2.5–3
Poland € 1,631 24.00 9
Sweden € 2,146 12.00 4

Source: Branching experiment country reports

Table 2. Comparison of cost items across countries

Item Austria Germany Italy Ireland Netherlands Norway Poland Sweden

UK Incorporation €348 €694 €939.91 €550 €600 €647 €581 (+£275 €872
with one-year for director’s
compliance package appointment report)
Notary fee – €19 €2,012.42
Certification of €36 €7
signature
Translation cost €1,801.22 €266 (+ translation
of director’s
appointment report)
Application fee €34
Registration fee €180 €170 €148.50 €300 €284 €212
Publication fee in €100 €142
Official Journal
Compulsory €408
membership fee
Tax registration €251.36
Administrative cost €1
(fax, post)
Company extract €11
Appointment of
certified auditor €1062
Total €698 €1,291 €5,006.91 €551 €759.50 €947 €1,631 €2,146
 6

Towards the end of the real seat theory in Europe?

Michel Menjucq *

I. Introduction
The mobility of companies has increased significantly over the last
decade1 but, after the Daily Mail 2 decision of the European Court of
Justice in 1988, the method of company mobility has not been via
the transfer of seat. 3 Moreover, recently, Mr McCreevy said ‘no to the
14th Company Law directive’4 on the transfer of registered seat from a
Member State to another Member State. In fact, the mobility became a
reality in Europe after the revolution realized by the ECJ in the field of
the European confl ict of corporate laws. 5 Referring to Articles 43 and
48 of the EC Treaty, the ECJ emphasized in its Centros,6 Überseering,7
Inspire Art8 and Sevic9 decisions the freedom of companies to create
establishments and to implement cross-border mergers within the EU.

* Chapter completed in April 2008.

1
See R. Dammann, ‘Mobilité des Sociétés et Localisation des Actifs’, JCP-Cahiers de Droit
de l’Entreprise, (2006), 41. See also: M. Menjucq, La Mobilité des Sociétés dans l’Espace
Européen (Paris: LGDJ 1997); M. Menjucq, ‘La Mobilité des Entreprises’, Revue des Sociétés
(2001), 210; H. Le Nabasque, L’Incidence des Normes Européennes sur le Droit Français
Applicable aux Fusions et au Transfert de Siège Social, Revue des Sociétés (2005), 81.
2
Case C-81/87, Daily Mail and General Trust, [1988] ECR 5483.
3
See E. Wymeersch, ‘The Transfer of the Company’s Seat in European Company Law’,
Common Market Law Review, 40 (2003), 661.
4
Speech by Commissioner McCreevy at the European Parliament’s Legal Affairs
Committee, Brussels, 3 October 2007. See, K. E. Sorensen and M. Neville, ‘Corporate
Migration in the European Union: an analysis of the proposed 14th EC company law
directive’, Columbia Journal of European law, 6 (2000), 181.
5
See, W. Ebke, ‘The European Confl ict of Corporate Laws Revolution: Überseering,
Inspire Art and Beyond’, The International Lawyer, 38 (2004), 813.
6
Case C-212/97, Centros Ltd v. Erhvervs- og Selskabsstyrelsen, [1999] ECR I-1459.
7
Case C-208/00, Überseering BV v. Nordic Construction Company Baumanagement
GmbH, [2002] ECR I-9919.
8
Case C-167/01, Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd,
[2003] ECR I-10155.
9
Case C-411/03, SEVIC Systems AG, [2005] ECR I-10805.

124
 Towa r ds the end of the r ea l seat theory in Eu rope? 125

These ECJ decisions in favour of the incorporation theory, raise the

question about the future of the real seat theory in Europe. Is it the end
of this theory?
As is well known, where the incorporation theory ‘recognizes all for-
eign legal entities according to the rule applicable in the State of origin’,10
the real seat theory in private international law considers the location
of the central administration (or effective centre of management) of the
company which cannot be dissociated from the location of its regis-
tered office.11 In that case, according to the real seat theory, the company
should be no longer recognized as a legal person under the law of the
state of its central administration. Th is was exactly the Überseering case
which applied the German confl ict of laws rule.
A less dogmatic interpretation can be found in the interpretation of
Article L. 210–3 of the French commercial code, which provides that the
location of the registered office determines the lex societatis. However,
such place of the registered office cannot be invoked against third par-
ties if the effective centre of management of the company is located else-
where.12 The classical French doctrine13 considers that this provision
reflects the theory of siège réel. Modern doctrine has suggested replacing
this principle by the criterion of the statutory office, corresponding to the
State of incorporation, unless the registered office is fraudulent.14 That
said, it appears that French law is less dogmatic than the ‘Sitztheorie’ in
German private international law.15
The real seat theory has, however, been viewed as an obstacle to the
freedom of establishment in Europe guaranteed by Articles 43 and
48 EC Treaty. In its Centros, Überseering, Inspire Art and Sevic deci-
sions the ECJ judged that the prohibition on dissociating the place of

10
Wymeersch, ‘The Transfer of the Company’s Seat’, (note 3, above), 661.
11
H.J. Sonnenberger, Münchener Kommentar zum Bürgerlichen Gesetzbuch, Internationales
Privatrecht (München: Beck, 2005), 163, 181 et seq.
12
Art. 1837 para. 2 of the French civil code provides for a similar provision.
13
See H. Batiffol, and P. Lagarde, Droit international privé (Paris: LGDJ, 1981) No. 196,
Y. Loussouarn, P. Bourel and P. de Vareilles-Sommières, Droit international privé, Précis
Dalloz, (Paris: Dalloz, 2007), No. 707.
14
See Menjucq, Droit international et européen des sociétés, Précis Domat, (Paris: Montchrestien,
2001), No. 71 et seq.; also J. Béguin and M. Menjucq (ed.), Droit du commerce interna-
tional, (Paris: LexisNexis Litec, 2005), No. 470; P. Mayer and V. Heuzé, Droit interna-
tional privé, 9th edn, (Paris: Economica, 2006), No. 1037.
15
In the Überseering-case, German lower courts held that a company incorporated in the
Netherlands with an effective seat located in Germany does not exist as a legal person
under German law. Th is jurisprudence was reversed by the BGH after the Überseering
decision of the ECJ.
126 Perspectiv es in compa n y l aw

incorporation from the administration or business activities of a com-

pany was contrary to the EC Treaty. Th is jurisprudence constitutes ‘the
victory of the Anglo-Saxon incorporation theory pursuant to which
the founders of a corporation freely choose the place of incorporation
of a company and hence the law applicable to its organization (lex
societatis)’.16 Once incorporated, the company can develop its business
activities without any geographical restriction within the European
Community. Consequently, the company is also free to choose the place
of its headquarters and its central administration. The generalization
of the incorporation theory will favour the mobility of companies in
Europe. Following the jurisprudence of the ECJ, an increasing number
of companies have been incorporated in the United Kingdom, despite
exercising their activities exclusively in Germany.

II. What are the direct consequences of

Centros, Überseering, Inspire Art decisions?
The Centros, Überseering, Inspire Art and Sevic decisions have provoked
a ‘legal earthquake’ in Germany. After years of discussions, German
doctrine and jurisprudence has drawn the following conclusion: the
real seat theory is, de facto, contrary to the EC Treaty and needs to
be abrogated and replaced by the incorporation concept. Therefore, in
early 2006, the German government prepared a proposal for a Council
Regulation (CE) regarding confl ict of law issues with respect to com-
panies adopting, inter alia, the theory of incorporation.17 The purpose
of this proposal is to harmonize the private international law regard-
ing companies in Europe. Even if this proposition is not adopted in the
form of an EC Regulation, in any event, the German legislator plans to
amend its private international law accordingly.
In France, the modern doctrine mostly agrees with the ECJ deci-
sions but insists on the need to take into consideration the fraud or
abuse as it is evoked in the Centros and the Inspire Art cases.18 With this
16
See R. Dammann, ‘Mobility of Companies and Localization of Assets – Arguments in
Favour of a Dynamic and Teleological Interpretation of EC Regulation no 1346/2000
on Insolvency Proceedings’, in G. Affaki, Cross-border Insolvency and Conflict of
Jurisdictions, a US-EU Experience, (Brussels: Bruylant, 2007), 105.
17
See the proposal of the German Council for Private International Law under the
presidency of Prof. H. J. Sonnenberger, Revue Critique de Droit International Privé
(2006), 712.
18
See M. Menjucq, ‘La notion de siège social : un unité introuvable en droit international et
en droit communautaire’, Mélanges en l’honneur de J. Béguin (Paris: Litec, 2005), 499.
 Towa r ds the end of the r ea l seat theory in Eu rope? 127

consideration of fraud or abuse, articles L. 210–3 of the commercial

Code and 1837 of the civil Code could be read in conformity with art-
icles 43 and 48 EC Treaty: indeed, if a third person could invoke the real
seat only in case of fraud or abuse, the interpretation of articles L. 210–3
of the commercial Code and 1837 of the civil Code would comply with
the ECJ jurisprudence.
But the problem is the definition of fraud or abuse in the field of conflict
of corporate laws. Merely circumventing the application of Member State
companies law is not fraudulent or abusing as the ECJ stressed in the Centros
decision, except perhaps if the purpose of the founders is to realize a fraud or
an abuse of third-party interests. But the ECJ had not given any concrete ele-
ments to determine what are fraud and abuse against third-party interests.
Finally, in the field of Community freedom of establishment, if there
is a place for the real seat theory, it is only for a much reduced real seat
theory, limited only to the consideration of the real seat when there is a
fraud or an abuse against third-party interests.
However, this is obviously paradoxical, as the real seat theory is
applied in the status of all Community legal persons European Economic
Interest Grouping,19 European Cooperative Society20 and especially the
European Company.

III. The real seat theory and the European

Company: a paradox?
A paradox can be drawn with the European Company (Societas
Europea – SE) that is governed by Council Regulation (EC) no. 2157/01
of 8 October 2001. Pursuant to Article 7 of this Regulation, the registered
office must always be situated at the place of its central administration.21
This provision, which reflects the real seat theory, has been imposed by
Germany in the first draft Regulation in the seventies, when German
company laws were the model for Community corporate Regulations.22

19
Council Regulation 2137/85/EEC on the European Economic Interest Grouping (EEIG),
Article 12.
20
Council Regulation 1435/2003/EC on the Statute for a European Cooperative Society
(SCE), Article 5.
21
See also art. L. 229–1 paragraph 3 C. com.
22
The first draft Regulation on European Company also contained provisions on
groups of companies inspired by German law. About the opportunity of such rules,
see, E. Wymeersch, ‘Do We Need a Law on Groups of Companies?’, in K. J. Hopt and
E. Wymeersch, Capital Markets and Company Law, (Oxford University Press, 2003).
128 Perspectiv es in compa n y l aw

Consequently, according to Article 8, the transfer of the registered office

of an SE to another Member State is only possible, provided that a trans-
fer of its central administration occurs simultaneously in order to com-
ply with the provisions of Article 7.
In view of the foregoing, Council Regulation (CE) no. 2157/01 of
October 8, 2001 regarding the SE appears to be somewhat anachronis-
tic.23 That said, Article 69 provides for a reassessment of the effective
business seat rule by the Commission within five years after the entry
into force of the Regulation. Hence, it would appear rather likely that the
Regulation will be revised in the future by adopting the incorporation
theory in order to increase the attraction of the SE. Likewise, the Report
on the Societas Europeae, written in 2007 by Mrs Lenoir,24 former French
Minister of European affairs, suggests to modify the status of the SE to
introduce the incorporation doctrine.
Hence, it is not sure that the real seat doctrine has a future in the
European Company. But in the field of insolvency, the presumption in
favour of the registered office is losing ground. Is it the revenge of the
real seat theory?

IV. The Insolvency Regulation: the revenge of the real seat theory?
Council Regulation (EC) no. 1346/2000 of May 29, 2000 on insolvency
proceedings was conceived in the sixties.25 At the time the location of
the registered office was stable and corresponded to the place where
the headquarters and the main activities of the company were located.
Consequently, save in exceptional circumstances, the centre of main
interests of a company was always located at the place of its registered
office.
But, nowadays, as we said before, after the Centros, Überseering, Inspire
Art and Sevic decisions of the European Court of Justice, the mobility of
companies has increased significantly. In particular, the discussion has
focused on the famous term ‘centre of main interests’ – COMI – which
23
See M. Menjucq, ‘Rattachement de la société européenne et jurisprudence communau-
taire sur la liberté d’établissement : incompatibilité ou paradoxe?’, Recueil Dalloz (2003),
2874.
24
See N. Lenoir, Rapport au Garde des Sceaux sur la Societas Europeae (SE). Pour une
citoyenneté européenne de l’entreprise, La documentation Française (2007).
25
It is based on the text of a draft treaty of 1995 which was the fruit of a difficult compro-
mise, but which never entered into force because the United Kingdom refused to ratify
it. See for the historical genesis of the Regulation, C. Saint-Alary-Houin, Droit des entre-
prises en difficulté (Paris: Monchrestien, 2001), n°1147 et seq.
 Towa r ds the end of the r ea l seat theory in Eu rope? 129

determines the court with jurisdiction to open the main insolvency pro-
ceedings and, hence, in accordance with Article 4(1) of the Regulation,
the law applicable to such proceedings.
Moreover, most of the cross-border insolvencies falling within the
scope of the Regulation involve groups of companies, a phenomenon
that needs to be addressed. Unfortunately, the Regulation does not deal
with this topic. In order to efficiently address the insolvency of groups
of companies, a vast majority of European jurisdictions have adopted
a rather wide interpretation of Article 3(1) of the Regulation, judging
that the COMI of each entity of the group can be located at the regis-
tered office of the controlling (parent) company if such parent company
is directly involved in the management of its subsidiaries.26 This case law
has been severely criticized by some authors.27 It is accused of triggering
forum and law shopping, legal uncertainty for third parties and conflicts
of jurisdictions. Others have favoured a more teleological approach of
Regulation 1346/2001 which enables the application of the Regulation to
groups of companies.28
After the Eurofood decision of the ECJ dated 2 May 200629 and
despite the restrictions of ECJ, the application of the Regulation on
groups of companies has become an established fact, as it appears
from the Eurotunnel decision of the Court of Paris30 dated 2 August
2006.

26
For a synthesis of this jurisprudence see R. Dammann, ‘L’évolution du droit européen
des procédures d’insolvabilité et ses conséquences sur le projet de loi de sauvegarde’,
Lamy Droit des Affaires (2005), 18 and M. Raimon, ‘Centre des intérêts principaux et
coordination des procédures dans la jurisprudence européenne sur le règlement relatif
aux procédures d’insolvabilité’, Journal de Droit International (2005), 739.
27
See e.g. M. Menjucq, JCP – Cahiers de Droit de l’Entreprise (2006), 10089.
28
See R. Dammann, ‘Mobility of Companies and Localization of Assets’, (note 16, above),
105.
29
Case C-341/04, Eurofood, [2006] ECR I-3813. See Recueil Dalloz (2006), 1286 note
A. Lienhard; Recueil Dalloz (2006), 1752 note R. Dammann; JCP-Cahiers de Droit de
l’Entreprise (2006), 10089 note M. Menjucq; Bull. Joly (2006), 923 note D. Fasquelle;
Revue des Sociétés (2006), 360 note Rémery; JCP-Cahiers de Droit de l’Entreprise (2006)
n° 2071 note J.-L. Vallens; Lamy droits des affaires (2006), 29 note Y. Chaput.
30
See Recueil Dalloz (2006), 2329 note R. Dammann and G. Podeur, ‘L’affaire Eurotunnel,
première application du règlement CE n° 1346–2000 à la procédure de sauvegarde’. The
judgment was confirmed by the Commercial Court of Paris on January 15, 2007, Recueil
Dalloz (2007), 313; Bull. Joly (2007), 459 note Jault-Seseke and D. Robine. The appeal was
rejected by the Court of appeal of Paris in a judgment dated November 29, 2007, Recueil
Dalloz (2007), 12 note A. Lienhard; M. Menjucq, ‘Réflexions critiques sur les arrêts de la
Cour d’appel de Paris dans l’affaire Eurotunnel’, Revue des procedures collectives (2008), 9.
130 Perspectiv es in compa n y l aw

The risk of forum and law shopping is real since judges have a large
discretion when interpreting the notion of COMI. Consequently, ques-
tions arise as to whether an interested party taking the view that COMI is
situated in a Member State other than that in which the main insolvency
proceedings were opened could effectively challenge the jurisdiction
assumed by the court which opened proceedings. In the Eurofood deci-
sion, the ECJ emphasized the principle of mutual trust among the juris-
dictions of the Member States. Consequently it held that any review of
jurisdiction must be done by the court of the opening State in accordance
with the remedies prescribed by national law of that Member State.31
Recent decisions illustrate however some practical problems. In the
Hans Brochier case, on 4 August 2007, the London High Court of Justice
opened administration proceedings. The appointment of the joint liqui-
dators occurred in the framework of the so-called out-of court-appoint-
ment proceedings at the request of the management of Brochier. In such
proceedings, the court does not verify the underlying facts establishing
jurisdiction. Consequently, in the Brochier case the court relied on the
representations made by the management stating that the COMI of Hans
Brochier Ltd. was located at its registered office in the UK. A fortnight
later, German employees fi led a bankruptcy petition for Brochier with
the insolvency court of Nürnberg. In its order of 15 August 2007, the
German bankruptcy court held that the COMI of Brochier was clearly
located in Germany and that the UK main proceedings had been fraud-
ulently opened. Thus the Tribunal of Nürnberg refused to recognize the
opening of the UK main proceedings on the grounds that they were con-
trary to public order in accordance with Article 26 of the Regulation.32
The principal of mutual trust is difficult to apply if a foreign court is not
obliged as a matter of national insolvency law to verify the underlying
facts establishing the COMI. In the Brochier case, the conflict of juris-
diction was rather quickly resolved. At the request of the UK joint liqui-
dators of Hans Brochier, on 15 August 2007, the High Court retracted its
judgment opening main proceedings in favour of Brochier.33
Finally, the question arises under what circumstances the simple pre-
sumption of the competence of the jurisdiction of the Member State
where the registered office of the debtor is located, could be rebutted. Is
there a place for the real seat doctrine in the Insolvency Regulation?

31
See recitals 43 et seq. of the Eurofood decision (note 29, above).
32
Zeitschrift fürWirtschaftsrecht (2007), 81.
33
Neue Zeitschrift für das Recht der Insolvenz und Sanierung (NZI) 3/2007 p. 137.
 Towa r ds the end of the r ea l seat theory in Eu rope? 131

The answer can be found in the Eurofood decision of the ECJ:34

It follows that, in determining the centre of the main interests of a debtor
company, the simple presumption laid down by the Community legisla-
ture in favour of the registered office of that company can be rebutted
only if factors which are both objective and ascertainable by third parties
enable it to be established that an actual situation exists which is different
from that which locating it at that registered office is deemed to reflect.
That could be so in particular in the case of a ‘letterbox’ company not
carrying out any business in the territory of the Member State in which its
registered office is situated.
By contrast, where a company carries on its business in the territory
of the Member State where its registered office is situated, the mere fact
that its economic choices are or can be controlled by a parent company in
another Member State is not enough to rebut the presumption laid down
by the Regulation.

There is no doubt: the COMI is not the real seat of the debtor because
it does not refer to the effective centre of management but to the place
where the company carries on its business. In fact, the ECJ refers to an
economic criterion. Consequently, there is no ‘revenge’ for the real seat
doctrine in the field of Insolvency Regulation.

V. Conclusion
In sum, it seems that there is no future for the real seat theory in the
European area even if ‘it will remain applicable in the relation to third
States’.35 Actually, this theory was conceived in a different economic
and legal environment which is now over. But the possible end of the
real seat theory in a few years does not mean that the real seat criterion
has absolutely no future. Indeed, if, referring to the Centros and Inspire
Art ECJ decisions, there is a place for fraud or abuse, especially towards
third persons, the real seat criterion could be the evidence of such fraud
or abuse. However, it is a very small place36 for a criterion and a theory
which were dominant in most of the Member States laws: it is probably
the symbol of the new leadership of Anglo-Saxon rules.

34
Recitals 34, 35 and 36 of the Eurofood decision (note 29, above).
35
See Wymeersch, ‘The Transfer of the Company’s Seat’, (note 3, above), 695.
36
In the same way, see Wymeersch, ‘The Transfer of the Company’s Seat’, (note 3,
above), 661.
 7

The Commission Recommendations of

14 December 20041 and of 15 February 20052
and their implementation in Germany
Marcus Lutter

I. Introduction
By virtue of their law-making powers European Union institutions
may enact Regulations and Directives. During the past forty years,
the Commission has made extensive use of both these powers par-
ticularly concerning company law. 3 Over the course of this time the
Commission’s actions were accompanied by remarkable changes in
its general policy on a number of occasions. Starting off with the idea
of a widespread harmonization of the law,4 this policy was virtually
abandoned by the Commission in 1990. However, under the impact of
the capital markets and under the banner of Corporate Governance,
the Commission discovered its own original policy at the turn of
the millennium. One of the key role players in this realignment of
the Commission’s policy was the so-called High Level Group and

1
Commission Recommendation of 14 December 2004 fostering an appropriate regime
for the remuneration of directors of listed companies 2004/913/EC [2004] OJ L 264/32.
2
Commission Recommendation of 15 February 2005 on the role of non-executive or
supervisory directors of listed companies and on the committees of the (supervisory)
boards 2005/162/EC [2005] OJ L 52/51
3
Cf. detail list in M. Lutter, Europäisches Unternehmensrecht, (Berlin: de Gruyter, 1996,
4th Edn). Since then, the Directive of the European Parliament and of the Council of
21 April 2004 on takeover bids 2004/25/EC [2004] OJ L 142 and the Directive of the
European Parliament and of the Council of 26 October 2005 on cross-border merg-
ers of limited liability companies 2005/56/EC [2005] OJ L 310/1 have been issued in
addition.
4
The famous Structure Directive (reform proposal of 20 November 1991, [1991] OJ C
321) has altogether undergone three reform changes since its original presentation on
9 October 1972 but has never been issued formally. The same is true of a directive mod-
elled on the German group law regime (‘Konzernrechts-Richtlinie’), which has never
been taken further on from the stage of its preliminary drafts in 1974 and 1984.
132
 Commission R ecommendations in Ger m a n y 133

their report dated from 4 November 2002. 5 The Commission warmly

welcomed this report by the High Level Group, which had in fact been
set up by the Commission itself, and implemented a corresponding
EU Action Plan.6 At the same time, the Commission began reviewing
further options as to how the proposals made by the High Level Group
might be implemented as law in a form other than a Directive. It was
during this reviewing process that the Commission came to regard
the Recommendation as a viable alternative for the Directive, since
they, too, are listed as in Art. 249 (5) of the EC Treaty as an option
for action by the Commission. Yet Recommendations are not binding
(Art. 249 (5) EC Treaty) and therefore do not constitute law, at least in
the German sense of the word. Nevertheless, the Recommendation can
be of quite some interest to the Commission when it comes to using
it as a strategic device in order to influence Member States towards
its own ends. Th is is particularly true if the Commission combines
a Recommendation with a threat to the effect that a legally binding
Directive with an equivalent content shall be enacted should Member
States not observe the Recommendation in the fi rst place. In fact,
this is exactly what happened with respect to both of the aforemen-
tioned Recommendations. Alas for the Commission, combining a
Recommendation with a threat of enacting identical rules in the form
of a Directive in case of the former’s non-observance is easier said
than done. The option of acting by way of Recommendation has such
great appeal for the Commission because the Commission may enact
the Recommendation on its own without having to consult either the
European Parliament or the European Council of Ministers. By com-
parison, with respect to the Directive, the Commission only reserves
the power of initiative, the power of enactment itself remaining with
the Parliament and the Council. The difficulties which thus lie behind
this balance of power have only been too visible for observers of the
recent enactment of the Directive on Takeover Bids.7
With regard to the transformation into national law of its two
Recommendations, the Commission has not ruled out from the start
the possibility for member states to bring about harmonization by other

5
The report may be downloaded from http://ec.europa.eu/internal_market/company/
docs/modern/report_en.pdf; an abstract in German language may be found here: Maul,
Der Betrieb (DB) 2003, 27.
6
Communication from the Commission to the Council and the European Parliament of
21 May 2003, COM (2003), 284 fi nal.
7
Directive 2003/25/EC, (supra note 3).
134 Perspectiv es in compa n y l aw

means than legislation, but instead has talked of ‘appropriate actions’

which the Member State must undertake. Accordingly, harmoniza-
tion may also be resolved through the respective national Corporate
Governance Codes.
The Commission therefore attaches most importance to the effec-
tive implementation of the Recommendations as such, insofar as this
can be reasonably expected. The implementation of both Commission
Recommendations in Germany is going to be the topic of this
contribution.

II. Remuneration policy and publication of directors’

remuneration (Recommendation of 14 December 2004)
This Commission Recommendation deals with the concept of a general
remuneration policy for the board directors of listed (stock) companies
as well as the publication of each director’s respective remuneration,
with a special focus on stock-option programmes.
A listed company is therefore required to publish a report on remu-
neration annually, providing information as to the concrete concept
according to which remuneration is determined. Further to this, a listed
company is required to publish each director’s individual annual remu-
neration. And thirdly, remuneration by way of stock options requires an
approving decision of the shareholders’ meeting.
In Germany, this Commission Recommendation for the most part
was a case of preaching to the converted.

A. Approval of shareholders’ meeting in case of remuneration

by way of stock-options
Since its introduction in 1937, the German Stock Companies
Act (‘Aktiengesetz’) contains provisions on authorized capital (‘bed-
ingtes Kapital ’) which serves the hedging of conversion rights
(‘Umtauschrechte’), bonds and debentures (‘Wandelschuldverschrei-
bungen’) and stock-options (‘Bezugsrechte’). Stock-options such as these
may be granted to employees since 1965, and since 1998 to members of
the board of directors (‘Mitgliedern der Geschäftsführung ’) also.
Pursuant to §§ 192–3 of the German Stock Companies Act, author-
ized capital as well as the specific terms and conditions of correspond-
ing conversion rights and stock options may only be granted by a
decision of the shareholders’ meeting. To this extent the Commission
 Commission R ecommendations in Ger m a n y 135

Recommendation had been fulfi lled long before its enactment in

Germany.
However, according to the wording of Section 2.1 of the Commission
Recommendation the term ‘members of the board of directors’
(‘Mitglieder der Unternehmensleitung ’) also refers to members of
the supervisory board, which in Germany is called ‘Aufsichtsrat ’. In
Germany, the legislative8 and the judicial9 branch have reached a com-
mon view that supervisory directors may not receive remuneration
in the form of stock options as a matter of law – contrary to the view
regarding management directors. This understanding has been adopted
due to fears for their independence, for example concerning enterprise
strategy and valuation policy.10

B. Publication of directors’ individual annual remuneration

In Germany, this particular Commission Recommendation also was
a case of teaching the pope Latin. This was largely due to the fact that
the debate on such publication requirements had by 2002 developed as
follows.
As a consequence of the insolvency of giant construction firm Philipp
Holzmann AG, Chancellor Schröder appointed a commission with the
following mandate:11
It shall be the commission’s task to review the Philipp Holzmann Case,
and on the basis of its findings, the commission shall then deal with
possible areas of improvement concerning Corporate Governance and
Corporate Control. Furthermore, against the backdrop of constant fun-
damental change in our companies and market structures owing chiefly
to globalization and internationalization of the capital markets, the
Commission shall make recommendations for a modernization of our
present legislation.

8
Official Reasoning in connection with the Government’s Proposal for the Company
Control and Transparency Act (‘Gesetz zur Kontrolle und Transparenz im
Unternehmensbereich’) (KonTraG), Bundestag printing matter (‘Drucksache’) 13/9712,
Annex (‘Anlage’) 1, p. 24.
9
German Federal Court (BGH), 16 February 2004, II ZR 316/02, BGHZ 158, 122.
10
Opinions from the scientific community show that this issue is still highly controver-
sial; see Bezzenberger, in K. Schmidt and M. Lutter (eds.), Kommentar zum AktG, 2008,
(Köln: Schmidt, 2007), § 71, NO. 49.
11
T. Baums (ed.), Bericht der Regierungskommission Corporate Governance, (Köln:
Schmidt, 2001), 1.
136 Perspectiv es in compa n y l aw

The commission dealt with its task within only ten months and pro-
duced a volume of more than 130 recommendations, most of which
were targeted at reforming or amending the German Stock Company
Act. Two of these recommendations were concerned with developing a
Corporate Governance Code and to compel German stock companies
by law to report annually on the compliance or non-compliance there-
with.12 And so it happened. Two months later, the Minister of Justice
appointed a second commission and assigned to it the task of develop-
ing a German Corporate Governance Code and amending it at regu-
lar intervals (standing commission). Again this assignment took the
standing commission only six months to fulfi l, and in February 2002 the
newly developed Code was published.13
Parallel to this development, in June 2002 the Bundestag passed a
law introducing a new Section 161 to the German Stock Company Law
which compels both the directors of the management board and of the
supervisory board to annually publish a declaration concerning their
compliance or non-compliance with the Code in the respective past
year, as the case may be, and their intention whether or not to comply
with it in the future.14
The Code differentiates between recommendations and sugges-
tions, and this difference was taken into account by the legislature
when it decided upon the wording of Section 161. The law therefore
requires members of both the management and the supervisory board
to annually declare themselves on the compliance or non-compliance
of recommendations only, while the same duty does not exist for
suggestions.
Much to the astonishment of the general public and executive direc-
tors of about 800 listed companies alike, the 2002 first version of the
12
Baums (ed.), Bericht der Regierungskommission, NO. 5–15 (supra note 11).
13
The Rules may be downloaded from www.ecgi.org/codes/code.php?code_id=217.
14
Section 161 of the German Stock Company Act reads as follows:
Directors both of the management board and of the supervisory board of a
listed company shall declare annually whether or not in the past they complied
and in the future intend to further comply with the recommendations as laid
down by the Government Commission German Corporate Governance Code
(‘Regierungskommission Deutscher Corporate Governance Kodex’) and published
by the Ministry of Justice in the Official Journal of the Electronic Federal Gazette
(‘Bundesanzeiger’), or, which of these recommendations were not or will not be
applied. Th is declaration shall be made permanently accessible to the company’s
shareholders. [NB: English version by author]
For more detail see H.M. Ringleb, T. Kremer, M. Lutter, A. von Werder, Deutscher
Corporate Governance Kodex, (Munich: Verlag C.H. Beck, 2008, 3rd edn.).
 Commission R ecommendations in Ger m a n y 137

Code under Section 4.2.4 already comprised a suggestion for each direc-
tor to individually publish their annual remuneration. The said section
read:
the individual remuneration of each director of the management
board shall be reported in the annex to the consolidated accounts
(‘Konzernabschluss’), divided into the following categories: fi xed salary,
components according to performance and components based on the
concept of long-term incentive. The report shall be personalized.

The reaction of the general public was very welcoming, whereas com-
panies and management directors reacted in a rather reserved or even
hostile manner. By some the said suggestion was even viewed as an
unlawful interference with the personal integrity and privacy of man-
agement directors, and therefore to be regarded as unconstitutional.15
The suggestion failed to achieve much success. Because of this modest
success, and because of the general public’s growing displeasure with high
salaries and compensation payments following the termination of man-
ager’s contracts, the Code commission reviewed the very same provision
only one year later, and after heated debates upgraded it to the level of
recommendation in June 2003. From then on, companies were compelled
by law to publish their compliance or non-compliance, as the case may be,
and moreover, in case of the latter, to publish their reasons as well.16
This measure’s success started hesitantly all the same; two years later
(by 2005) only two-thirds of the DAX-30 companies and only half of
the rest of all listed companies had published their directors’ remu-
neration details. At this point in time politicians had had enough, and
the Bundestag passed the Publication of Directors’ Remuneration Act
(‘Vorstandsvergütungs-Offenlegungsgesetz’) (VorstOG), which came into
force on 11 August 2005.17 The Act compels listed companies to pub-
lish each of their directors’ remuneration in a personalized and detailed

15
In favour of this view: W. Porsch, ‘Verfassungs- und europarechtliche Grenzen eines
GesetzeszurindividualisiertenZwangsoffenlegungderVergütungderVorstandsmitglieder’,
Betriebsberater (BB) (2004), 2533; S. Augsberg, ‘Verfassungsrechtliche Aspekte
einer gesetzlichen Offenlegungspfl icht für orstandsbezüge’, Zeitschrift für
Rechtspolitik (ZRP) (2005), 105; opposed to this view: G. Thüsing, ‘Europarechtlicher
Gleichbehandlungsgrundsatz als Bindung des Arbeitgebers?’, Zeitschrift für
Wirtschaftsrecht (ZIP) (2005), 1389, 1395.
16
Code Sec. 3.10.
17
Publication of Directors’ Remuneration Act (‘Gesetz über die Offenlegung von
Vorstandsvergütungen’) of 3 August 2005, Federal Law Gazette (‘Bundesgesetzblatt’)
(BGBl.) I, S. 2267.
138 Perspectiv es in compa n y l aw

manner in either the annex to the balance sheets (‘Anhang zur Bilanz’)
or in the management report (‘Lagebericht ’) and the group management
report (‘Konzern-Lagebericht ’) following due examination by the annual
auditor.
In short, at the time when the Commission issued its
Recommendation concerning the remuneration of management
directors on 14 December 2005, the German Corporate Governance
Code already comprised an equivalent provision. A few months later,
this Code provision was elevated to the status of Act of law, as can
be seen in Section 285 Sentence 1 No. 9 of the German Commercial
Code (HGB).

III. The composition and independence of supervisory board

directors as well as the formation of committees according
to the Recommendation of 15 February 2005
A. The election of supervisory board members
Section 11.1 of the Recommendation reads:
It is recommended that the supervisory board defi ne, and review at regu-
lar intervals, its own ideal composition in light of the company’s structure
and field of activity in order to guarantee well-balanced diverse profes-
sional competence among its ranks. It is further recommended that the
supervisory board ascertains that its members as a team can command
the necessary professional competence, soundness in decision making
and expertise.

In Germany, this topic has a story of its own.

The supervisory board as formed by German law (‘Aufsichtsrat ’)
has always, from its very inception, been assigned the task of super-
vising the management, and – with hindsight – has never shied away
from this task. However, its self-image had widely been quite different
all the same: the average supervisory board was part of a nationwide
entrepreneurial network: management directors of one company often
acted as supervisory directors of many other companies. In this respect,
the integration of banks as helpers in need into supervisory boards and
the establishment of links with suppliers and recipients was of crucial
importance. Supervision ranked only second to networking, and was of
a merely reactive nature. In cases of economic disaster, more than one
company’s supervisory board was unable to accomplish anything more
than to simply grin and bear.
 Commission R ecommendations in Ger m a n y 139

This attitude has changed drastically since the mid-1990s, i.e. since
the international capital markets conquered the hitherto sealed-off
German system. The idea of Corporate Governance was being put at the
top of the agenda then, and the German legislature gradually awarded
the Aufsichtsrat its fair share of entrepreneurial responsibility. As if over-
night, the Aufsichtsrat was given co-responsibility for general planning
and strategy, and it also became its task to give advice to the management
board and even to make joint managerial decisions. In short, the active,
co-entrepreneurial Aufsichtsrat today is a matter of law. Network rela-
tions were replaced by personal competence. More than one company’s
Aufsichtrat was not prepared for this change, and many more have not
caught up with the development even now. Cases where there is a lack of
personal competence to a degree as to render the Aufsichtsrat deficient
in terms of personal competence when compared to the management
board have been and continue to be numerous.18
Since that time, scientific writers have zoomed in on this issue,19
and have postulated the exact same recommendations as are the
Commission’s, that is:
(i) an abstractly termed outline of a composition scheme as to how
shareholders’ representation on the supervisory board ought ideally
be organized, for example:
• one financial expert
• one accounting and controlling expert
• one expert with technical knowledge
• one marketing expert
• one law and tax expert
• one expert for overseas business activity;
(ii) a hunt for the most qualified candidates to meet the requirements of
this composition scheme.

18
M. Lutter, ‘Der Aufsichtsrat im Wandel der Zeit – von seinen Anfängen bis heute’, in
W. Bayer and M. Habersack (eds.), Aktienrecht im Wandel, (Tübingen: Mohr Siebeck,
2007), 389.
19
M. Lutter, ‘Auswahlpfl ichten und Auswahlverschulden bei der Wahl von
Aufsichtsratsmitglieder, Zeitschrift für Wirtschaftsrecht (ZIP) (2003), 417; M. Lutter,
‘Legal Success’, Handelsblatt, 27 March 2008, No. 60, 9; S. Maul,’ Gesellschaft srechtliche
Entwicklungen in Europa – Bruch mit deutschen Traditionen?’, Betriebsberater (BB)
(2005), special issue, 19, 2; D. Bihr and W. Blättchen, ‘Aufsichtsräte in der Kritik: Ziele
und Grenzen einer ordnungsgemäßen Aufsichtsratstätigkeit – Ein Plädoyer für den
‘Profi-Aufsichtsrat’, Betriebsberater (BB) (2007), 1285.
140 Perspectiv es in compa n y l aw

Yet, Germany is still light years away from arriving at the utopia of a
seamless operationalization of these recommendations by listed com-
panies. At least, the first version Code under Section 5.4.1 already
showed a similar tendency:
Upon the proposal of candidates for the election as member of the super-
visory board, special attention shall be paid to ensuring that board mem-
bers as a team command the knowledge, the abilities and the expertise
necessary for the sound execution of the board’s lawful tasks at all times.

Here, the Code clearly tackles the issue of an ideal composition of the
supervisory board from the perspective of the required personal com-
petence; even so, the recommended solution is of an ad hoc nature, not a
systematic approach.
A step forward, the Code as amended by 2007 under Section 5.3.3
now recommends the formation of a nomination committee (see below).

B. The formation of committees

According to Section 5 the commission recommends the formation of
three committees to the supervisory board:
• a nomination committee
• a remuneration committee
• an audit committee.
Section 107 paragraph 3 of the German Stock Company Act provides
that a company may, at its discretion, form advisory and co-deciding
committees. In practice, the so-called President Committee has been
prevalent up till now, the task of it being to make recommendations to
the plenum with regard to the appointment of new management direc-
tors, and upon appointment, to conclude, on its own responsibility, the
corresponding manager’s contract including remuneration details.
Since its early beginnings, the Code has always recommended the for-
mation of an audit committee under Section 5.3.2. This recommenda-
tion has widely been put into practice; these days, almost every listed
company has an audit committee.20

20
The formation of an audit committee was made mandatory by the EU’s 8th directive,
Directive 2006/43/EC of the European Parliament and of the Council of 17 May 2006
on statutory audits of annual accounts and consolidated accounts, amending Council
Directives 78/660/EEC and 83/349/EEC and repealing Council Directive 84/253/EEC,
[2006] OJ L 15.
 Commission R ecommendations in Ger m a n y 141

In June 2007, the Code commission amended its said recommenda-

tion by adding to it the nomination committee (Sect. 5.3.3), to which it
assigned the task of making recommendations to the plenum regard-
ing the composition of the supervisory board. On the one hand, accord-
ing to Section 101 Paragraph 1 of the German Stock Company Act, the
election of supervisory directors from among the group of sharehold-
ers is reserved to the shareholders’ meeting. On the other hand, accord-
ing to Section 124 Paragraph 3 of the German Stock Company Act, it
is the acting supervisory board’s task to make candidate proposals to
the shareholders’ meeting. In practice, the shareholders’ meeting almost
always follows these proposals, to the effect that a de facto co-optation
is established.
Since the nomination committee is compelled to give reasons for
its recommendations in a plenary session, hopefully the system of due
selection as discussed above will more and more become standard
practice.

C. The independence of the supervisory board

In dealing with this topic, the Commission puts a decided emphasis on
it by not only drawing up a principle under Section 4, but also a number
of detailed recommendations, as in:
• Section 13.1 a defi nition
• Section 13.2 the establishment of criteria on Member State level
• Section 13.3 publication of these criteria.
Additionally, the Commission set up nine criteria in Annex II to the said
Recommendation, which, if fulfi lled, are assumed to have a detrimental
effect on the independence of supervisory directors, one of them read-
ing: ‘d) The person in question may in no case be a controlling stock-
holder, or its representative.’
The fate of this recommendation in Germany has been markedly dif-
ferent from those already discussed above. This is due to the fact that
controlling stockholders are a less rare phenomenon in Germany than
elsewhere (BMW, Porsche, VW, Dresdener Bank, METRO etc.), and it
comes as no surprise that they usually strive for and in fact do exert
influence on ‘their own’ company. Furthermore, it is common practice
in Germany for professionally successful and personally esteemed man-
agement directors to take up a seat on the supervisory board at the time
of their age-related withdrawal from management functions.
142 Perspectiv es in compa n y l aw

There are virtually no legal rules on independence in Germany, apart

from the law stating that no person may be a member of the management
board and the supervisory board at the same time. It thus comes as a bit
of a surprise that even the fi rst version Code (2002) comprised a provi-
sion on this very matter. The very first version of Section 5.4.1 reads:
Upon the proposal of candidates for the election of members of the super-
visory board, special attention shall be paid to…ensuring candidates’ suf-
ficient independence.

Also from the 2002 first version onwards, this was put into rather more
concrete terms by Section 5.4.2, which states:
Independent advice to and supervision of the management board by
the supervisory board is facilitated by the stipulation that the supervi-
sory board may comprise no more than two members who have been in
a managerial position in the same company at some time or another, and
that members of the supervisory board may neither act in a managerial
position of nor provide advisory service to another company which is a
substantial competitor.

After the publication of the Commission Recommendation of 15

February 2005 on the independence of supervisory board members, the
next plenary session of the Code commission dealt with this very issue
and decided on amending the Code. The wording ‘sufficient independ-
ence’ under Section 5.4.1 was eliminated, and under Section 5.4.2 the
following two sentences were added:
In order to facilitate independent advice to and supervision of the man-
agement board by the supervisory board, the latter shall comprise a suf-
ficient number of independent members, at its own discretion. A member
of the supervisory board is to be viewed as independent, if he or she is
in no way connected with the company or its management board either
business-wise or personally in a way that entails a confl ict of interests

whereas the limitation on two members who have been in a managerial

position in the same company at some time or another and the non-
competition requirement remained unamended.
The Code thereby almost verbally adopted the general wording of the
Recommendation (Section 13.1). This is nothing to write home about,
though. The general wording of both the Recommendation and the Code
more or less states what is self-evident anyway. What was of an explosive
nature about the recommendation was not its general wording, but a
list contained in its Annex, by which the Commission declared who, in
 Commission R ecommendations in Ger m a n y 143

its opinion, may not be viewed as independent. This is where opinions

differ. So what is the specific meaning of independence in this context?
(Almost) every human being is in some way or another dependent some
thing or another. That is not what this is about. What is essential is the
independence from the management board, be it personal or business-
wise. The Code stresses this understanding by its sentence 2 of Section
5.4.2 just cited above.
So is the holder of a controlling stake to be viewed as not independ-
ent – as the Commission suggests – or indeed independent? In my opin-
ion, and this is in accordance with the general opinion in Germany, the
management board is dependent on the controlling stockholder, but not
the other way around. Incidentally, this is equally congruent with what
the German law states in Sections 17 and 311 of the Stock Company Act.
Indeed, the boot is on the other foot: if one can righteously call anybody
independent from the company and the management board at all, it cer-
tainly is the controlling stockholder and its representatives.
This is at least a general rule. There may be exceptions to this rule,
i.e. in case business relations are intertwined to such a degree that the
controlling stockholder must actually be called dependent – after all, it
is the exception which proves the rule.
Consequently, the reception of the Commission Recommendation of
15 February 2005 on the independence of supervisory board members
has been ambivalent in Germany. We accept its main principal, and we
also accept the principal view that the heart of the whole issue is the
independence of supervisory board members from the company and
the management board. The German Code has therefore adopted these
principles.
Then again we beg to differ, and to differ clearly and decidedly, on a
number of sub-issues contained in the list of examples as published in
the Annex to the Recommendation. Th is is why none of these exam-
ples have been adopted by the Code: the interpretation of the meanings
of dependence and independence is focused solely on business relations
with the company and social and business relations with the manage-
ment board, but not illustrated with specific examples.

III. The manner of implementation in Germany

When the Recommendation on a regime for the remuneration of direc-
tors was published, the German Code already comprised an equiva-
lent recommendation. Shortly afterwards, the Publication of Directors’
144 Perspectiv es in compa n y l aw

Remuneration Act was passed, thereby completing implementation of

the Recommendation.
While the legislature did not react to the Recommendation on the role
of supervisory directors, the Code did, as described above. There never-
theless remains a difference concerning the interpretation. The Code has
almost verbally adopted the general wording of the Recommendation.
However, as the examples in the Annex of the Recommendation clearly
illustrate, our understanding of the supervisory board directors’ inde-
pendence from the company and the management board is not entirely
reconcilable with the Commission’s view. In Germany, a general view
has developed according to which controlling stockholders and their
representatives are to be viewed as independent. That is where we do not
find the Commission Recommendation convincing at all, and in this
respect we are not going to follow it in the future, either.
 8

The Nordic corporate governance

model – a European model?
Jesper Lau Hansen

I. A need for further harmonization?

Depending on your temper, there may be something slightly sadden-
ing about looking at the European directives on company law; a feeling
that a great momentum has ground to a halt. Then again, you may feel
relief.
In the beginning harmonization appeared to be as easy as one, two,
three: the First Company Law Directive on publicity and company
formation,1 the Second Company Law Directive on capital2 and the Third
Company Law Directive on mergers.3 But there soon came the first major
stumble, when the proposal for a Fift h Company Law Directive on cor-
porate governance4 was first brought to a halt, then forgotten and finally
abandoned.5 Although new directives would continue to be adopted with

1
First Council Directive 68/151/EEC of 9 March 1968 on coordination of safeguards
which, for the protection of the interests of members and others, are required by Member
States of companies within the meaning of the second paragraph of Article 58 of the
Treaty, with a view to making such safeguards equivalent throughout the Community
[1968] OJ L65.
2
Second Council Directive 77/91/EEC of 13 December 1976 on coordination of safe-
guards which, for the protection of the interests of members and others, are required
by Member States of companies within the meaning of the second paragraph of Article
58 of the Treaty, in respect of the formation of public limited liability companies and
the maintenance and alteration of their capital, with a view to making such safeguards
equivalent [1977] OJ L26.
3
Th ird Council Directive 78/855/EEC of 9 October 1978 based on Article 54 (3) (g) of the
Treaty concerning mergers of public limited liability companies [1978] OJ L295.
4
Proposal COM/72/887 for a fi ft h Directive on the coordination of safeguards which
for the protection of the interests of members and outsiders, are required by Member
States of companies within the meaning of Article 58, second paragraph with respect
to company structure and to the powers and responsibilities of company boards [1972]
OJ C131.
5
See the Commission’s decision to withdraw this proposal and others in OJ C 5,
9.1.2004, 2.

145
146 Perspectiv es in compa n y l aw

the Sixth Company Law Directive on the division of companies, this was
not quite the same, as this Directive was optional in its entirety.6 Later, a
proposal for a Ninth Company Law Directive on corporate groups was
never even adopted by the Commission,7 which left a gap between the
Eighth Company Law Directive on auditing8 and the Eleventh Company
Law Directive on branches,9 a gap that was widened by the stalling of the
proposal for a Tenth Company Law Directive on cross-border mergers.10
And when that Directive was eventually passed11 – due, as is so often the
case, to the gentle but firm assistance of the European Court of Justice12 –
it no longer carried a number in its title, leaving a permanent gap in the
numbering. In omitting its number, it emulated the Directive on takeover
bids13 which had originally been presented as a proposal for a Thirteenth
Company Law Directive14 before suffering a humiliating defeat at the

6
Sixth Council Directive 82/891/EEC of 17 December 1982 based on Article 54 (3) (g) of
the Treaty, concerning the division of public limited liability companies [1982] OJ L378.
7
The lack of European harmonization within this area was lamented by the Forum
Europeaeum, Corporate Group Law for Europe, (Stockholm: Corporate Governance
Forum, 2000).
8
Eighth Council Directive 84/253/EEC of 10 April 1984 based on Article 54 (3) (g) of the
Treaty on the approval of persons responsible for carrying out the statutory audits of
accounting documents [1984] OJ L126.
9
Eleventh Council Directive 89/666/EEC of 21 December 1989 concerning disclosure
requirements in respect of branches opened in a Member State by certain types of com-
pany governed by the law of another State [1989] OJ L395.
10
Proposal for a tenth Directive of Council based on Article 54(3)(g) of the Treaty
concerning cross-border mergers of public limited companies, COM(84) 727, later
revised as COM(1993) 570 fi nal. The proposal was withdrawn in 2004, see footnote 5
supra.
11
Directive 2005/56/EC of the European Parliament and of the Council of 26 October 2005
on cross-border mergers of limited liability companies [2005] OJ L310.
12
The right to carry out a cross-border merger in accordance with provisions in national
law was upheld by the ECJ on the basis of Articles 43 and 48 of the EC Treaty (i.e. pri-
mary European law) in its decision of 13 December 2005 in Case C-411/03, SEVIC
Systems, [2005] ECR I-10805, making the adoption of the Directive the only way
for the Member States to regulate this activity under secondary European law. On
this judgment, see M. M. Siems, ‘SEVIC: Beyond Cross-Border Mergers’, European
Business Organisation Law Review, 8 (2007), 307–16, noting the further implications
of the judgment on related problems such as the transfer of a company registered
office.
13
Directive 2004/25/EC of the European Parliament and of the Council of 21 April 2004
on takeover bids [2004] OJ L142.
14
Proposal for a thirteenth Council Directive on company law concerning takeover and
other general bids in COM(88) 823 fi nal, which was revised in COM(90) 416 final of 10
September 1990, and revised again more thoroughly in COM(95) 655 final of 7 February
1996.
 the Nor dic cor por ate gov er na nce model 147

hands of the European Parliament,15 and it was only passed after all its
controversial parts had been made optional,16 leaving it vulnerable to
the accusation that it did not comply with the principle of subsidiarity
enshrined in Article 5 of the EC Treaty.17 With the recent declaration
by Commissioner Charlie McCreevy that the proposal for a Fourteenth
Company Law Directive on the cross-border transfer of a company’s reg-
istered office will not be proceeded with, as no further action is deemed
necessary in this area,18 it would appear that the Twelft h Company Law
Directive on single-member companies adopted in 1989 will be the last
of the line.19 Indeed, when the Directive on shareholders’ rights was
adopted, it was not presented as a Company Law Directive, but more
as an appendix to the regulation of publicly traded (listed) companies as
it does not apply to all companies, or even to all companies of the PLC
type, but only the sub-set of companies whose securities are admitted to
trading on a regulated market.20 Regulation of company law per se seems
to have been superseded by the regulation of publicly traded companies
in order to enhance the working of the fi nancial markets.
As the harmonization of national company law has ground to a halt,
the situation has hardly been any better with European company law

15
On the defeat of the proposal by the European Parliament in 2001 and the preparation of
a new proposal that was eventually passed, see J. L. Hansen, ‘When less would be more:
The EU Takeover Directive in its latest apparition’, Columbia Journal of European Law,
9 (2003), 275–298.
16
The controversial parts are Article 9 (requiring the board of a target company to remain
passive in face of a takeover bid) and Article 11 (providing a ‘breakthrough rule’ which
allows a bidder, upon acquiring at least 75% of the capital, to call a general meeting at
which all shares carry votes in proportion to their capital and all other limitations on
voting are set aside). Article 9 confl icts with the German corporate governance model
which allows management considerable discretion to decide on the welfare of the com-
pany. Article 11 confl icts with the ubiquitous use of multiple voting shares in the Nordic
Member States. Both Articles 9 and 11 are optional for the Member States, though a
Member State cannot prevent a national company from applying these provisions, see
Article 12.
17
Article 5, second paragraph reads: ‘In areas which do not fall within its exclusive com-
petence, the Community shall take action, in accordance with the principle of subsidi-
arity, only if and in so far as the objectives of the proposed action cannot be sufficiently
achieved by the Member States and can therefore, by reason of the scale or effects of the
proposed action, be better achieved by the Community.’
18
Speech by Commissioner McCreevy on 3 October 2007 at the European Parliament’s
Legal Affairs Committee in Brussels, (SPEECH/07/592).
19
Twelft h Council Company Law Directive 89/667/EEC of 21 December 1989 on single-
member private limited-liability companies [1989] OJ L232.
20
Directive 2007/36/EC of the European Parliament and of the Council of 11 July 2007 on
the exercise of certain rights of shareholders in listed companies [2007] OJ L184.
148 Perspectiv es in compa n y l aw

as such. For many years the only truly European company entity was
the European Economic Interest Grouping (EEIG) adopted in 1985.21
As an entity without limited liability and without the capacity to con-
duct business, the EEIG remained unwanted by many and unknown to
most. What should have been the flagship of European harmonization,
the creation of a European public limited liability company to challenge
the various national forms of company while sailing under the grand
Latin name of Societas Europaea (SE), remained unfinished for more
than forty years while successive rounds of negotiations chipped away
at it until the resulting hulk was so diminished and so full of holes that
the SE could not possibly keep itself afloat above the jurisdictions of the
Member States, as originally envisioned.22 Thus the true European SE
does not exist; what exists is a national SE, e.g. a Danish SE as opposed to
a German SE, and so far very few SEs have been formed.
A survey of the harmonization efforts so far reveals that it is the
issue of corporate governance that most often has delayed or even hin-
dered harmonization. In particular the participation of workers (co-
determination) appears to have been a contentious issue. Although a
solution of sorts has been provided by the model invented for the SE
company,23 the organization of a company and the internal distribution
of powers remain controversial and thus remain unharmonized.
This is not to belittle the extent of the harmonization that has been
achieved over the years, but compared to the high degree of harmoniza-
tion of financial market law on banking, insurance and securities trad-
ing, it is undeniable that the harmonization of company law so far is
considerably more modest.
The lower level of harmonization of company law than of fi nancial
market law is not necessarily a failure. A similar distinction has been
observed in the United States of America, where securities trading
and exchange law has been harmonized to a great extent by federal
law, while company law remains a matter of state jurisdiction, with

21
Council Regulation (EEC) No 2137/85 of 25 July 1985 on the European Economic Interest
Grouping (EEIG) [1985] OJ L199.
22
Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European
company (SE) [2001] OJ L294. Article 5 in particular springs a major leak in the vessel as
it refers all questions of capital to national law. Although some harmonization of capital
requirements has been provided by the Second Company Law Directive (note 2, above),
this broad reference to national law means that an SE is stuck in the jurisdiction where it
is formed.
23
Council Directive 2001/86/EC of 8 October 2001 supplementing the Statute for a
European company with regard to the involvement of employees [2001] OJ L294.
 the Nor dic cor por ate gov er na nce model 149

only some harmonization by way of the Model Business Corporation

Act (MBCA).24 It has been argued that the distinction between federal
securities regulation and state company law mirrors the distinction in
Continental European law between public and private law.25 This has
some merit, as private law is characterized by having less extensive regu-
lation, because individual parties are expected to be able to negotiate in
their own interests, whereas public law relies on more extensive regula-
tion, because the parties and interests involved are not equally capable of
protecting themselves. Thus, the distinction between more harmonized
financial market law and a less harmonized company law may reflect
the fact that harmonization is required for financial market law but is
unwarranted for company law.
Support for this proposition can be found in the fact that the company
law of most European jurisdictions is traditionally of an enabling nature,
leaving considerable discretion to the participants in the company to nego-
tiate the arrangements between them, except for provisions on capital
where the protection of creditors as ‘outsiders’ is deemed necessary. To the
extent that the national jurisdictions of the Member States abstain from
regulating corporate governance issues to allow for greater flexibility, then
the EU should follow suit, in compliance with the principle of subsidiarity.
The brief survey of harmonization at the start of this article is a
reminder of something else. All secondary European law must have
a basis in primary European law. In the case of the harmonization of
company law that used to be Article 54 of the EEC Treaty, now Article
44 of the EC Treaty, notably its subsection (3)(g) which concerns ‘safe-
guards’ for the protection of the interest of members and others, that is,
creditors. However, since the Single European Act of 1986 had the aim
of introducing an ‘internal market’ in lieu of the ‘common market’ that
had eluded the politicians of the Member States, the aim of harmoniza-
tion appears to have been broadened. A case in point is the Directive on
shareholders’ rights, which refers both to Article 44 on ‘safeguards’ and
Article 95 on the establishment and functioning of the internal market.26
Where Article 44 is more modest in scope and strives to harmonize these

24
The MBCA and the revised MBCA is prepared by the Committee on Corporate Laws
of the Section of Business Law of the American Bar Association. It has been adopted
by many states, but some jurisdictions of major importance for company law have not
adopted it, notably Delaware.
25
See A. N. Licht, ‘International Diversity in Securities Regulation: Some Roadblocks on
the Way to Convergence’, Cardozo Law Review, 20 (1998), 227–85.
26
On the Directive, see note 20, above.
150 Perspectiv es in compa n y l aw

‘safeguards’, Article 95 is much more open to the argument that any dif-
ference, no matter what, should be subject to harmonization in order to
iron out any hindrances to cross-border activity. The principle of sub-
sidiarity and the related principle of proportionality, both laid down in
Article 5 of the EC Treaty, would prevent this kind of argument. When
it comes to corporate governance, there is even more reason to object to
a harmonization aimed at creating a single European model. There is
no empirical evidence to suggest that a superior corporate governance
system exists. Nor is it likely that one could be identified by academics or
lawmakers when the market participants themselves have been unable to
do so through generations of competitive market behaviour. Indeed, as
noted by the Commission, all available expert evidence cautions against
imposing one model of corporate governance to fit all.27
Consequently, the fact that the harmonization of company law appears
to have slowed down and may even have stopped altogether (except for
issues pertaining to regulated markets and listed companies) may be due
to the fact that the necessary harmonization has been achieved and that
those parts where national jurisdictions differ, notably in the field of cor-
porate governance, should remain unharmonized, as there is no single
model that would be best for all. Different corporate governance models
may suit different needs. If there is any need for harmonization, it ought
to be in providing flexibility for the citizens of the EU, so that different
jurisdictions should offer a choice of the different corporate governance
models available throughout Europe. However, even here there may be
no need for European legislation, as the ECJ has already provided such
flexibility by its judgments granting the freedom to choose any juris-
diction for the formation of a company and the freedom to move that
company within the EU.28
27
Communication from the Commission to the Council and the European Parliament –
Modernising Company Law and Enhancing Corporate Governance in the European
Union – A Plan to Move Forward, COM(2003) 284 fi nal of 21 May 2003, pp. 10–12.
28
The landmark decision was the judgment of 9 March 1999 in Case C-212/97, Centros
Ltd., [1999] ECR I-1459. The judgment relied on previous decisions, notably Case
270/83, Commission v. France, [1986] ECR 273 and Case 79/85, Segers, [1986] ECR 2375.
The judgment in the earlier Case 81/87, The Queen v. Treasury and Commissioners of
Inland Revenue, ex parte Daily Mail and General Trust, [1988] ECR 5483, established
that a company had no right to transfer its registered office as this was not in accordance
with Article 220 of the EEC Treaty (now Article 293 of the EC Treaty). However, in its
judgment of 5 November 2002 in Case C-208/00, Überseering BV v. Nordic Construction
Company Baumanagement GmbH, [2002] ECR I-9919, the ECJ pointed out that Centros
concerned recognition of foreign companies and the resulting freedom of establish-
ment, whereas Daily Mail concerned a transfer of registered office, see paragraph 40. See
 the Nor dic cor por ate gov er na nce model 151

II. A distinct Nordic model?

The corporate governance debate in Europe is dominated by the
distinction between the one-tier model known in English law, where
there is only one company organ (the board of directors) below the gen-
eral meeting of shareholders, and the two-tier model where there are
two company organs below the general meeting (the management board
and the supervisory board) known in German law. At fi rst glance, the
Nordic model would appear to be a two-tier model, because there are
two company organs below the general meeting (the board of directors
and the management board, that is, a dual executive system). However,
if the purpose is to place the Nordic system in relation to this prevailing
dichotomy, the model must be seen as belonging to the one-tier group.29
The model was first developed in the reform of the Danish Companies
Act of 1930. Before the reform, the prevailing corporate governance
model was the one-tier model with a single administrative company
organ: the board of directors. During the deliberations on reform of the
law, it was argued convincingly that liability should follow capability,
and in very large companies the board of directors was not alone in run-
ning the company; the senior management headed by the chief execu-
tive officer (CEO) would effectively decide all the daily business, subject
of course to the instructions of the board, but often with considerable
autonomy. Consequently, the Act of 1930 provided that large compa-
nies30 should have another company organ below the board of directors,
that of the management board. This model was adopted by Sweden in
the reform of its Companies Act in 1944, and later spread to the other
Nordic countries, Finland, Norway and Iceland. As the Nordic countries
entered either the EU or the EEA,31 they had to introduce the originally
German distinction between public companies and private companies.32

on this distinction, J. L. Hansen, ‘A new look at Centros – from a Danish point of view’,
European Business Law Review, 13 (2002), 85–95. With its judgment in the SEVIC case,
the ECJ has in effect made it possible to transfer the registered office by way of a cross-
border merger, see footnote 12 supra.
29
On the Nordic corporate governance model, see J. L. Hansen, Nordic Company Law,
(Copenhagen, DJØF Publishing, 2003), 57 – 141.
30
Companies with a paid up share capital of DKK 100,000, a considerable sum at the
time.
31
Denmark joined the European Community along with the United Kingdom and Ireland
in 1973. Finland, Iceland, Norway and Sweden joined the European Economic Area in
1994. Finland and Sweden later joined the EU in 1995.
32
The distinction was introduced in Germany in 1892 with a separate law on the GmbH,
a private limited liability company, that was to be regulated more lightly than the AG,
152 Perspectiv es in compa n y l aw

At that time, the dual executive system became mandatory for all public
companies, whereas it remained optional for private companies.33 In its
present form, the corporate governance model of the public company is
identical in all five Nordic countries, except for the minor fact that the
management board in Denmark and Iceland can be a collective body
with more than one member, while in Finland, Norway and Sweden it is
a one-member body comprising the CEO.
Several features indicate that, in a European context, the Nordic dual
executive system is a one-tier model. The system is strictly hierarchical.
The general meeting of shareholders is the supreme company organ with
all the residual powers not explicitly denied it by legislation. However,
the general meeting does not have executive powers and must thus rely
on the two executive organs to carry out its instructions. Of the two
executive organs, the board of directors is the senior organ and can
instruct the management board. The management board deals with the
day-to-day running of the company, under the instructions of the board
of directors and submits to the board of directors any extraordinary or
far-reaching decisions. To ensure the hierarchical nature of the model,
the upper level appoints and dismisses members of the lower level. Thus,
the general meeting of shareholders appoints the directors and may dis-
miss a director at any time and the board of directors hires and fires
the managers.34 Others may also have a right to appoint directors, if
the articles of association so provide, and the employees may appoint

a public limited liability company. The stricter regulation of public limited companies
compared to private companies is reflected in the European directives, notably the
Second Directive on capital (footnote 2 supra) which only applies to public companies.
In order to avoid the stricter regulation of all limited companies, new Member States
had to introduce a similar distinction. It should be noted that a public company is public
by its choice of company form and not because it is publicly traded on a stock exchange
(regulated market), as would be the understanding in US law. Since most of the protec-
tion afforded to investors is given in respect of publicly traded companies, and since the
revision of the Second Company Law Directive by Directive (2006/68/EC) has eased the
strict regulation of capital, the distinction in company law between a ‘public’ company
and a ‘private’ company is moot and should be replaced by a distinction between publicly
traded companies and other companies with limited liability.
33
If a private company is subject to co-determination, it may be obliged to have both a
board of directors and a management board.
34
The power to dismiss a director at any time prevents the occurrence of ‘staggered boards’
which may curtail shareholder influence, as is known in some American jurisdictions.
The power to dismiss a director or a manager without reason is different in German com-
pany law, where a member of a management board (Vorstand) can only be dismissed for
good reason, see AktG § 84, subsection 3.
 the Nor dic cor por ate gov er na nce model 153

directors according to legislation on co-determination, 35 but the major-

ity of directors must always be appointed by the shareholders in a gen-
eral meeting. As the board of directors decides by simple majority, this
mandatory provision ensures that the shareholders enjoy actual power
over the board. The strict hierarchy of the dual executive system is very
different from the two-tier model known in Germany, where the power
of shareholders is limited and the management board is entrenched.
Another difference is that under the Nordic system, managers may serve
as directors (dual capacity), which is unlawful in the German model.
However, in the Nordic model, managers may only constitute a minority
on the board of directors and a manager cannot serve as a chairman of
the board of directors, which enhances the supervision of the manage-
ment board by the board of directors.
Although clearly related to the one-tier model and quite distinct from
the two-tier model, the Nordic model also has characteristics which set
it apart from the one-tier model. Most notable is the allocation of powers
between the board of directors and the management board, both being
independent company organs with distinct powers and responsibili-
ties. It may be argued that the English corporate governance model has
evolved in the same direction since the Cadbury Report of 1992, which
emphasized the need to separate the functions of executive and non-
executive directors to enhance supervision of the former by the latter.36
However, there is still a greater emphasis on this separation in Nordic
law than in English law. Another minor difference is that the Nordic
model is governed by legislation, while the English model relies much
more on the soft-law recommendations of the Combined Code of the
London Stock Exchange. However, here it is the Nordic countries that
appear to be emulating the English approach in providing more regula-
tion by soft law, in the form of codes rather than by legislation.37
That the Nordic corporate governance model is different from the
models more commonly known in the European corporate governance
debate is apparent from the Regulation on the SE statute, where it is dif-
ficult to fit the Nordic dual executive system in between the Regulation’s

35
Co-determination, where employee representatives serve as directors, is known in
Denmark, Norway and Sweden, and to some extent in Finland, but not in Iceland.
36
Report of the Committee on the Financial Aspects of Corporate Governance, 1 December
1992.
37
See J. L. Hansen, ‘Catching up with the crowd – but going where? The new codes on
corporate governance in the Nordic countries’, International Journal of Disclosure and
Governance, 3 (2006), 213–32.
154 Perspectiv es in compa n y l aw

two corporate governance models of either a one-tier or a two-tier sys-

tem.38 It is also evident that the Commission’s Recommendation on the
role of directors relies on the distinction between a unitary board system
and a dual board system akin to the one-tier/two-tier and not the Nordic
dual executive system.39
However, what really sets the Nordic model apart is not the law but the
reality on the ground. There is a predominance of controlling sharehold-
ers who either on their own or together with a few others hold enough
votes to control the decisions of general meetings; this is even the case in
publicly traded companies. In the Nordic corporate governance debate,
the active governance of shareholders is seen as a good thing, something
to be encouraged, because shareholders will strive to make the company
as profitable as possible. As there will only be profits when all other stake-
holders have been paid their dues, shareholders are considered to be the
best ultimate decision makers. It is sometimes argued that shareholders
may pursue short-term gains and that it would be better for a company to
pursue long-term gains. However, as at any given time the value of a share
depends on the discounted future earnings, there is no difference between
the short and the long term when investing in shares, because the price
of the share reflects its long-term value and even short time variations
reflect changed expectations about the future consequences of present
decisions on long-term performance. The problem of shareholder power is
more that shareholders enjoy an asymmetrical risk profile with a limited
downside and an unlimited upside, which may make then dangerously
risk-willing. However, this problem is solved by removing all executive
powers from the shareholders in the general meeting and vesting them in
the management who are then held personally liable for their executive
decisions. Hence, the shareholders may govern the company but cannot

38
On the Regulation, see note 22, above. The Nordic corporate governance model with
its dual executive system is made available by Article 43, Subsection 1, that permits the
appointment of a ‘managing director’ under the same conditions that are known in the
national company law of the home Member State. Whether this reference to national
(Nordic) law is enough to provide for at separate company body for day-to-day manage-
ment remains doubtful.
39
Commission Recommendation 2005/162/EC of 15 February 2005 on the role of non-
executive or supervisory directors of listed companies and on the committees of the
(supervisory) board, [2005] OJ L52/51. Section 2 relies on the distinction between a uni-
tary board and a dual board, which leaves out the non-executive director (dual board)
known in the Nordic model. Nonetheless, the overall distinction between executives and
non-executives or between supervisory directors and managing directors makes it clear
that the Recommendation aims at the directors who are not also serving as managers.
 the Nor dic cor por ate gov er na nce model 155

run it without the acceptance of the management who are personably lia-
ble for not abusing the limited liability of the company.40 Consequently,
in the Nordic corporate governance debate dominant shareholders are
viewed favourably and the legislation is fine-tuned to provide for their
dominance, while protecting minorities against any abuse of power.

III. Challenges to the Nordic model

Although the one-tier and two-tier models appear to represent two very
different approaches to corporate governance, in reality they combine to
form a quite threatening hegemony when viewed from a Nordic perspec-
tive. In the two-tier model shareholders are afforded a very limited role
and the management is entrenched to prevent shareholders having undue
influence; in other words, shareholders are viewed with considerable sus-
picion. In the one-tier model shareholders are formally on top, and even
the latest reform of the English Companies Act in 2006 was based on the
idea of ‘enlightened shareholder value’. However, where publicly traded
companies are concerned, dominant shareholders are equally viewed
with suspicion. Because dominant shareholders are relatively unknown
in the UK, and especially so in the USA, their presence is considered
highly unusual and possibly harmful. Apparently the suspicion is that
the only justification for dominant shareholders not diversifying their
investments like everybody else must be that they want to use their pow-
ers over the company to extract private benefits from the company to
the detriment of the other shareholders. The fact that monitoring and
disciplining of management may sufficiently increase the reward on the
investments of dominant shareholders, even if they have to share some of
that reward with the minority shareholders, appears not yet to have been
fully appreciated in the corporate governance debate. Consequently, both
sides of the one-tier/two-tier debate consider that dominant and influen-
tial shareholders are potentially harmful and possibly illegal.
The few measures on corporate governance that have been adopted at
European level have mostly been directed at publicly traded companies.
But this is exactly the area in which the Nordic model, with its reliance on

40
Strictly speaking, there is no such thing as limited liability for a company, but only for
the shareholders who invested in the company. And limited liability is always accom-
panied by private liability by those who can decide on behalf of the company, that is,
the management. In Nordic company law, as in many other jurisdictions, the personal
liability of the management may be extended to shareholders if in fact they act as manag-
ers (shadow director liability).
156 Perspectiv es in compa n y l aw

dominant shareholders, is most at odds with the major European powers.

A brief overview will show the challenges that have appeared so far.

A. Proportionality of votes and capital

Votes are a way of providing security by reducing risk in an invest-
ment in shares. As such, it is similar to a mortgage or a pledge, as the
preferred security of lenders. How many votes you get for your share
depends on how much you are willing to pay and how eager the com-
pany is to get your money; it is a business transaction like any other.
To invoke the concept of ‘shareholder democracy’ is just plain wrong;
votes can be bought and sold, and even in a company with only one
class of shares, one person may hold more votes than others. To argue
that there must be proportionality between capital and votes in order
to provide an incentive for the proper governance of the company dis-
regards the fact that shares may be bought at different times and prices
and consequently there is hardly ever proportionality between the
prices different shareholders have paid for their shares and the associ-
ated voting rights even in companies with only one class of shares. To
consider shares with multiple votes unfair compared to shares of the
same size but carrying fewer votes is as unfounded as to fi nd it unfair
that some lenders enjoy collateral for their loans while others do not.
As shares with multiple voting rights are often used to maintain con-
centrated control, it is a measure that enhances the position of dominant
shareholders. As such it is viewed favourably in the Nordic countries.
Nonetheless, for a long time the Commission has argued in favour of
a one-share/one-vote regime. Commissioner McCreevy initiated a
major report to investigate control-enhancing mechanisms.41 As the
report found no clear link between these mechanisms and economic
performance,42 Commissioner McCreevy announced that there was no
reason for further action.43 It is all too rare to see a politician refrain
from action simply because it is unwarranted, and there is all the more
reason to praise the courage and good sense of the Commissioner.

41
Report on the proportionality principle in the European Union – ISS Europe, ECGI,
Shearman & Sterling, 18 May 2007.
42
Economic surveys of this kind are notoriously difficult to undertake. One may wonder
whether it is at all possible to compare the economic performance of companies with control-
enhancing mechanisms and those without, as the former have little incentive to value their
assets highly, and the latter have every incentive to inflate their assets to avoid takeovers.
43
See speech of 3 October 2007 (footnote 18 supra).
 the Nor dic cor por ate gov er na nce model 157

However, the assault on multiple voting rights is not over. Article 11

of the Directive on takeover bids contains a breakthrough rule that is
intended to set aside multiple voting shares under certain conditions.
The rule is made optional according to Article 12, because it was fiercely
resisted by the some Member States, notably the Nordic Member States.
As the Directive is up for revision, a survey has been conducted to inves-
tigate the use of the opt-out in Article 12.44 The survey concluded that
the vast majority of Member States had not imposed or were unlikely
to impose the breakthrough rule. It could be argued that this calls for
the rule to be made mandatory, in order to ensure compliance by all
Member States. However, it could equally be argued that a rule which
most Member States would not apply voluntarily should not be made
mandatory. It rather depends on whether you believe that the Member
States are capable of making a sound decision.
Since the Directive already exempts shares where different voting
rights are not assigned on issue but accrue over time,45 even though such
shares do actually hinder takeovers contrary to ordinary multiple vot-
ing shares that are covered by the Directive46, and since the Directive
also exempts non-voting shares and thus accepts a deviation from pro-
portionality between capital and votes,47 it would be better to give up
this campaign against multiple voting shares altogether and accept

44
Report on the implementation of the Directive on Takeover Bids, SEC(2007) 268, 21
February 2007. On Article 12 of the Directive, see footnote 16 supra.
45
According to Article 2, Subsection 1(g) the Directive only covers shares of different
classes with different voting rights, in other words where the difference was already
present when the shares were issued and as such known to the investor and publicly
by way of the articles of association. In the case of shares where multiple voting rights
accrue over time, it is not possible for investors or the public in general to know the dis-
tribution of votes, because this depends on how long the shares have been owned by the
individual shareholders.
46
Shares that always carry multiple voting rights can be acquired with their full votes by a
bidder as part of a takeover. Shares where multiple voting rights accrue over time would
lose their extra votes if acquired by a bidder, which creates a lock-in effect.
47
Article 11, Subsection 6 exempts ‘securities where the restrictions on voting rights
are compensated for by specific pecuniary advantages’. The reach of this provision is
unclear. It may aim at voteless shares which carries a preferential right to dividends.
However, as shares with no (or less) voting rights are always compensated by a lower
price upon subscription and in later market transactions compared to shares with the
same right to dividends but carrying better voting rights, all non-voting shares could be
covered by this Article. Either way, the acceptance of that fact that sometimes sharehold-
ers accept less votes than other shareholders if they like the business investment offered
should have been applied to all other shares with different voting rights rendering the
breakthrough rule unnecessary.
158 Perspectiv es in compa n y l aw

that it is up to the company and its investors to determine what rights

should be carried by shares issued by the company and subscribed by the
investors.48

B. Independent directors
The Commission’s Recommendation on the independence of direc-
tors could be viewed as yet another challenge to the Nordic corpo-
rate governance model.49 The Nordic model is very specific in making
each director directly accountable by ensuring that whoever appoints
them may dismiss them again without notice and without reason.
Furthermore, the legislation mandates that the majority of directors
must be appointed by the shareholders in a general meeting, and as
dominant shareholders are ubiquitous at least half and possibly all of
the board will often have been appointed by a dominant shareholder. In
the Nordic model there is no room for an independent director, as each
director is appointed by some person or persons and accountable to
them and is liable to be removed if they fail to fulfi l their expectations.
Independent control of management is provided by the auditor who is
also elected at the general meeting, and there is no need to insert yet
another controller inside the board. That at least is the law as it stands,
but recent Nordic corporate governance codes have now followed the
Commission Recommendation and recommend the appointment of
independent directors to the board. 50
The reasoning behind the Recommendation, the prevention of mis-
management, is sound, but the chosen solution defers to the corporate
governance models which distrust major shareholders and it is difficult
to reconcile it with the Nordic model. One may ask how a director can
be truly ‘independent’ when they are appointed by a dominant share-
holder and are conscious of that fact that they are subject to immediate
removal by that shareholder? And if a director really feels independent,

48
If the breakthrough rule were abandoned, it would probably be wise to abandon the
‘board passivity’ rule in Article 9 as well. It would make the shareholders vulnerable to
the confl ict of interest of a management faced with a takeover bid, but if the Germans
and others have chosen a corporate governance model where management is entrenched
and the interests of shareholders deferred, then there is little reason to challenge that
choice in the absence of firm empirical evidence of the existence of a problem.
49
On the Commission’s Recommendation, see footnote 39 supra.
50
On the Nordic corporate governance codes, see note 37, above. All codes have, at the very
least, implemented the Commission Recommendation, and some have gone further,
notably the Danish code.
 the Nor dic cor por ate gov er na nce model 159

will the director then feel accountable to the shareholders or to the other
directors they are supposed to monitor?
From a Nordic perspective, it would appear that the Recommendation
has overlooked how these problems are solved in the Nordic model. A
director is accountable to the shareholders, but owes a duty of loyalty
to the company and all its stakeholders; directors are personally liable
if they set the interests of ‘their’ shareholders above those of others. If a
conflict of interest arises, a director cannot participate in the decision
and the decision is voidable if they do. Control of daily management,
that is, the executives of the company, is guaranteed by the requirement
that a majority of the board of directors cannot be made up of managers.
That is what is understood by independence in Nordic company law.

C. Insider dealing
The ban on insider dealing in the securities of a publicly traded company
is well justified and was part of the law in the Nordic countries long before
it was mandated by European law.51 It is also sensible to prevent selective
disclosure of inside information, because the less inside information is
disseminated before its publication to the securities market, the less risk
there is of insider dealing.52 There is an exception to the ban on selec-
tive disclosure where the disclosure is ‘made in the normal course of the
exercise of [a person’s] employment, profession or duties’. The exception
is necessary as it is often important that inside information is passed on
to others, even if there is a risk of abuse of the information.
In the Nordic corporate governance model, where active participa-
tion by shareholders in the governance of the company is encouraged
and where the presence of dominant shareholders ensures that there is
such participation, it is normal to inform major shareholders of issues
relevant to the running of the company even in publicly traded compa-
nies. This is especially the case where decisions would ultimately be made
at the general meeting and thus depend on the consent of the majority
shareholders. For example, it would be a waste of time to negotiate a

51
A ban was introduced by Council Directive 89/592/EEC of 13 November 1989 coor-
dinating regulations on insider dealing [1989] OJ L334. The Directive was replaced by
Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003
on insider dealing and market manipulation (market abuse) [2003] OJ L96 (hereinafter:
MAD).
52
The ban on selective disclosure of inside information is found in Article 3(a) of MAD
(note 51, above).
160 Perspectiv es in compa n y l aw

merger if the dominant shareholder is going to veto it, so it is better to

inform the dominant shareholder confidentially in advance. The right to
appoint and in particular to dismiss a director at will is a clear indica-
tion that the directors are accountable to the shareholders. Dominant
shareholders may appoint themselves to serve as directors or appoint
somebody else on their behalf, either way their right to govern the com-
pany is the same.53
However, the corporate governance debate is dominated by the
UK and USA where the experience is that shareholders are small and
dispersed, which leaves the board isolated or even ‘independent’ of
them. Communication between a director on the board and a share-
holder is viewed as highly unusual, and perhaps even downright ille-
gal. This approach, however, risks a too-narrow interpretation of the
exception to the ban on selective disclosure of inside information
that may effectively sever communication between directors and
shareholders, and by extension prevent the participation by share-
holders in the governance of the company which the Nordic model
relies upon.
Fortunately, when a case came before the ECJ on the interpretation of
the ban on selective disclosure,54 the Court wisely chose to point out that
what constituted ‘normal’ disclosure for the purposes of the exception
to the ban would depend on the national corporate governance model
and for that reason the Court limited itself to stressing that where such
disclosure was normal, the ban would require a strict understanding of

53
Only natural persons can serve as directors, so legal persons are dependent on appoint-
ing a natural person as director on their behalf which only underlines the need to receive
information in confidentiality.
54
See Judgment of 22 December 2005 in Case C-384/02, Grøngaard and Bang, [2005] ECR
I-9939. The case concerned Danish criminal proceedings against an employee represent-
ative serving on the board of a publicly traded company who had disclosed to his union
president that a merger offer was imminent. The director was also a vice-president of the
union and had learned of the news both from serving on the board and from his partici-
pation on a cooperation committee. The union president disclosed the information to a
union employee who used the information for trading and was convicted of insider deal-
ing. Both the employee representative and the union president were convicted by the City
Court of Copenhagen for violating the ban on selective disclosure of inside information.
The conviction was upheld by the Eastern Division of the High Court in its judgment of
15 January 2008, but contrary to the City Court, the High Court accepted that disclosure
could be made confidentially between a director and his ‘constituency’, i.e. the union,
in order for the union to prepare for the merger and the expected lay-offs. However, the
disclosure had been made to a greater extent than necessary, hence the conviction. The
judgment may be appealed to the Danish Supreme Court.
 the Nor dic cor por ate gov er na nce model 161

whether the disclosure really was necessary, taking into account the risk
of insider dealing. The judgment has thus made it possible to uphold
the Nordic corporate governance model, but there is a risk that national
supervisory authorities or even national courts may be influenced by
the international corporate governance debate and construe the sound
limitations put forward by the ECJ to narrowly and thereby prevent the
Nordic model from functioning.

IV. Conclusion
The Nordic corporate governance model, with its dual executive system,
is closely related to the English one-tier model but has unique features.
The most distinctive feature is probably the dominant role given to the
shareholders, and the prevalence of major shareholders ensures that this
role is taken up even in publicly traded companies. The risk of dominant
shareholders, that they may pursue private aims and exploit the minor-
ity, has been countered by the provisions of companies legislation. Over
the years, a highly sophisticated and investor-friendly model has evolved
and major scandals have been few and far between.
Although the harmonization of company law has been carried on for
many years and covers many areas, the area of corporate governance has
largely remained outside the scope of harmonization. The few examples
of harmonization have proved to be of limited value and some measures
are difficult to reconcile with the Nordic model.
It is argued that the harmonization of corporate governance should
only be pursued with great care and only to the limited extent necessary
to protect parties who cannot be expected to fend for themselves. There
is no need to seek a single European model to replace the many differ-
ent national models of corporate governance. The existence of a variety
of different corporate governance models should not be viewed as an
obstacle to the internal market, but as an asset. The recent case law of the
ECJ has made this asset available to all investors in the European Union,
so there is even less reason to legislate in this area. Better to have many
different European corporate governance models than just one.
 SEC T ION 2

Corporate governance, shareholders’ rights

and auditing
 9

Stakeholders and the legal theory of

the corporation
Peter Nobel

I. Introduction
It is a pleasure for me to write for the lively Eddy, always full of a variety
of fertile thoughts, combining eloquence with rapidity. He has worked
and published many learned treatises on the law of corporations and
the field of finance, which has become more and more integrated in
the study of corporations. This is because the capital markets need the
producers of their ‘deal objects’ and continuously try to reshape these
objects according to their wishes. For Eddy, I shall endeavour to go off
the beaten track in search of a better theory of the corporation. My pro-
posal also contains an incomplete inventory of areas where the science
of corporate law is somewhat mired down.

II. Phenomenological analysis

A. The notion of a ‘stakeholder’
When I am unsure about the exact meaning of a word like ‘stake’, I consult
the Oxford English Dictionary, bearing in mind that a mad professor
has made many contributions to it.1
A ‘stake’ is essentially a pole to which something is attached; histori-
cally, it might be a convicted person condemned to death by fi re or other
means, but when I hear ‘stakeholder’ I initially think of a situation of
gaming where an independent party holds the prize money. This mean-
ing is then extended to a person who holds an interest or concern in
something, especially a business.
In the business of commercial law, the term ‘stakeholder’ is cus-
tomarily used to show that we are not deprived of a social conscience;

1
H. Sudermann, The Mad Professor (London: John Lane The Bodley Head Ltd.,
1929).

165
166 Perspectiv es in compa n y l aw

when we point to the shareholders’ interest, we have been taught to add,

already routinely, that the corporation is also run in the interest of the
stakeholders,2 and here – in lacking any exact knowledge – we designate all
classes of persons or functions – contractual or otherwise – that our imagin-
ation produces as being affected by corporate behaviour: workers, creditors,
customers, the state, the environment, etc. Obviously, the shareholders are
also stakeholders as the corporation’s residual income belongs to them.
In this respect and as an example, the OECD Code of Corporate
Governance provides that the ‘corporate governance framework should
recognize the rights of stakeholders established by law or through mu-
tual agreements and encourage active cooperation between corpora-
tions and stakeholders in creating wealth, jobs and the sustainability of
financially sound enterprises’.3
A further examination of who may be included in the circle of stake-
holders leads to the question of the relationship between the different
groups of stakeholders: what is the relationship of these stakeholders to
the corporation if we do not merely characterize it as ‘contractual’?

B. Approaches in economic theory

Digging deeper into the phenomenon of a corporation, we are not
helped very much by the abstract constructions of the economists. The
‘nature of the fi rm’, based on the idea of transaction costs,4 is indeed
applicable to all participants in the production process. The ‘bundle’ or
‘nexus’ of contracts notion5 is helpful to integrate many participants,
but it does not provide a design for the relationship between share-
holders and stakeholders. Also the idea of ‘incomplete contracts’, and
hence the need of good corporate governance, does not lead us further.6
Moreover, the view on the ‘institution’ is not able to say what the right
stake of the stakeholders is, even though the institutional approach is
seen as a remedy against decline.7 ‘Property rights’ as a theory is devel-
oped when the choice for shareholder dominance has already been

2
P. Forstmoser, Wirtschaftsrecht im Wandel’, Schweizerische Juristenzeitung, 104 (2008),
133, 140.
3
OECD, OECD Principles of Corporate Governance (2004), 21.
4
R. H. Coase, ‘The nature of the firm’, Economica, vol. 4, 16 (1937), 386–405.
5
O. Hart, Firms, Contracts and Financial Structure (Oxford University Press, 1995), 1–12.
6
Hart, Firms, Contracts and Financial Structure, (note 5, above), 3–5.
7
A. O. Hirschman, Exit, Voice and Loyalty – Responses to Decline in Firms, Organizations
and States (Harvard University Press, 1970).
 Stak eholders a nd lega l theory of cor por ation 167

made. Economic property rights were defi ned as the individual’s ability,
in expected terms, to consume merchandise (or the services of an asset)
directly or to consume it indirectly through exchange. According to
this defi nition, an individual has fewer rights over a commodity that
is prone to restrictions on its exchange. 8 Bearle and Means have shown
that the focus of this view is circling around the relationship between
shareholders and assertive managers.9 Law and Economics give us tools
to play with, but no legal clues.

1. Corporate governance discussion

The discussion about corporate governance was very helpful to open our
eyes. It actually came out of the shareholder value chain of thought try-
ing to tie down the ‘selfish’ managers:
How do the suppliers of finance get managers to return some of the profits
to them? How do they make sure that managers do not steal the capital
they supply or invest it in bad projects?10
Characterized by principal-agent issues, the problems addressed by
corporate governance have been manifest in their impact on economic
and efficiency and, at times, in the self-serving and/or abusive behaviour
by management that jeopardizes company viability and the welfare of
shareholders.11

Originally, it was the shareholder–manager relationship which seemed

to be the main source of preoccupation; but now eyes are open wider:
Pure shareholder wealth maximization fits poorly with a modern
democracy. Everywhere democracies put distance between strong
shareholder control and the day-to-day operations of the fi rm, shield-
ing employees from tight shareholder control…How a nation settles
social confl ict and distances shareholders from the fi rm’s day-to-day
operation can thereafter deeply affect that nation’s institutions of
corporate governance.12

8
Y. Barzel, Economic Analysis of Property Rights (Cambridge University Press, 1997), 3.
9
A. A. Berle and G. C. Means, The Modern Corporation and Private Property (New York:
The Macmillan Company, 1932), 188.
10
A. Shleifer and R. W. A. Vishny, ‘Survey of Corporate Governance’, The Journal of
Finance, vol. LII/2 (June 1997), 737.
11
B. Shull, ‘Corporate governance, bank regulation and activity expansion in the United
States’ in B. E. Gup (ed.), Corporate Governance in Banking (Cheltenham: Edward Elgar,
2007), 7.
12
M. J. Roe, Corporate Governance: Political and Legal Perspectives (Cheltenham: Edward
Elgar, 2005), 12.
168 Perspectiv es in compa n y l aw

A fi rm has many stakeholders other than its shareholders: employees,

customers, suppliers, and neighbours, whose welfare must be taken into
account. Corporate governance would refer them to the design of insti-
tutions to make managers internalize the welfare of stakeholders in the
fi rm.13

This widening of horizons could have led to an integrated theory of

the firm, but destiny was, unfortunately, not kind with these efforts. The
attention of the shareholder discussion was drawn in another direc-
tion. The discussion on stakeholders has shifted away to takeovers and
their potential impacts on the various groups. On one side, takeovers
were considered as an effective means to control inefficient, underper-
forming managers: a bad stock price was supposed to attract the sharks
cleaning out the second tier people. On the other side, such actions were
seen as a social challenge, mainly for the employees not having a golden
parachute, or for not having any parachute at all. But, a defence also
developed here, and an important argument was often brought forward
(at least in Europe) that the corporation was not only prey for greedy
stockholders, but also for an entire economic community of different
stakeholders.
It is not only the national interest in certain key industries that cre-
ated ideas of anti-takeover rules (ironically accompanying the realiza-
tion of the 13th Directive – an unlucky number?),14 but also (although
perhaps less outspoken) the fear that enterprises might move to other
locations on the planet.15 The idea has been formulated that corporate
decision-making centres involving important economic assets should
be bound to given political communities and should not have the free-
dom to relocate elsewhere. The issue of the day is the (possible) impact of
SWFs on sovereign states affairs.

2. Anatomy of the corporation

A recent structural elaboration, the anatomy of the corporation,16 is
also founded on the principal-agency theory. This is a characteristic

13
V. Xavier, Corporate Governance: Theoretical & Empirical Perspectives (Cambridge
University Press, 2000), 1.
14
Directive 2004/25/EC of the European Parliament and of the Council of 21 April 2004
on takeover bids [2004] OJ L 142.
15
Nokia, ‘Nokia plans closure of its Bochum site in Germany’, press release (January 15,
2008), www.nokia.com/A4136001?newsid=1182125.
16
R. Kraakman et al., The Anatomy of Corporate Law: a Comparative and Functional
Approach (Oxford University Press, 2006).
 Stak eholders a nd lega l theory of cor por ation 169

of almost all theoretical undertakings since the seminal work of Berle

and Means.17 The agency discussion is almost as old as the discussion
on economic organization, which already occupied the ancients and is
also found in Adam Smith’s work.18 The anatomy, however, goes a step
beyond to include into the agency theory the shareholder–manager rela-
tionship and the concepts of majority and minority in the corporation;
significantly, it also encompasses the relationship between the corpor-
ation and the stakeholders. With regard to the aim of corporate law, it
has been noted that
the appropriate goal of corporate law is to advance the aggregate welfare
of a firm’s shareholders, employees, suppliers, and customers without
undue sacrifice – and, if possible, with benefit – to third parties such as
local communities and beneficiaries of the natural environment.19

But all non-shareholders are merely ‘contractual’ partners or even

exist only ‘in fact’. Here, we get to a practically new age differentiation
between ‘status’ and ‘contract’, a concept known since Maitland.20 This
might be justified because we also find severe warnings that the notion
of agency should not be enlarged for political reasons.21 Nevertheless,
none of this is a sufficient theoretical foundation for the law of the mod-
ern enterprise.

C. Legal doctrine
In searching for a theoretical foundation, legal theory is of even less use
than economic theory; this is attributable to the fact that the era of the
‘grand’ theories of the corporation as a legal person is over. For a long
time, German legal thought tried to come to terms with the ‘reality’
of the legal person. A legal person is not a tangible reality, but a social
phenomenon. Otto von Gierke demonstrated a strong sense of this idea

17
Berle and Means, The Modern Corporation, (note 9, above).
18
A. Smith, The Wealth of Nations (New York: The Modern Library, 2000; fi rst edition
1776), translated into German by H. C. Recktenwald, Der Wohlstand der Nationen
(Munich: Deutscher Taschenbuch Verlag, 1978), 629–30.
19
Kraakman et al., The anatomy of Corporate Law, (note 16, above), 18.
20
Cf. F. W. Maitland, Introduction to Gierke’s Political Theories of the Middle Age (Trans-
lation), (Cambridge and New York: Cambridge University Press, 1987; first edition
1900).
21
H. C. von der Crone, ‘Verantwortlichkeit, Anreize und Reputation in der Corporate
Governance der Publikumsgesellschaft’, Zeitschrift für Schweizerisches Recht, vol. 2, 119
(2000), 239–75.
170 Perspectiv es in compa n y l aw

in his monumental works centring on the cooperative type of mutual

interdependence.22 At the end, from the idea of a ‘legal person’, it was
only the farsighted concept of a bundle of assets and liabilities, separate
and subject to specific governance for specific purposes, that prevailed.23
The endeavour in the 1970s and 1980s, namely to substitute the cor-
poration by the ‘enterprise’ – a productive entity composed of all par-
ticipating interests – did not succeed.24 The main reason was that the
discussion got stuck for more than twenty-five years with the conflicting
(but beloved in Germany) aim of introducing workers’ co-determina-
tion in the board rooms.25 Thomas Raiser’s most inspiring book 26 about
the enterprise as an organization remained a lonely star, hinting at the
neglected necessity of opening up legal thinking towards economic
notions and tools.
If a corporation is not a tangible reality, it is an abstract legal con-
struct. The famous Dartmouth case describes a corporation as
an artificial being, invisible, intangible and existing only in contempla-
tion of law. Being the mere creature of law, it possesses only those prop-
erties which the charter of its creation confers upon it, either expressly,
or as incidental to its very existence. These are such as are supposed best
calculated to effect the object for which it was created.27

I would not hesitate to elevate the idea of a legal person to that of a real
legal invention.28 It enables the organization of both assets and people in
an efficient manner. If we dig into legal history and notions, we find the
idea of an ‘Anstalt’ in German legal doctrine, which is defined as a com-
position of material forces and personal means.29 This legal concept, still

22
O. von Gierke, Das deutsche Genossenschaftsrecht, 4 vols. (Graz: Akademische Druck-
und Verlagsanstalt, 1954), vol. III.
23
F. Wieacker, ‘Zur Theorie der juristischen Person des Privatrechts’ in Festschrift Ernst
Rudolf Huber (Göttingen: Schwartz, 1973), 339 ff.
24
P. Nobel, ‘Das “Unternehmen” als juristische Person?’, Wirtschaft und Recht, (1980),
27–46. Now looking again at the enterprise as a whole, composed of various interests, see
M. Amstutz and R. Mabillard, Fusionsgesetz (FusG), Kommentar (Basel: Helbing, 2008).
25
See M. Lutter, ‘Societas Europaea’ in P. Nobel (ed.), Internationales Gesellschaftsrecht
(Bern: Stämpfl i, 2004), vol. V, 35–8; G. Mävers, Die Mitbestimmung der Arbeitnehmer in
der Europäischen Aktiengesellschaft (Baden-Baden: Nomos, 2002).
26
T. Raiser, Das Unternehmen als Organisation: Kritik und Erneuerung der juristischen
Unternehmenslehre (Berlin: de Gruyter, 1969).
27
Trustees of Dartmouth College v. Woodward, 4 Wheat. 518, 636 (1819).
28
H. Dölle, Juristische Entdeckungen: Festvortrag (Tübingen: Mohr, 1958).
29
P. Tschannen and U. Zimmerli, Allgemeines Verwaltungsrecht, 2nd edition (Bern:
Stämpfl i, 2004), § 7 nos. 3–4.
 Stak eholders a nd lega l theory of cor por ation 171

used in the domain of public law today, combines both of these latter
aspects, and it might also prove useful as a theoretical tool.30
The ‘legal person’ also allows for the preparation of preconditions for
the creation of a great work in a structural manner; this comprises a
setting in which we no longer have commanding kings and princes and
must assure control through organizational means. It also signifies a
setting that is acceptable for a democratic society.
It might be added here that, after we had overcome early (American)
restrictions, we were able to create whole ‘families’ of legal persons,
groups of companies or Konzerne. Their law still presents one of the
really unfinished challenges of modern corporation law. Any major
bankruptcy case shows this clearly.
The concept of the legal person was a prerequisite for the development
of modern corporate law. However, it is of limited value for the develop-
ment of a theory of the firm. Corporate law itself is probably not able
to deliver a theory of the firm as it is (only) concerned with the structure
of main command over the firm.

III. Reaching out for a new theoretical foundation of the firm

A. Traditional model of the entrepreneur
The entrepreneur, his ideas and his talent, in combination with other
people and assets are still the basic ingredients of a capitalist market
economy. There are, as we have seen, the property rights that continu-
ously move the ‘creative destruction’.31 As in statistics, however, the reli-
ability of results depends on large numbers, evening out the outliers;
here, we must consider that the model of individual entrepreneurs is
only true for a part of the economy. Although it is still an important
part,32 it is not the part where public attention is nowadays focussed.
This comprises the part of the big enterprise, the group of companies,
the firm, the Konzern and the listed corporation, usually multinational.
For these, legal theory is somewhat at a loss.
30
P. Nobel, Anstalt und Unternehmen: Dogmengeschichtliche und vergleichende Vorstudien
(Diessenhofen: Rüegger, 1978), chapter 4.
31
J. A. Schumpeter, Theorie der wirtschaftlichen Entwicklung, (Leipzig: Springer, 1912),
525–33.
32
99.7% of all enterprises in Switzerland are small and medium-sized businesses (up to 249
employees); 87.6% employ nine employees at most and are considered as micro enter-
prises. See Bundesamt für Statistik, Betriebszählung 2005, www.bfs.admin.ch.
172 Perspectiv es in compa n y l aw

B. Groups of companies
The model of the company law codes is still the single corporation. A few
countries have tried to enact rules for groups of companies. The success
was more limited than the ensuing academic discussion on the law of
company groups. It also remained national and no (European) country
could embrace the whole of its multinational corporations with a law
of company groups, making one enterprise out of it. There is one major
and main exception: the groups have to present ‘consolidated accounts’,
making the economic unit more transparent. This is, to a large extent,
sufficient as there are no downstream ‘external’ shareholders; but in case
of financial difficulties, the creditors of subsidiaries remain as a major
problem.
Here, the law and the legal scholars cope with a considerable number
of instruments in order to come to terms with such problems. We are,
however, far from a consistent approach in this matter. Corporate law
has somewhat abdicated here; and the lawyers also seem to have gotten
tired of the discussion on this issue.
For some time there was a short but emotional discussion in
Switzerland as to whether a group of companies is a company itself. 33
In European law, things have not developed further than an aborted
attempt to a (9th) Directive, and the proposals of the Forum Europaeum
based on the French Rozenblum case, which only suggests a somewhat
vague standard. 34 Th is proposal was recently commented on by Klaus
J. Hopt in a friendlier manner. Hopt does not anticipate that there
will be a European law of groups of companies in the near future; in
his opinion, it is more likely that there will be a capital markets law,
which takes the dimensions of groups of companies into account. 35
There are also a series of rules relating to groups of companies where
the regulation and supervision of the capital markets are concerned;

33
H. Peter and F. Birchler, ‘Les groupes de sociétés sont des sociétés simples’, Swiss Review
of Business and Financial Market Law, 70 (1998), 113–124; R. von Büren und M. Huber,
‘Warum der Konzern keine einfache Gesellschaft ist – eine Replik’, Swiss Review of
Business and Financial Market Law, 70 (1998), 213–220.
34
Forum Europaeum Konzernrecht, ‘Konzernrecht für Europa – Thesen und Vorschläge’,
Zeitschrift für Unternehmens- und Gesellschaftsrecht, (1998), 672–772, 705; The
Rozenblum-concept is based on the point of view that the self-interests of the individual
companies within a group have to be aligned with the overall interest of the group, i.e.
with the group interest.
35
K. J. Hopt, ‘Konzernrecht: Die Europäische Perspektive’, Zeitschrift für das gesamte
Handels- und Wirtschaftsrecht, 171 (2007), 232, 235.
 Stak eholders a nd lega l theory of cor por ation 173

together with take-over rules, these are contributing to the creation of a

European Capital Markets Law for large corporate groups.
The conclusion remains that we have no European law for groups of
companies. The regulation of the SE, contrary to earlier proposals, no
longer contains such rules. In view of the fact that the SE is becoming
a preferred statute by big corporations; it is a pity that the occasion was
missed.

C. The corporate governance discussion

During the past few years, the big issues in corporate law have concerned
shareholder value and corporate governance, including the role of the
auditors.36 The corporate governance discussion has been somewhat
stuck, continuously turning the same wheel with the hope that it might
stop at a lucky number. There is, however, one issue that has politicized
the corporate governance discussion: the discussion on executive com-
pensation. In many countries, this topic caused a public outcry, which
corporate lawyers were not really able to respond to, except with a con-
siderable amount of political bias. The phrase ‘pay without perform-
ance’37 expressed the criticism of executive pay arrangements and the
corporate governance processes producing them.
The response of the business circles was very clever and in the relevant
corporate governance codes the links to performance were introduced
as an obligation.38 However, as ‘performance’ is difficult to measure, the
appropriate question is whether this is the solution or not, at least in
the long term. For a shorter period, it might be a ratio, combining share
price and profit.

D. Underdeveloped shareholder governance

In my opinion, we have to take a second look at the basics: here we see that
the corporation is built on the idea of the shareholder–proprietor who
attends the general assembly as if it were a democratic political arena,
in spite of the fact that voting rights are regulated in relation to capital

36
F. H. Easterbrook and D. R. Fischel, The Economic Structure of Corporate Law (Harvard
University Press, 1991).
37
L.Bebchuk and J. Fried, Pay without Performance: the Unfulfilled Promise of Executive
Compensation (Harvard University Press, 2004).
38
Swiss Business Federation, Swiss Code of Best Practice for Corporate Governance, new
edition (Dielsdorf: Lichtdruck AG, 2007), 17.
174 Perspectiv es in compa n y l aw

and not per capita. All in all, we are still far away from ‘one share, one
vote’. All endeavours of the more or less recent developments of corpora-
tion law were nevertheless directed at the improvement of shareholders’
rights. Have we been successful? I do not think so. The fact remains that
shareholders do not do what they could do. Academians have to learn
to live with the reality that the majority of shareholders allow things
that could be changed or disapproved to continue. The shareholders are
entitled to select the company’s chief executives, reject accounts, sue
the directors, etc. But, they simply do not do this. It might thus be the
case that the model is wrong. Shareholders can distribute their risk and
they can also walk away. They are also not ‘real’ owners of the corporate
assets, only economic beneficiaries.
It is true that I paint a kind of black and white picture here and that
one could make finer distinctions. For instance, the American situation
is somewhat different because the orientation of the federal security laws
has caused many differences and has also had a very strong impact on
the SEC.
All this has not prevented the big anti-fraud reaction of the US
Congress through the Sarbanes–Oxley legislation, especially its section
404.39 Another example is the necessity to distinguish between ordinary
and institutional shareholders. The emergence of the latter has not only
brought changes, but also problems related to their governance.

E. The firm as a result of varying bargaining power

Already the seminal work of Berle and Means (a lawyer and an economist)
has described the modern corporation in terms of its transformation of
private property.40 In the New Economy, property rights correspond to
the ability of an agent to capture the present cash-flow value that a given
asset is expected to generate.41
In civil law countries this is even more difficult because we cling to
the notion of undivided property and only allow, under strong Anglo-
American influence, a distinction between property in the legal sense and
‘economic property’. Here, we encounter systemic impediments because
the whole of civil law is construed with the idea of a free individual able

39
Sarbanes–Oxley Act of 2002 (Pub.L. 107–204, 116 Stat. 745, enacted 2002–07–30).
40
Berle and Means, The Modern Corporation, (note 9, above).
41
U. Cantner, E. Dinopoulos and R. Lanzillotti, Entrepreneurship, The New Economy and
Public Policy (Springer, 2005).
 Stak eholders a nd lega l theory of cor por ation 175

to contract and dispose of property in the sense of using it as an eco-

nomic tool. There is no doubt that this individual might sell his shares; if
he wants to have a say in the way that his money is invested, he has only
one vote out of many. The decisive feature is that the individual share-
holder cannot only sell but can also spread his risk over a number of cor-
porations, whereas the employee-insiders are fully bound by their ‘job’.
For lawyers the idea of a ‘legal person’ is a great achievement. A cor-
poration can behave in economic matters, legally speaking, like a natu-
ral person. Legal theory, however, has had a hard time to come to terms
with the development of such a ‘person’. It is very difficult to bridge the
gap to the economists, as they describe the firm as a bundle of contracts.
In my opinion, the agency theory is in fact a legal notion taken up by
the economists to support the lawyers’ model, which was prone for
derailment.
The bundle of contracts’ approach is visibly also an abstract construc-
tion of legal elements, but for lawyers it is hard to re-integrate this idea
back into the legal system. We might call a certain situation ‘a bundle
of contracts’, but this will not be a legal term. Trying again, a ‘bundle of
contracts’ is a plurality of contracts, maybe of the same contracts or of
different contracts. With the idea of ‘same contracts’, we are not getting
further than an unknown number of contracts. With different contracts
we might see contracts with the state, contracts with investors, contracts
with managers, labour contracts, creditors, etc. But, here we soon realize
that the law is much further developed in that it already contains models
to combine such contracts institutionally. What is the lesson to learn
here? Perhaps it is the idea, as suggested by the economists, that every-
thing should be based on the contract model. Then, the whole institution
of the firm becomes a result of the relevant bargaining power.
Even though the contract model (the bundle of contracts) and the idea
of bargaining power are closely linked together, bargaining power goes
further in that not all bargaining power necessarily leads to a contract;
therefore, it is more precise to talk about a ‘negotiation model’. In this
respect, an open system is formed because all stakeholders may have
bargaining power, which is determined by a large number of parame-
ters. In comparison with the principal-agent theory, a model that puts
the bargaining power into the centre is able to give a more comprehen-
sive picture of the reality of the firm. Even though the agency model (in
its broad interpretation) may capture a large number of different stake-
holders, it can only explain a certain part of the reality of the firm. As
it focuses on the information asymmetry and the difference of interests
176 Perspectiv es in compa n y l aw

between the principal and the agent, it leaves out many aspects that may
influence the relationship of the stakeholders. The negotiation model, on
the other hand, may easily incorporate these two elements of the agency
model: an informational advantage improves the bargaining power of
a contractor, and it is virtually a standard situation in negotiations that
the contracting parties have non-homogenous interests.
The proposed model may also include other elements that strengthen
or weaken the bargaining power such as interrelations or coalitions
among the relevant players, acceptance of a position in society or the law
of supply and demand.
Bargaining power is not only the relevant criterion in the situation
of actual ongoing negotiations among the stakeholders of a company. It
remains the core factor in a corporation, even when the various stake-
holders of the firm have committed themselves to follow certain rules for
an agreed period of time. Contracts are to be seen as nothing but ‘frozen’
bargaining power. They show a picture of the moment. Corporate reality
tells us that the principle of pacta sunt servanda does not prevent stake-
holders from violating treaties. Once their negotiating power reaches
certain strength, they may attempt to renegotiate a compromise to make
it more favourable for them or simply behave contrary to the contractual
terms.
Hierarchies and delegations are commonly found in corporations,
and they are in line with the negotiation model: both regularly derive
from concluded contracts. If they are established by non-contractual
means, they may still influence the individual bargaining power of the
involved persons and respectively have an effect on contracts.
Tangible and non-tangible assets of a company may be included in
the contractual model as well. Assets may be owned or rented by the
company or, e.g., licensed from IP owners. (If one understands contracts
in a broad Rousseauian sense, even the so-called social obligation of
property that is recognized in some states may be seen as contractual.)
The ownership of assets may have an impact on the bargaining power as
well, be it on the side of the suppliers or on the side of the shareholders/
managers vis-à-vis the workers.

F. Implications of the negotiation model

When bargaining power is found to be the core factor of all activity
within the corporation, the question of legitimacy of the individual
power and respectively of the validity of the results of the negotiations
 Stak eholders a nd lega l theory of cor por ation 177

among the stakeholders may arise. A number of theories of the firm

consider the criteria of legitimacy as an attribute for stakeholder iden-
tification and salience. In the negotiation model, legitimacy is only one
of many aspects that may raise or limit the bargaining power. It may be
a parameter that strengthens the position of a stakeholder. However, it
may not serve as an additional factor next to bargaining power, which
forms the basis of the theory of the firm.
The concept of the ‘one share, one vote’ is very much in line with the
idea of legitimacy. The implementation of this approach was lately aban-
doned by the European Commission. Within the negotiation model, this
concept of ‘one share, one vote’ is not helpful as it takes a – possible –
result of a negotiation and turns it into a prerequisite of the negotiation.
Another question concerns the role of the law or regulation within
the negotiation model. In this context, it is important to distinguish
carefully between regulation and legitimacy. The law may be seen as the
major external effect on the corporation. While the law sets clear limits
to the bargaining power, legitimacy is somewhat an unclear element. It is
the function of the law to limit the negotiation power of the contractual
partners, who act without legitimacy. For example, as soon as monopol-
istic structures are identified, the negotiation power has to be looked at
from the viewpoint of competition law. As we have seen, corporate law is
not useful to develop a theory of the firm. However, the shift to a negoti-
ation model also has legal consequences.

G. Bargaining power of stakeholder groups

Without going into any depth about the position of creditors, it is suffi-
cient to mention that banks, if corporations need them at all, are usually
quite able to bargain their position. It is even the case that industry is
somewhat disadvantaged when facing investment bankers because their
command of the channels to the capital markets as well as the ‘customs
duty’ is often substantial.
Concerning labour, there is already a long tradition of examining
bargaining power and establishing rules for negotiations, strikes and
lockouts. Very often, instruments of state assistance are also involved.42
It seems, all in all, that the law is able to come to terms with this aspect
of ‘social unrest’, even though the power of the unions is very differ-
ent in the various countries. And, all of this is customarily based on

42
See for Switzerland: 28 III BV, for Germany: 9 III GG.
178 Perspectiv es in compa n y l aw

the contract model, enlarged, it is true, by the instrument of ‘collective

labour agreements’.
In Germany43 (and in other countries, e.g. France, Great Britain, Italy,
Sweden),44 the workers entitlement to co-manage is well established.45
This was the social model of compromise after the Second World War.
Nowadays, co-determination is heavily criticized46 and corporations try to
evade it (e.g. by using the SE), but its abolishment is unlikely. It was, how-
ever, not possible to export the model into the European law as a general
model, with the exception of the directive accompanying the SE statute.47
The bargaining powers have indeed changed in other places. The
managers are much more powerful and they are much better organ-
ized than the shareholders. I am of the opinion that they have a large
amount of bargaining power at their disposal, which is not matched by
the shareholders.
A question arises as to who belongs to the management? I think that
all people, except auditors, elected by the shareholders to hold office in
the corporation, belong to the management group. This also comprises
the Swiss Board of Directors (Verwaltungsrat), even though the manage-
ment might be separate. Even the German Aufsichtsrat48 belongs here,
despite the contrary opinion of doctrine (and the courts)49 still view-
ing it to some extent in the historical role as the shareholders’ repre-
sentative committee. In fact, one must concede that, compared with the
management or the committee, the German Aufsichtsrat does not have
the same degree of competence to govern the corporation.
43
See German Montan-Mitbestimmungsgesetz (MontanMitbestG) of 21 May 1951;
German Mitbestimmungsgesetz (MitbestG) of 7 May 1976 and German
Drittelbeteiligungsgesetz (DrittelbG) of 18 May 2004.
44
See J. Brown, ‘Implications for the Disclosure of Financial Information’, Employment
Law Bulletin, 25 (1999).
45
R. Göhner und K. Bräunig, ‚Bericht der Kommission Mitbestimmung’, unpublished
Report, Berlin, November 2004, 23–6.
46
See criticism of the German Institut für Arbeitsmarkt und Berufsforschung, www.iab.
de/de/195/section.aspx/Publikation/k051227n15.
47
Directive 2002/14/EC of the European Parliament and of the Council of 11 March
2002: establishing a general framework for informing and consulting employees in the
European Community, [2002] OJ L 80/29. See also P. Hommelhoff and Ch. Teichmann,
‘Die Europäische Aktiengesellschaft – das Flaggschiff läuft vom Stapel’, Swiss Review
of Business Law, 74 (2002), 6 and M. Lutter, ‘Societas Europaea’ in P. Nobel (ed.),
Internationales Gesellschaftsrecht, (Bern: Stämpfl i, 2004), vol. V, 19–45.
48
See §§ 98–116 AktG of Germany; P.C. Leyens, Information des Aufsichtsrats (Tübingen:
Mohr Siebeck, 2006).
49
See BGH II ZR 316/02 of 16 February 2004, Zeitschrift für Wirtschaftsrecht und
Insolvenzpraxis (2004), 613 (MobilCom).
 Stak eholders a nd lega l theory of cor por ation 179

Furthermore, careful analysis is required. It must first be stated that

the economic system of free enterprise requires a fair amount of free
action of management, which it must then account for in a transpar-
ent manner. Then, a careful examination is needed of the aspect of
the shareholder passivity. It is maybe ‘rational’ not only because of the
cost–benefit relationship, but also because shareholders know that large
incentives might produce large results. Generally, people are much more
open-minded about a profit distribution than a situation where they see
an asymmetrical loss bearing.
Here, we might see an inequality of weapons. The general meeting of
shareholders is not an ideal bargaining arena. The model is flawed. The
shareholders should be able to bargain with the management and then
make recommendations to the AGM.
The bargaining model is a good model for the future and, cur-
rently, the agency model is outdated. Such a bargaining procedure
requires an appropriate forum. A large hall with a fancy screen that
only offers the possibility to accept or reject the motions presented is
not constructive. Sadly, the only other alternative is disruptive activ-
ist action.

IV. Legal future of the enterprise

A. Organizational scheme
It can be anticipated that large enterprises will also play an important
role in the future. These large enterprises need (and have) a legal organi-
zation. The legal organization consists of a number of legal persons, usu-
ally incorporated in various jurisdictions. An enterprise is therefore an
international legal organization of decision making over assets. This is
the economic reality for which we have to find solutions. The theory of
the firm must be, above all, holistic and then duplex: it must encompass
the corporate control of assets and the notion of the corporation as a
social organization.
Already at this point we have to note that reality is further developed
than the law. There is no truly (unitary) international organizational
scheme. Not even the Societas Europea could succeed without deep inte-
gration and incorporation in the national law of the domicile. We must
therefore make use of the existing instruments; but, we should cease
to stick to fictitious concepts such as handling the responsibility of the
(poor) board of a subsidiary as if there would be no ‘boss’.
180 Perspectiv es in compa n y l aw

B. Creditors
Concerning creditors, I would distinguish between ‘trade’ creditors,
belonging to the business, and ‘fi nancial’ creditors. Trade creditors
should be protected throughout the whole group. Financial creditors
are sufficiently sophisticated to negotiate the securities they consider as
necessary.

C. Workers
Workers are probably the most difficult subject. Their bargaining power
comes primarily from the skills they can offer combined with the extent
to which they form coalitions.
As far as the skills are concerned, it is the law of supply and demand
that decides on the bargaining power of the workforce. In a globalized
world, workers find themselves in competition with all workers, on
a universal level. In a situation where the skills of the workers are of
equal quality, the bargaining power is somehow reduced to the price of
their labour. There is no right to maintain production in a place when
a new combination of assets and a workforce at other locations is more
efficient. This is the price of globalization of the economy. Structural
changes cannot be avoided. A high level of specialization may be the
best way to strengthen the bargaining power of the workforce. When
negotiating on compensation schemes, the asymmetry of information
between the management and the workers on the true financial situa-
tion of the company may strengthen the management’s position. As far
as groups of companies are concerned, the design of the compensatory
schemes must take the situation of the whole group into consideration,
and not only that of the relevant subsidiary.
The other aspect, the bargaining power that results from coalition
structures, is declining as the influence of trade unions is constantly
receding. This holds true for at least a number of branches and a number
of jurisdictions.
Workers may be able to compensate their loss of bargaining power
by getting another stake in the corporation. Regularly, workers are
also consumers and consumers are also workers, which may result in a
potentially high amount of bargaining power. However, this bargaining
power is only potential as workers behave very differently in their role as
consumers, and vice versa; e.g., as consumers they hunt for the product
with the lowest price and as workers they ask for high incomes. The fact
 Stak eholders a nd lega l theory of cor por ation 181

remains that the bargaining power of the workforce may improve once
the workforce buys shares of their own company. For that, however, a
shift in the mentality of many nations is needed. We are still very far
away from the worker as an employee–shareholder.

D. Consumers
From a theoretical point of view, consumers should have the most bar-
gaining power of all stakeholders as they are the buyers of the products
or services produced by the firms. However, their level of integration is
very low. They act through the ‘agent’ of the consumers’ associations.
Their bargaining power will depend to a large extent if they manage to
form more forceful coalitions.
Legal measures may improve their situation and lead to a more power-
ful position in the negotiation situation with corporations. As an exam-
ple, class actions or legal remedies can be mentioned here.

E. Shareholders
Listing of a corporation means that shareholders and potential share-
holders get much closer to the economic activity because a whole add-
itional set of information is required to increase transparency. ‘Corporate
governance’ then becomes a major issue here because for many people
managers are per se suspicious persons. Th is leads (somewhat) to a
temptation: the shareholders think that they are called to participate in
the management; such a notion is, however, prone to lead to a lot of in-
efficiency and should be avoided at all costs. It should be crystal clear
that the management is in charge of the firm. The management is also
accountable for its acts and can be dismissed by the board of directors.
Shareholders are a disorganized group of individuals and often have
only one opportunity in a year to express their opinion. Institutions like
the ‘supervisory board’ or even auditors were, at one time, supposed to
defend shareholders’ interests. Nowadays, all being institutionalized
with other directional goals, it would be worthwhile to study the idea of
electing a shareholders’ committee to negotiate certain items reflected
in the AGM agenda with the management. A hot topic here is manager
compensation. I do not think that the prevailing types of compensa-
tion, mainly in banks, have contributed much to the current crisis in the
financial world. It is by far not natural law that gross profits are evenly
distributed between staff and shareholders. The compensation system
182 Perspectiv es in compa n y l aw

should be a matter of negotiation, especially when it also comprises

share (or option) allocations, usually at favourable rights; under these
circumstances, the compensation system may dilute the position of the
other shareholders and, in the medium or long run, may even have the
effect of a transfer of control to the employee–shareholders.

F. Management
The principal-agent model does not hold true any more. It sounds nice,
however, in a society of property owners. The historic origin is some-
what darker and must be attributed to a master–slave environment
rather than to that of a modern democratic society. The agent has not
only natural self interests, but is also the master of economic perform-
ance. His nomination is maybe the most important task of a board. Such
agents are no longer simple executors of instructions given from above
but business partners open to negotiations. It would also be the share-
holder committee’s task to accompany and supervise such negotiations.

V. Summary
Neither legal doctrine nor the theories of the economists offer a com-
prehensive theory of the firm. The agency model is outdated as we have
moved from a structure of order and obedience to a world of pluralis-
tic interests. As a consequence, we need to shift from a commandeer-
ing model to a negotiating model. This enables us to get to a theory of
the firm that takes into account all different kind of stakeholders and to
map all their differing interests. All the parameters that strengthen or
weaken the bargaining power of the various stakeholders characterize
the reality of the firm. Negotiations may result in contracts in the legal
sense or not. The bargaining power is the key element that shapes the
corporation in all its aspects.
The shift to a negotiation model has also legal consequences. We
should come to solutions which also look at the legal person as a con-
tract, which is to some extent performed by company law, but neverthe-
less open to negotiation results. The negotiating parties should be the
shareholders, the management, the workers and – as far as credits are
concerned – the banks. For various purposes (permits, tax) the State is a
necessary partner as well.
 10

The renaissance of organized shareholder

representation in Europe
Stefan Gru ndman n

I. Renaissance of shareholder voting rights and

organized shareholder representation
A. Renaissance
When Eddy Wymeersch retires, like a good farmer, he leaves us with plenty
of crops. Although this is of course not the last harvesting season, these
years are certainly particularly rich years in his garden. They are years of
a renaissance of shareholder voting rights in Europe and, very prominent
among them, shareholder voting via organized shareholder representa-
tion. There are at least three reasons for making such a statement.
The fi rst is that one of Wymeersch’s core statements in his exten-
sive input to the large stream of European and worldwide corporate
governance debate1 has proven to be impressively right: he was one of
the rather few who contributed to this debate in a truly international
manner, based on the very extensive comparative law corpus, and who
nevertheless did not succumb to the temptation to bet only on mecha-
nisms of external corporate governance. Many of his writings on cor-
porate governance – also early writings – could be summarized in short
words as follows: despite the power of external corporate governance
mechanisms, despite Wall Street rule and accounting law, ‘do not forget

1
See E. Wymeersch, ‘Unternehmensführung in Westeuropa – ein Beitrag zur Corporate
Governance-Diskussion’, Aktiengesellschaft, 40 (1995), 299–316; K. Hopt and E.
Wymeersch (eds.), Comparative Corporate Governance – Essays and Materials, (Berlin:
Walter De Gruyter, 1997); K. Hopt, H. Kanda, M. Roe, E. Wymeersch and S. Prigge
(eds.), Comparative Corporate Governance – the State of the Art and Emerging Research,
(Oxford University Press, 1998); E. Wymeersch, ‘Gesellschaft srecht im Wandel –
Ursachen und Entwicklungslinien’ in S. Grundmann and P. Mülbert (eds.), Festheft
Klaus J. Hopt, ‘Corporate Governance – Europäische Perspektiven’, Zeitschrift für
Gesellschaftsrecht, 2 (2001), 294–324; Id. ‘Factors and Trends of Change in Company
Law’, International and Comparative Corporate Law Journal, 4 (2000), 476–502.

183
184 Perspectiv es in compa n y l aw

shareholder voting rights’.2 Th is is indeed the lesson to be learnt from

the balance sheet scandals in the United States and then in various
Member States.3 The more mechanisms of external corporate govern-
ance show their flaws, the more a combination of external and internal
mechanisms of corporate governance becomes attractive – and voting
rights are paramount in this respect. The fi rst reason for a renaissance
of shareholder voting rights can therefore be summarized as ‘back to
Wymeersch’s early monita!’
The second reason is that, of course, this trend has found its way into
European legislation as well, and this in a prominent and in an aston-
ishingly rapid way. It did not take more than one and a half years (from
proposal to adoption), to enact the EC Directive on ‘certain rights of
shareholders’, all related to shareholder voting (EC Shareholder Voting
Directive).4

2
See last footnote, passim, and, of course as well T. Baums and E. Wymeersch (eds.),
Shareholder Voting Rights and Practices in Europe and the United States, (Kluwer Law
International, 1999). On the other side, focusing mainly on mechanisms of external cor-
porate governance: K. Hopt and E. Wymeersch (eds.), Capital Markets and Company
Law, (Oxford University Press, 2003). For a large survey on the question which approach
is stronger in which Member State(s), see early E. Wymeersch, ‘Unternehmensführung
in Westeuropa – Ein Beitrag zur Corporate Governance-Diskussion’, Aktiengesellschaft,
(1995), 299, 309–15 (namely Germany on the one hand, the United Kingdom on the
other, France and Belgium in between).
3
In this sense as well, for instance, early the OECD Principles of Corporate Governance,
Part 1 II and 2 II; Committee on Corporate Governance, The Combined Code – Principles
of Good Governance and Code of Best Practice, E 1, available at www.fsa.gov.uk/pubs/
ukla/lr_comcode.pdf; and recently M. Siems, Die Konvergenz der Rechtssysteme im Recht
der Aktionäre, (Tubingen: Mohr Siebeck, 2005), 102–5; N. Winkler, Das Stimmrecht der
Aktionäre in Europa, (Berlin: De Gruyter, 2006), 1.
4
European Parliament and Council Directive 2007/36/EC [2007] OJ L 184/17;
Proposal of 5 Jan. 2006, COM(2005) 685 fi nal. On this directive, see, among oth-
ers: S. Grundmann and N. Winkler, ‘Das Aktionärsstimmrecht in Europa und der
Kommissionsvorschlag zur Stimmrechtsausübung in börsennotierten Gesellschaften’,
Zeitschrift fürWirtschaftsrecht, (2006), 1421–8; U. Noack, ‘Der Vorschlag für eine
Richtlinie über Rechte von Aktionären börsennotierter Gesellschaften’, Neue Zeitschrift
für Gesellschaft srecht, (2006), 321–7; U. Noack and M. Beurskens, ‘Einheitliche
“Europa-Hauptversammlung”? – Vorschlag für eine Richtlinie über die (Stimm-)
Rechte von Aktionären’, Gemeinschaft sprivatrecht, (2006), 88–91; E. Ratschow, ‘Die
Aktionärsrechte-Richtlinie – neue Regeln für börsennotierte Gesellschaften’, Deutsches
Steuerrecht, (2007), 1402–8; J. Schmidt, ‘Die geplante Richtlinie über Aktionärsrechte
und ihre Bedeutung für das deutsche Aktienrecht’, Betriebs-Berater, (2006), 1641–6;
P. Wand and T. Tillmann, ‘EU-Richtlinienvorschlag zur Erleichterung der Ausübung
von Aktionärsrechten’, Aktiengesellschaft, (2006), 443–50; D. Zetzsche, ‘Virtual
Shareholder Meetings and European Shareholder Rights Directive – Challenges and
Opportunities’, http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=357808;
 R enaissa nce of sh a r eholder in Eu rope 185

The third reason is one more focused on organized shareholder

representation already – not so much only on shareholder voting in gen-
eral: For sceptics, it comes somehow as a surprise that, indeed, share-
holder voting seems to increase considerably again. At least in Germany,
over the last three years, the percentage of voting stock in the thirty lar-
gest listed companies which is in fact voted on general assemblies rose
from 45.87% to 56.42%.5 This increase is due to a large extent to organ-
ized shareholder representation.

B. The overall picture

The EC Shareholder Voting Directive aims at enabling informed share-
holder voting (see namely recitals 2, 4–6 and 9–12). The legislative history
shows that this scope has received a more positive reaction throughout
Europe than, for instance, such fundamental principles as ‘one share one
vote’ – which the new Directive leaves untouched while the EC Takeover
Directive, in its Arts. 10 and 11, had been only partially successful in
establishing this principle as a European one at least in the more specific
arena of takeovers.6
Instead, the EC Shareholder Voting Directive deals with more ‘pro-
cedural’ issues – some, however, of high practical importance and
some of which had received an astonishingly high variety of answers
before. The variety is evident in all three bundles of issues approached
by the directive. The first bundle is about the preparatory phase, namely

D. Zetzsche, ‘Shareholder Passivity, Cross-Border Voting and the Shareholder Rights

Directive’, Journal of Corporate Law Studies, 8 (2008), 283–336; critical M. Siems, ‘The
Case against Harmonisation of Shareholder Rights’, European Business Organization
Law Review, 6 (2005), 539–52.
5
Deutsche Schutzvereinigung für Wertpapierbesitz, HV-Präsenz der DAX-30-
Unternehmen (1998–2007) in Prozent des stimmberechtigten Kapitals, http://www.
dsw-info.de/uploads/media/DSW_HV-Praesenz/2007_02.pdf. For figures in other
countries, see for instance, Shearman&Stearling/ISS/ECGI, Report on the Proportionality
Principle in the European Union, External Study Commissioned by the European
Commission, http://ec.europa.eu/internal_market/company/docs/shareholders/study/
fi nal_report_en.pdf.
6
European Parliament and Council Directive 2004/25/EC [2004] OJ L 142/12. On the
long history (and importance) see e.g. S. Grundmann, European Company Law –
Organization, Finance and Capital Markets, (Antwerp/Oxford: Intersentia, 2007), para.
995–1004. See also G. Ferrarini, ‘One share – one vote: A European rule?’, European
Company and Financial Law Review, (2006), 147–77; for a short comparative law survey
on the deviations from this principle in the large Member States see Grundmann, ibid.,
paras. 452–54 (deviations stronger in France, the United Kingdom, and Scandinavia
than in Germany and Italy).
186 Perspectiv es in compa n y l aw

questions of record date, information, and timing (see Arts. 4–7, also
9). The second is about voting by the shareholder himself. In these two
bundles, the directive deals with: rendering information about the items
on the agenda more easily accessible also from abroad; eliminating rules
which block stock between the record date and the date of the general
assembly; abolishing unnecessary requirements of physical presence
in the general assembly (voting in absentia and voting via electronic
media). The third bundle is about reducing restrictions to shareholder
representation (proxies), and, of particular importance, (restrictions to)
organized shareholder representation.
The variety existing so far in the Member States can well be shown by
concentrating on just one bundle, the second one which, functionally, is
already highly related to the third one: both voting in absentia (also by
electronic means) and voting via (organized) shareholder representation
allow for voting without shareholder presence, which, of course, often is
excluded by reasons of costs, time etc.7 Voting in absentia or by electronic
means has, however, been extremely restricted so far even in countries
which, such as Germany, were rather liberal with respect to shareholder
representation and vice versa. This status could not really be justified by
reasoning that one of the two ways of participation was already suffi-
cient: a shareholder may rather opt for the expertise of the representative
(and therefore not be satisfied by the possibility to vote in absentia) or he
may rather mistrust him because of the danger of conflicts of interests
(and therefore not be satisfied by the possibility of shareholder repre-
sentation). The EC Directive, in principle, forces Member States to allow
companies to take all measures necessary to enable shareholders to vote
in absentia, by electronic means or by letter (Art. 8, 12), and it forces
the Member States to allow for a free choice among the different forms
of organized shareholder representation and impose this as well on the
companies (Arts. 10, 11, 13).
There is quite considerable change required – in various Member
States – already with respect to the second bundle of rules named above.
7
G. Bachmann, ‘Verwaltungsvollmacht und “Aktionärsdemokratie” – Selbstregulative
Ansätze für die Hauptversammlung’, Aktiengesellschaft, (2001), 635, 637; W.W. Bratton
and J.A. McCahery, ‘Comparative Corporate Governance and the Theory of the Firm:
The Case against Global Cross Reference’, Columbia Journal of Transnational Law, 38
(1999), 213, 260; T. Baums and Ph. v. Randow, ‘Der Markt für Stimmrechtsvertreter’,
Aktiengesellschaft, (1995), 145, 147; J.C. Coffee, ‘Liquidity Versus Control: The
Institutional Investor As Corporate Monitor’, Columbia Law Review, 91 (1991), 1277;
U. Noack, ‘Die organisierte Stimmrechtsvertretung auf Hauptversammlungen’,
Festschrift for Lutter, (2000), 1463.
 R enaissa nce of sh a r eholder in Eu rope 187

The comparative law status so far shows substantial variety and can be
summarized as follows: in Germany, voting in absentia is not permitted
today, neither by letter nor by electronic media. Functionally, however, it
can be seen as an equivalent to have a representative in the general meet-
ing, follow the meeting on the internet and give instructions to the rep-
resentative contemporaneously via electronic media.8 Also in the United
Kingdom, electronic means could be used only to give proxy. Conversely
in France, voting by letter is possible.9 In Italy, at least in listed compa-
nies, a vote is possible in absentia if the statutes so provide (Art. 127 Testo
Unico), probably also by electronic communication or via videoconfer-
ence.10 The EC Shareholder Voting Directive now forces Member States
to allow companies to choose themselves whether they want to provide
the facilities for voting in absentia, by electronic means and/or by letter
(Art. 8, 12).11 The scope of these rules is summarized in its 6th Recital
saying that all ‘shareholders should be able to cast informed votes at, or
in advance of, the general meeting, no matter where they reside’.

II. Organized shareholder representation as a

centre-piece of the development
The following will show that there is quite considerable change
required as well – in other Member States – with respect to organized
shareholder representation (third bundle of rules named above, see
below). A legislature may, however, opt as well for reforming quite sub-
stantially his law on organized shareholder representation more generally.
This is so in the case of the proposal now discussed in Germany in the

8
Permissible, see, for instance: G. Spindler, in K. Schmidt and M. Lutter (eds.), Aktiengesetz,
(2007), § 134 para. 56.
9
Art. L 225–107 [L = Code de Commerce (Loi, L), Annexe à l’ordonnannce no 2000–912
du 18 septembre 2000, Livre II, Des Sociétes Commerciales et des Groupements d’interêt
économique, last amendment (Nouvelles Régulations Économiques) J.O. 2001, 7776];
M. Cozian, A. Viandier and F. Deboissy, Droit des Sociétés, (Paris: Litec, 2001), para.
847; Y. Guyon, Droit des affaires, vol. 1: Droit commercial général et Sociétés, (Paris:
Economica, 2001), para. 301–1 and 301–2 (for the Code de Commerce as legal basis
see there para. 27, 95); since 2001 electronic voting and voting via video conference are
accepted (Art. L 225–107 para. 2).
10
On all this (and on the disputed question whether this rule applies to other PLCs as well):
L. Picardi, ‘L’articolo 127 del Tuf’, in G.F. Campobasso (ed.), Testo Unico della Finanza –
Commentario, (Utet, 2002), Art. 127 para. 10.
11
The Proposal for a Fift h EC Company Law Directive still did not contain rules on vot-
ing in absentia; see e.g. M. Pannier, Harmonisierung der Aktionärsrechte in Europa –
insbesondere der Verwaltungsrechte, (Duncker & Humblot, 2003), 136.
188 Perspectiv es in compa n y l aw

context of the transposition of the EC Shareholder Voting Directive.12

This proposal concerns the parts which will play a role in the following.
Indeed, the German legislature proposes to do more than is required
in the directive and this mainly with respect to organized shareholder
representation. Eddy Wymeersch has always had a particular eye on new
developments – and often has initiated them himself. Therefore, it may
not bother him too much that it is still highly uncertain whether the parts
of this proposal discussed in the following will be enacted at all (or only
the parts strictly necessary for the transposition).

A. High density of regulation and admission of all forms

The reason why the focus is on organized shareholder voting representa-
tion in the following is simple. In practice, this is by far the most impor-
tant way of shareholder voting.13
This finding is by now means new. Already, the Proposal for a Fift h
Directive, had dealt with this issue rather extensively. This is true even
though organized proxy – the proposal calls it ‘publicly invit[ing]
shareholders to send their forms of proxy to him and . . . offer[ing] to
appoint agents for them’14 – is not yet prescribed as a possibility in this

12
See, on the one hand: [Ministry of Justice] Referentenentwurf eines Gesetzes zur
Umsetzung der Aktionärsrechterichtlinie (ARUG), www.bmj.bund.de/fi les/-/3140/
RefE%20Gesetz% 20zur% 20Umsetzung%20der%20Aktionärsrechterichtlinie.pdf;
on this proposal U. Seibert, ‘Der Referentenentwurf eines Gesetzes zur Umsetzung
der Aktionärsrechterichtlinie (ARUG)’, Zeitschrift für Wirtschaft srecht, (2008),
906–10. See, on the other hand: [Federal Government] Entwurf eines Gesetzes zur
Umsetzung der Aktionärsrechterichtlinie (ARUG), BR-Drs. 847/08, as of 7 November
2008. Th is second proposal could be taken into account only aft er this chapter was
completed.
13
In 1992, up to 99% of the capital present at the general meeting was represented by
fi nancial institutions which typically acted as proxies for their clients, see T. Baums,
‘Vollmachtstimmrecht der Banken – Ja oder Nein?’, Aktiengesellschaft, (1996), 11, 12.
The newest trend would seem to be that independent service providers (ISS, ECGS,
IVOX) offer proxy voting services, see U. Schneider and H.M. Anziger, ‘Institutionelle
Stimmrechtsberatung und Stimmrechtsvertretung – “A quiet guru’s enormous clout”’,
Neue Zeitschrift fürGesellschaftsrecht, (2006), 88–96.
14
Th is refers to proxies given to banks, the management or shareholder associations:
J. Temple Lang, ‘The Fift h EEC Directive on the Harmonization of Company Law –
Some Comments from the Viewpoint of Irish and British Law on the EEC Draft for a
Fift h Directive Concerning Management Structure and Worker Participation’, Common
Market Law Review, 12 (1975), 345, 366; Pannier, Harmonisierung der Aktionärsrechte
in Europa, 135 et seq.; G. Schwarz, Europäisches Gesellschaftsrecht – ein Handbuch
für Wissenschaft und Praxis, (Baden-Baden: Nomos, 2000), para. 767; C. Striebeck,
 R enaissa nce of sh a r eholder in Eu rope 189

proposal.15 If, however, a Member State allowed organized shareholder

voting, already the Proposal of a Fift h Directive would have imposed cer-
tain important conditions (Art. 28)16 with a view to increase the chances
that the intentions of shareholders really come to bear: when making the
public offer, the representative would have had to propose one method of
voting for each item on the agenda, diverging instructions by the share-
holder would have had to be rendered possible for each item separately
and this would have had to be mentioned explicitly. Moreover, the proxy
would have had to be restricted to one meeting only (as formerly in
Germany the proxy to banks, the so-called ‘deposit-bank voting right’)
and revocable. This would already have constituted a framework – des-
pite the considerable differences between the (big) Member States.17
Today, long after the Proposal has been withdrawn, this only helps
to understand which importance has been attached to organized
shareholder representation since very early on the European level.
In the EC Shareholder Voting Directive, even the starting point has
changed and it has done so very radically: this Directive now obliges
Member States to allow all forms of organized shareholder representa-
tion. In fact, Art. 10 of the directive eliminates all obstacles to organ-
ized shareholder representation which are not specified in its first two
paragraphs (legal capacity and maximum number of representatives,
with further specifications in Art. 13) and, in addition, allows certain
restrictions of the use of the proxy in case of conflicts of interests in
its para. 3 – not more. Thus, the EC legislature goes further than for

Reform des Aktienrechts durch die Strukturrichtlinie der Europäischen Gemeinschaften,

Broschiert, (1992), 85–99.
15
EC Commission’s explanation to Art. 28 (COM(72) 887 fi nal). Th is is now a core ingredi-
ent in the EC Shareholder Voting Directive 2007/36/EC, [2007] OJ L 184/17.
16
In more detail on these conditions see EC Commission’s explanation to Art. 31 (COM(72)
887 fi nal); Lang, ‘The Fift h EEC Directive on the Harmonization of Company Law’, 345,
366; Schwarz, ‘Europäisches Gesellschaftsrecht’, (note 14, above), para. 767; Striebeck,
‘Reform des Aktienrechts’, (note 14, above), 87 et seq.
17
Short comparative law surveys in the following text; and T. Baums, ‘Shareholder
Representation and Proxy Voting in the European Union: A Comparative Study’ in
K. Hopt, H. Kanda, M. Roe, E. Wymeersch and S. Prigge (eds.), Comparative Corporate
Governance – the State of the Art and Emerging Research, (Oxford University Press,
1998), 545–64; Th. Behnke, ‘Die Stimmrechtsvertretung in Deutschland, Frankreich
und England’, Neue Zeitschrift für Gesellschaft srecht, (2000), 665–74; and also DSW-
Europastudie – 15 europäische Länder im Vergleich, eine rechtsvergleichende Studie
über Minderheitenrechte der Aktionäre sowie Stimmrechtsausübung und -vertretung
in Europa, (1999), 86 et seq.; and many contributions to T. Baums and E. Wymeersch
(eds.), Shareholder Voting Rights, (note 2, above) (entry: proxies).
190 Perspectiv es in compa n y l aw

voting in absentia (second bundle of rules) where it obliges Member

States only not to hinder companies from installing such possibilities
(Arts. 8 and 12).

B. High diversity in member state laws so far

Proxy rules (both on general and organized proxy) are regulated
quite differently in different Member States so far. In Germany,
proxy has always been regulated in quite a liberal way, and as of
2002 the NaStraG has admitted board members as proxies as well (§
134 para. 3(3) Aktiengesetz ; however, probably not the PLC itself).18
Proxy has to be given in writing (the company statutes can deviate,
§ 134 para. 3(2) Aktiengesetz), may be given without time limits, but
may not be irrevocable.19 The NaStraG also abolished the time limit
for proxies given to banks (see § 135 para 2(2) Aktiengesetz). 20 This
is ambivalent: banks are subject to conf licts of interests (albeit often
not more than management), but the presence of shareholdings in

18
See, for instance G. Bachmann, ‘Verwaltungsvollmacht und “Aktionärsdemokratie” –
Selbstregulative Ansätze für die Hauptversammlung’, Aktiengesellschaft, (2001),
635–44; S. Hanloser, ‘Proxy-Voting, Remote-Voting und Online-HV – § 134 III 3
AktG nach dem NaStraG’, Neue Zeitschrift für Gesellschaft srecht, (2001), 355–58;
U. Seibert, ‘Aktienrechtsnovelle NaStraG tritt in Kraft – Übersicht über das Gesetz
und Auszüge aus dem Bericht des Rechtsausschusses’, Zeitschrift für Wirtschaft srecht,
(2001), 53, 55 et seq.; see also U. Noack, ‘Die organisierte Stimmrechtsvertretung auf
Hauptversammlungen’, Festschrift for Lutter, (2000), 1463, 1474–80; comparative law
investigations into (organized) proxies: Baums, ‘Shareholder Representation’, (note 17,
above), 545–564; B.C. Becker, Die Institutionelle Stimmrechtsvertretung der Aktionäre
in Europa, (Frankfurt am Main: Lang, 2001); Behnke, ‘Die Stimmrechtsvertretung’,
(note 17, above), 665–74; M. Hohn Abad, Das Institut der Stimmrechtsvertretung
im Aktienrecht – ein europäischer Vergleich, (1995); also J. Hoff mann, Systeme
der Stimmrechtsvertretung in der Publikumsgesellschaft – eine vergleichende
Betrachtung insbesondere der Haft ung des Stimmrechtsvertreters im deutschen und
US-amerikanischen Recht, (Nomos, 1999).
19
U. Hüffer, Aktiengesetz (8th edn 2008), § 134 AktG para. 21; J. Reichert and S. Harbarth,
‘Stimmrechtsvollmacht, Legitimationszession und Stimmrechtsausschlußvertrag in der
AG’, Aktiengesellschaft, (2001), 447–55.
20
See U. Seibert, ‘Aktienrechtsnovelle NaStraG tritt in Kraft – Ubersicht über das Gesetz
und Auszüge aus dem Bericht des Rechtausschusses’, Zeitschrift für Wirtschaftsrecht,
(2001), 53, 54–6; M. Weber, ‘Der Eintritt des Aktienrechts in das Zeitalter der elektro-
nischen Medien – das NaStraG in seiner verabschiedeten Fassung’, Neue für Zeitschrift
Gesellschaftsrecht, (2001), 337, 343; not very common in other countries, see references
in Grundmann, European Company Law, (note 6, above), § 14 N. 66.
 R enaissa nce of sh a r eholder in Eu rope 191

the meeting is increased. 21 Today, there is another restriction on the

proxy given to a bank: the bank may not use it if the bank itself holds
(and votes) 5% of the company’s capital (§ 135 para. 1 (3) Aktiengesetz ,
except for those proxies containing explicit instructions). Moreover,
under specific information rules it is made clear how the bank will
vote and that the client can deviate for each item individually (§§ 128
para. 2, 3, 135 para. 5 Aktiengesetz). In any case, the bank must take
the client’s interest as a guideline and try to avoid conflicts of inter-
ests as far as possible. 22 The French solution is much more restricted:
proxies can be given only to other shareholders or the spouse23 and
only for one meeting and in writing, and revocation must remain pos-
sible. 24 Organized proxy is typically given to management (mostly in
blank). 25 Proxy given to banks – if they do not own stock – would
contradict the basic principle of accepting only other shareholders
as proxies, in any case, the law does not provide for it.26 Particularly
developed are the bases for organized shareholder representation in
the United Kingdom where proxy is not confined to other sharehold-
ers (although possible only for polls). 27 Proxy can be given in writing
or (as of 2000) in electronic form. 28 Organized proxy is possible with-
out giving specific instructions (general proxy) or with them, and also

21
On this advantage (and on the problem of concentrating power in banks and confl icts
of interests): Baums, ‘Germany’ in T. Baums and E. Wymeersch (eds.), Shareholder
Voting Rights (note 2, above), 127; and more extensively Hohn Abad, Das Institut der
Stimmrechtsvertretung, 109 (note 18, above), 13–17; Behnke, ‘Die Stimmrechtsvertretung
in Deutschland, Frankreich und England’, (note 17, above), 667. On existing conflicts of
interests see also short explanations in Grundmann, European Company Law, (note 6,
above), para. 504 et seq.
22
§ 128 para. 2 (2) Aktiengesetz (German PLC-Code); in the event of unavoidable con-
fl icts there is a duty nevertheless to act in the sole interest of the client, see references in
Grundmann, European Company Law, (note 6, above), § 12 N. 78.
23
Art. L 225–106 [L = Code de Commerce, see above N. 9]; critical Guyon, Droit des
affaires, (note 9, above), para. 301.
24
Art. D 132 [D = Décret (D) no 67–236 du 23 mars 1967 sur les sociétes commerciales;
see note 3, above]; Guyon, Droit des affaires, (note 9, above), para. 301; Behnke, ‘Die
Stimmrechtsvertretung ‘, (note 17, above), 668.
25
Art. L 225–106; Cozian, Viandier and Deboissy, Droit des Sociétés, (note 3, above) para.
838; Guyon, Droit des affaires, (note 9, above), para. 301.
26
Y. Guyon, in T. Baums and E. Wymeersch (eds.), Shareholder Voting Rights, (note 2,
above), 35, 106.
27
Sec. 372 (old) Companies Act (C.A.), sec. 59 Table A; P. Davies, Gower’s and Davies’ Principles
of Modern Company Law, (4th edn, Thomson, 2003), 361 and 363; J. Farrar and B. Hannigan,
Farrar’s Company Law, (7th edn, Lexis Law Publishing, 1998), 315, 322 et seq.; R.R. Pennington,
Pennington’s Company Law, (8th edn, LexisNexis UK, 2001), 766, 779 et seq.
28
Sec. 372 II para. 2 (old) C.A.; sec. 60 et seq. Table A.
192 Perspectiv es in compa n y l aw

for only a few of the items on the agenda (two-way proxy). 29 In listed
companies, only the latter is accepted. 30 When management asks for
proxies (i.e. unless the initiative came from the shareholder) it must
ask all shareholders. 31 In Italy, there are rather rigid formal require-
ments for proxies (in written form, not in blank). Moreover, a proxy
can represent only small capital and the company statutes can provide
for more restrictions; as of 1998, banks may ask for proxies (within
these limits), board members and auditors still not; and in listed com-
panies, (associations of) shareholders holding more than 1% of the
stock, can broadly ask for proxies. 32
Summarizing the status quo so far, the starting point is similar: prox-
ies are possible in all countries. There are, however, substantial differ-
ences so far in very important single questions: in Germany and the
United Kingdom, the proxy can be chosen freely, in France only from
among other shareholders and spouses and in Italy only for small capital
being represented. A proxy without time limits is possible in Germany,
and also in the United Kingdom if the statutes so provide. Organized
proxies follow different traditions – in Germany proxies are typically
given to banks, in France and Great Britain to management and in Italy
only to a very restricted extent. Proxies given to depositary banks are,
however, more important for bearer shares33 and registered stock, which
predominates in France and the United Kingdom, may well become
more important in Germany as well.

29
Sec. 60 et seq. Table A; Davies, Gower’s and Davies’ principles, (note 27, above), 360 et
seq.; Farrar and Hannigan, Farrar’s Company Law, (note 27, above), 315 et seq.; also
Pennington, Pennington’s Company Law, (note 27, above), 782.
30
On this question (and on the duty to vote which then probably exists): Davies,
Gower’s and Davies’ principles, (note 27, above), 360–63; Farrar and Hannigan,
Farrar’s Company Law, (note 27, above), 315 et seq.; Pennington, Pennington’s
Company Law, (note 27, above), 782 et seq.; Behnke, ‘Die Stimmrechtsvertretung ‘ ,
(note 17, above), 670.
31
Davies, Gower’s and Davies’ principles, (note 27, above), 361; Farrar and Hannigan,
Farrar’s Company Law, (note 27, above), 316; Pennington, Pennington’s Company Law,
(note 27, above), 767.
32
The relevant rules are Art. 2372 Codice Civile and Art. 136–144 Testo Unico della
Finanza; on all this P. Marchetti, G. Carcano and F. Ghezzi, ‘Shareholder Voting in Italy’
in T. Baums and E. Wymeersch (eds.), Shareholder Voting Rights, (note 2, above), 171–79.
33
T. Baums, ‘Corporate Governance in Germany: The Role of the Banks’, American Journal
of Comparative Law, 40 (1992), 503, 506; M. Hüther, ‘Namensaktien, Internet und die
Zukunft der Stimmrechtsvertretung’, Aktiengesellschaft, (2001), 68, 69 et seq.; Noack, ‘Die
organisierte Stimmrechtsvertretung’, (note 18, above), 1466.
 R enaissa nce of sh a r eholder in Eu rope 193

III. Structuring organized shareholder representation –

three Cartesian rules
For a ‘market order’ for organized shareholder representation, three types
of rules would seem to develop in Europe – all of them aimed at containing
dangers resulting from this type of proxy while profiting from its advan-
tages. The trend is to allow for competition between all forms of organized
shareholder representation, i.e. admit them all and subject them to the
same or similar safeguards, and to target safeguards more carefully. The
German scheme of deposit-bank voting right (§ 135 Aktiengesetz) and the
English scheme of proxies given to management would seem to be par-
ticularly refined. For the former, as has been mentioned, the Ministry of
Justice and now also the Federal Government have published reform pro-
posals (N. 12) with three major changes. The English scheme is brand-new
anyhow after the adoption of the Company Law Reform.34 The three basic
types of rules developing in Europe are about (i) having an uninterested,
professional representative, (ii) providing, as far as possible, the full picture
of the market of proposals (proxies) to the shareholder, and (iii) reducing
the representative’s strategic options via a mandatory vote:

A. Striving for an uninterested, professional representative

1. Impartiality v. specific shareholder instructions
The first Cartesian rule developing in Europe for organized shareholder
representation would seem to be that it is advisable and permissible for
national law to strive for an uninterested, professional representative.
The EC Shareholder Voting Directive, while not regulating safeguards
in this respect positively, does nevertheless foster them in Art 10 para. 3.
In fact, professional representatives are more likely to have the knowl-
edge to cast the vote in the best interest of the shareholder represented.
This advantage of the use of an information intermediary35 has to be set
off against the disadvantage that there is often a danger of confl ict of
interests.
34
See, for instance, P. Davies, Gower and Davies, Principles of Modern Company Law, (7th
edn, London: Sweet & Maxwell, 2008), 53–62.
35
For the concept of information intermediaries, advantages and disadvantages (chances
and dangers) of their use see more in detail S. Grundmann and W. Kerber, ‘Information
Intermediaries and Party Autonomy – the example of securities and insurance markets’
in: S. Grundmann, W. Kerber and S. Weatherill (eds.), Party Autonomy and the Role of
Information in the Internal Market, (Berlin: De Gruyter, 2001), 264–310 (and literature
quoted there).
194 Perspectiv es in compa n y l aw

Theoretically, two rules seem feasible: either a rule which requires

the absence of conflicts of interests (impartiality) and excludes all rep-
resentatives who do not satisfy this requirement; or a rule which asks
for specific instructions on the side of the shareholder in cases where
there is a considerable confl ict of interests. Already before the adoption
of the EC Shareholder Voting Directive, the rule named first would seem
to have been a rather theoretical option only. Both Germany and the
United Kingdom where this problem was approached with particular
intensity opted for the second rule in principle.
In Germany, this was done in § 135 para. 1 (2) Aktiengesetz for any
proxy given to management in the general assembly of PLC: While this
rule applies directly only to (general assemblies of) credit institutions
which adopt the form of a PLC, it is increasingly held to apply by anal-
ogy to all types of enterprises adopting the form of a PLC.36 Moreover,
§ 135 para. 1 (3) Aktiengesetz asks for special instructions – i.e. two-way
proxies in the English terminology – in cases where proxy is not given to
management of the PLC, but to the deposit-bank , if this bank owns in
addition 5% of the stock subscribed.
Deposit bank voting is, however, not possible so far in France (unless
it owns stock itself), only to a very limited extent in Italy and not usual in
the United Kingdom either. Here, as has been said, proxies are given to
management (as in France). The peculiarity of the English development
is, however, that proxies can be given without specific instructions (gen-
eral proxies) only in PLCs which are not listed, while in listed companies
two-way proxies are needed: Proxies can be voted here only for those
items on the agenda where such instructions exist.

2. Management, credit institutions, and shareholders’

associations as potential representatives
The question thus arises not so much whether there should be the
requirement of a specific instruction by the shareholder but whether all
forms of organized representation should be admitted in parallel and
36
See only (also for the opposing view) C. Bunke, ‘Fragen der Vollmachtserteilung zur
Stimmrechtsausübung nach §§ 134, 135 AktG’, Aktiengesellschaft, (2002), 57, 60;
M. Habersack, ‘Aktienrecht und Internet’, Zeitschrift für das gesamte Handelsrecht, 165
(2001), 172, 187–89; S. Lenz, Die gesellschaftsbenannte Stimmrechtsvertretung (Voting) in
der Hauptversammlung der deutschen Publikums-AG, (Berlin: Duncker & Humblot, 2005),
285; U. Noack, ‘Stimmrechtsvertretung in der Hauptversammlung nach dem NaStraG’,
Zeitschrift für Wirtschaftsrecht, (2001), 57, 62; G. Spindler, in K. Schmidt and M. Lutter
(eds.), Aktiengesetz, (2007), § 134 para. 56; opposite, for instance, P. Kindler, ‘Der Aktionär
in der Informationsgesellschaft’, Neue Juristische Wochenschrift, (2001), 1678, 1687.
 R enaissa nce of sh a r eholder in Eu rope 195

how to define the conflict of interests which gives rise to the requirement
of a specific instruction by the shareholder.
While this seems rather simple in the case of proxies given to man-
agement or to representatives named by the company – at least in PLCs
which are listed – the German rule described above is more problematic.
It basically assumes that there is a strong confl ict of interest whenever
the deposit bank owns 5% of the stock subscribed, but does not take
into consideration loans (although in 1998 this had been discussed
as well). This rule which has been introduced after long policy debate
in the 1990s about the power of banks and their role within the then
highly ‘cartelized’ system of stock-holdings in Germany, the so-called
‘Deutschland AG’ (PLC Germany), was aimed at combating a differ-
ent type of conflict of interests: while the potential of bias in the case
of management is obvious, that of the bank is seen in four phenomena:
deposit banks do not only act as representatives of their clients, but, in
a universal bank system, act as well as providers of loans, as owners of
their own stock and via their presence on the supervisory board, poten-
tially as well as counsellors.37 Their conservative – risk averse – attitude
in the PLCs which they influence by their votes has often been high-
lighted. Moreover, interests of large block-holders often diverge from
that of small capital represented.
Two developments in the last two years are interesting. The German
legislature would like to increase the threshold from which specific
instructions are required from 5% to 20% (Federal Government) or
even 50% (Ministry of Justice). In fact, the 5% threshold has often been
criticized as being much too low and meaningless. 38 Another argu-
ment advanced by the legislature is that deposit banks have lost quite
substantially the multifold power described. 39 While the German leg-
islature has admitted proxies given to management (only) in 2002, the
legislative trend would now seem to be that deposit bank voting is seen
(again) as the alternative which should be fostered. Banks are seen

37
D. Charny, ‘The German Corporate Governance System’, Columbia Business Law
Review, 1 (1998), 145; K. Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in
Europa?’, Zeitschrift für Gesellschaftsrecht, (2000), 773, 802–6.
38
See, for instance, G. Spindler, in K. Schmidt and M. Lutter (eds.), Aktiengesetz, (2007),
§ 135 para. 20–22.
39
Even in the 1990s, the share banks owned in listed companies on average was only at about
10% of the stock subscribed: E. Wymeersch, ‘A Status Report on Corporate Governance
Rules and Practices in Some Continental European States’ in K. Hopt , H. Kanda, M. Roe,
E. Wymeersch and S. Prigge (eds.), Comparative Corporate Governance, (note 1, above),
1176 et seq. (similar, however, only in Italy).
196 Perspectiv es in compa n y l aw

(again) as potentially less biased than management – as an interesting

balancing factor in a general assembly.
The second development occurred on the European level. The EC
Shareholder Voting Directive does not accept a general exclusion of
certain types of (organized) shareholder representation, namely not
requirements as to which person may be chosen as a proxy. An exclu-
sion of banks is thus no longer admissible (see Art. 10). Moreover, the
requirements which may be imposed are channelled now: apart from
exclusion based on questions of capacity (para. 1) and restrictions as
to numbers (para. 2), only confl icts of interests may be taken as a cri-
terion for restrictions (para. 3). In addition, these restrictions then
may not take any form, namely not outright exclusion: it may only be
forbidden to pass on the proxy or prescribed to give information on
the confl ict of interests. The third – and last remaining – tool is that
specific instruction by the shareholder may be asked. Finally, also a
defi nition of confl ict of interests is given. Although this defi nition is
open (‘in particular’), it shows a trend: it would seem as if only (direct
or indirect) majority holdings were seen as serious enough a danger.
Thus, what the German legislature now proposes may even be required
by the Directive (although the German legislature does not think he is
bound).
Shareholders’ associations would certainly be the least problematic
alternative – if there was not the problem that a high level of professional
action requires funds as well. Therefore, the real alternative is commer-
cial representation, ISS, ECGS and IVOX being the most prominent
players in this respect (see Fn. 13).

3. Striving for a full picture of the market of

proposals (proxies)
Specific instructions given by the shareholder are seen as the first best
choice in all national laws and in the EC Shareholder Voting Directive.
This follows from the fact that such instructions are required in situa-
tions where shareholder protection is seen to be particularly important
(see, for instance, Art. 10 para. 3 of the directive) and from the fact that
they always take precedence over proposals made by management or
organized shareholder representatives (Art. 10 para. 2 of the directive).
The EC Shareholder Voting Directive does, however, not specify how
and which proposals should be made and which effect they have in the
absence of such specific instructions.
 R enaissa nce of sh a r eholder in Eu rope 197

This is perhaps the most interesting aspect of the reform proposal made
by the German Ministry of Justice for the German deposit bank voting
scheme, and deserves close attention – even though the chance for this model
to become law has now considerably decreased, as it is no longer part of the
Federal Government’s draft.40 The first rule proposed is that the credit institu-
tion is no longer forced to make its own proposal of how to vote in the absence
of a specific shareholder instruction, but that it is still allowed to do so. The sec-
ond rule is that if the credit institution chooses not to make its own proposal,
it may not only propose to follow management’s proposals. This is interesting
because the rule clearly starts from the assumption that the risk of biases in
management’s proposals is the strongest. This shows that with respect to the
question of who is the ideal proxy, the dividing line within Europe is prob-
ably not less prominent than with respect, for instance, to co-determination.
The credit institution may refer to the proposal made by any shareholders’
association, but if it refers to the proposals made by management, it always has
to offer as an alternative at least one proposal made by a shareholders’ associa-
tion as well. The bottom line is that – absent a specific instruction made by
the shareholder – credit institutions may act as proxies only if they offer an
alternative to management’s proposals – which, of course, can also coincide
with these proposals in large parts – but they have to make the choices made
explicit. In other words, the credit institution has to offer its own alternative
to management’s proposals or an alternative proposed by another independ-
ent ‘professional’ actor – because this should have ex ante a disciplining effect
on management.41 Weakening this responsibility of the credit institution is
a major back-step in the recent Government’s Entwurf (see note 12, above).
The third rule in the Ministry’s Entwurf is that the credit institution may even
choose to offer the shareholder the whole picture of proposals. This goes even
further than just disciplining management. A (relatively) independent profes-
sional actor gathers all alternative proposals for the shareholder42 (even so far,
credit institutions had to inform about the existence of alternatives and this
remains the mandatory rule also in the future). The Ministry’s Entwurf would
have had more control than the Government’s Entwurf.
40
On the model, see [Ministry of Justice] Referentenentwurf (note 12, above), 48 et seq.;
first comment by M. Sauter, ‘Der Referentenentwurf eines Gesetzes zur Umsetzung der
Aktionärsrechterichtlinie (ARUG)’, Institute for Law & Finance, Frankfurt, Working
Paper Series No. 85, 06/2008, www.ILF-Frankfurt.de, 4 et seq and 17 (overall positive).
[Federal Government] Entwurf (see note 12, above), provides for a different model, see
S. Grudmann, ‘Das neue Depotstimmrecht nach der Fassung im Regierungsentwurf zum
ARUG’, forthcoming in Zeitschrift für Bank- und Kapitalmarktrecht, issue 1 (2009).
41
See [Ministry of Justice] Referentenentwurf , (note 12, above), 48.
42
See [Ministry of Justice] Referentenentwurf , (note 12, above), 49.
198 Perspectiv es in compa n y l aw

B. Striving for the reduction of representative’s

strategic options – the mandatory vote
More questionable may be another proposal of deregulation made in
Germany.
So far, § 135 para. 10 Aktiengesetz forced credit institutions, if at all they
offered themselves as organized shareholder representatives, to do so for
all their clients. A very similar rule – now for the management – is to be
found in English Company Law where management, if it asks for proxies
(i.e. unless the initiative came from the shareholder), must ask all sharehold-
ers (see Fn. 31). Conversely in Germany, most authors are opposed to an
analogous application of said § 135 para. 10 Aktiengesetz to management’s
solicitation of proxies.43 Thus in Germany, there is no equal treatment or
level playing field between these two forms of organized shareholder rep-
resentation. The rationale behind the rules in the United Kingdom and in
Germany is similar: the organized shareholder representative should not be
able to exclude those shareholders in fact who are likely to be opposed to the
proposals made by the representative.44 As there is an offer to act as a proxy
already, the burden of this duty is low. In Germany it is even further reduced
by the fact that the duty is owed only to other clients – not all shareholders
– and only if the credit institution has an establishment at the place where
the general assembly takes place. Thus, additional burden is in fact avoided.
Under these circumstances, the gains from deregulation would seem to
be minimal and the policy considerations in favour of equal treatment of
shareholders and the trend in Europe go into the opposite direction.

IV. Conclusions
With the transposition of the EC Shareholder Voting Directive, Europe
not only develops some basic rules for a level playing field in the core
area of organized shareholder representation, namely: (i) any outright
exclusion of one or the other type of organized shareholder represen-
tation is prohibited (open competition between the different forms);
(ii) the grounds on which regulation or restrictions for such organized

43
U. Hüffer, Aktiengesetz, (2008), § 135 AktG para. 32; G. Spindler, in K. Schmidt and
M. Lutter (eds.), Aktiengesetz, (2007), § 135 para. 45; W. Zöllner, in Kölner Kommentar
Aktiengesetz, (1979), § 135 para. 103.
44
Explanation to the Aktiengesetz 1965, Regierungsbegründung Kropff, 200; U. Hüffer,
Aktiengesetz, (2008), § 135 AktG para. 32; G. Spindler, in K. Schmidt and M. Lutter
(eds.), Aktiengesetz, (2007), § 135 para. 44.
 R enaissa nce of sh a r eholder in Eu rope 199

representation may be based are substantially reduced; (iii) there is a

clear priority rule for specific instructions made by shareholders. With
the transposition of the EC Shareholder Voting Directive, however,
Europe also seems to enter into a new phase of competition between
different designs of organized shareholder representation. Germany has
made highly interesting reform proposals for its deposit bank voting
scheme which deserve discussion in their underlying rationale. They are
an original input to a debate which follows Eddy Wymeersch’s monitum:
‘do not forget shareholder voting rights’.
 11

In search of a middle ground between the perceived

excesses of US-style class actions and the generally
ineffective collective action procedures in Europe
Douglas W. Hawes 

I. Introduction
There is a general recognition in Europe that the existing methods of
compensating the victims of consumer fraud, anti-competitive behav-
iour, fraud on investors and other actions with multiple victims are
inadequate. Some look longingly at the results obtained in the US class
action system but in Europe most people recoil at what are viewed as its
excesses.
As the limited survey in Section IV in this chapter shows, two coun-
tries in Europe have new class action laws and several others have been
working around the edges of the apparent bars to class actions, both
legal and cultural, in their countries to provide some effective means
for large groups of claimants to obtain damage relief. Most European
countries and the European Union itself allow collective or representa-
tive actions for injunctions. Even the US role of lawyer’s fi nancing class
actions on a contingent fee basis is being fi lled in a limited way by third-
party funders (albeit to date mostly in normal commercial litigation).
The question remains whether these various substitutes for US class
actions (‘class actions lite’) will provide an adequate and efficient basis
for compensating large numbers of claimants without impairing pro-
cedural fairness or otherwise suffering any of the maladies associated
with the US system.
Class actions have existed for a long time in the United States but
were given a significant boost in 1938 when the Federal Rules of Civil

1
The author wishes to acknowledge the help of the following: Damian Cleary, Alain
Hirsch, Thomas Schmuck, George Williams and my wife, Marie-Claude Robert Hawes.
However, the views expressed in this article are solely those of the author.

200
 US-st y le cl ass a nd Eu ropea n collectiv e actions 201

Procedure were amended to codify the process. US class actions have

been brought primarily in securities, product liability and anti-trust
actions, but are generally applicable. In the securities field, the principal
focus of this essay, in 2007 there were 175 securities class actions fi led –
somewhat below the average of the last ten years.2 Since 2005 there have
been seven settlements of such actions for over $500 million each topped
by Enron at over $7 billion.
In brief, the US class action procedures are as follows. First, an action
is fi led on behalf of one or more named plaintiffs. The plaintiffs’ repre-
sentative then must prove the class satisfies Rule 23 (see discussion of
the requisites in the Vivendi case in Section III). After a class is certified,
notice must be given to the class by direct mail and/or advertising. A
class member can then ‘opt out’ of the class either because the member
wants to bring a separate action or is not interested. Those not opting
out are foreclosed from bringing their own case and are bound by the
outcome of the class action whether by judgment or settlement.
Because US law permits contingent fees, most class action cases
are initiated by experienced plaintiffs’ counsel who underwrite all the
expenses of the litigation in exchange for a percentage of the recovery
which tends to be around one-quarter or one-third but can be higher and
must be approved by the court at the end of the process. 3 Why are there
so many US class actions? First, it has proven to be a lucrative business
for plaintiffs’ counsel. Second, there is a well-recognized and organized
class action process including advertising for claimants. Th ird, there is
a possibility of punitive damages which while rarely applied can influ-
ence settlements. Fourth, there is no loser pays rule as in England and
other European countries so plaintiffs risk nothing and their counsel
only their own expenses and time (which of course can be considerable
in a protracted case). Fift h, jury trial is available, which, as a kind of
wild card, presents defendants with a serious risk of losing even where
they have a strong defence; such risk adds to the pressure to settle. Sixth,
the fraud-on-the-market theory allows a presumption that investors
relied on corporate misrepresentations even if not specifically aware of
them. Seventh, derivative suits allow shareholders to sue on behalf of
the corporation, albeit the recovery goes to the company but plaintiffs’
counsel receives a fee. Eighth, the Securities and Exchange Commission
is active in investigating and taking action against securities violations

2
Stanford Law School Securities Class Actions, http://securities.stanford.edu/
3
See note 6.
202 Perspectiv es in compa n y l aw

thus paving the way for civil suits.4 Ninth, there are extensive discovery
obligations on defendants.
The principal perceived excesses of the US class action are: (1)
the contingent fee aspect which encourages lawyers to stir up litiga-
tion especially given the absence of a regime of loser pays the fees and
expenses of the other side; (2) the risks associated with jury trials and
the possibility, however remote, of punitive damage actions; and (3) the
methods by which some counsel have obtained the clients to bring the
case (resulting in at least one prominent criminal indictment brought
against plaintiffs’ lawyers for giving kick-backs to obtain lead clients)5
and the bringing of frivolous class actions to obtain settlements (a prac-
tice considerably reduced since the passage of the Private Securities
Litigation Reform Act of 1998 (PSLRA).6 One of the failures of the
US class actions system in securities cases that is not enough talked
about in my opinion is the fact that the forms sent to potential claim-
ants are extremely burdensome so that an individual investor with little
or no idea of how much he or she might be entitled to, just dumps the
forms in the wastebasket.
Using two US class actions involving European defendants, Shell and
Vivendi, as a jumping-off place, this paper first examines the Shell settle-
ment with its non-US shareholders under a relatively new Netherlands
Settlement Act (Section II), and then the US District Court’s analysis in
Vivendi that led it to conclude that certain European countries inhospita-
ble to opt-out procedures would not enforce a US court’s judgment in an
opt-out class action (Section III). Finally, in Section IV, I provide a brief
overview of some recent developments in Europe and discuss middle

4
Indeed in this case, Shell had agreed to pay the SEC $120 million for securities law
violations and the UK Financial Services Authority £47 million for market abuse.
5
The leading US class action securities law firm, Milberg Weiss Bershad & Shulman and
two of its partners were indicted on 18 May 2006, and charged with making more than
$11 million of secret payments to three individuals who served as plaintiffs in more than
150 lawsuits. Bershad and Shulman subsequently pleaded guilty and in February 2008
William Lerach, a former partner of the firm was convicted and sentence to two years in
jail for his role in the scandal. On 20 March 2008, Melvyn Weiss himself pleaded guilty.
6
Under the PSLRA, the court not only selects the lead plaintiff and thereby its counsel
(mostly on the basis of the financial interest of the plaintiff ) it also scrutinizes the fees
in relation to reasonable hours spent and a reasonable hourly basis times some multiple
(generally around 2.5 to 3.0 times but depending also on the amount of the recovery for
the class – so-called lodestone test). Before the 1998 Act, there was a race to the court-
house with the winner being designated lead counsel, which explains why Milberg Weiss
needed a stable of ready plaintiffs each of whom owned a few shares in many public
corporations.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 203

grounds between the perceived excesses of the US class action system

and the generally ineffective collective action procedures in Europe.
As shown by my wife’s companion essay in the next chapter, ‘Some
modest proposals to provide viable damage remedies for French inves-
tors’, there also may be other interim solutions available. In her exam-
ple of France, she advocates remedies for investors by: (1) utilizing the
existing injunctive powers of the French Autorite des Marches Financiers
(AMF) to order restitution to investors in exchange for not sanctioning
the violators; or (2) after additional legislation, empowering the AMF
through its Mediator function to determine and require restitution to
investors after the AMF Commission on Sanctions has condemned
persons subject to the AMF’s jurisdiction.

II. The Shell Settlement

In January, 2004 and again in March, Royal Dutch Shell announced
drastically revised estimates of its proven oil reserves.7 By September
2004, domestic and foreign shareholders had fi led a class action in the
US.8 In December 2004 Shell moved to dismiss the claims asserted by
the non-US purchasers for lack of subject matter jurisdiction. In April
2007, Shell reached a several hundred million dollar settlement with a
substantial group of European shareholders under a new Netherlands
law.9 The settlement was conditioned on the foreign shareholders being
denied jurisdiction in the US case. That occurred in November 2007 in a
decision by the US District Court in New Jersey.10
I will use the Shell case to illustrate: (1) the US law relative to the access
of such foreign plaintiffs to the US courts; and (2) the operation of this
unusual new Netherlands law that permits settlements to bind parties
who do not opt out, such as shareholders, but does not permit claims for
damages. In part III, I will utilize the Vivendi case11 to illustrate how,
when access is granted in the US, the court must still determine if share-
holders from particular countries should be excluded where the opt-out
provisions of US law are not likely to be enforced.

7
See press releases by Royal Dutch Shell dated 9 January 2004 and 18 March 2004.
8
US D.Ct. Dist. of New Jersey, Civ. No. 04–374 (JAP) (Consolidated Cases).
9
Wet Collectieve Afwikkeling Massaschade, BW Art. 907–10 (the Civil Code of the
Netherlands) and 14 Rv Art. 1013–18 (the Code of Civil Procedure of the Netherlands).
10
In re Royal Dutch Shell Transport Securities Litigation (Royal Dutch II) 2007 US Dist.
LEXIS 84434 (D.N.J. 13 November 2007).
11
In re Vivendi Universal, SA Securities Litigation, Case 02 Civ. 5571, 23 March 2007.
204 Perspectiv es in compa n y l aw

A. Jurisdiction of US Courts in securities class actions

over non-US plaintiffs
As noted above, there is a general feeling in Europe among both enter-
prises and shareholders, especially institutional ones, that the US class
action system is excessive. Therefore, some European institutional
investors are reluctant participants in class action suits in the US, and
some would prefer, as happened in the Shell case, to find a European
mechanism for just compensation for any securities fraud. Indeed, the
European investors who participated in the Netherlands settlement
opted out of the US class action. At the same time, as illustrated by the
Shell decision of the District Court denying jurisdiction, the US courts
may be narrowing the gate through which foreign plaintiffs must pass.
That gate was also narrowed for foreign and US investors alike by the
decision of the Supreme Court on 15 January 2008, in the Stoneridge
case.12 The Supreme Court held that a securities fraud lawsuit against
suppliers and customers of Charter Communications, Inc., who alleg-
edly agreed to arrangements that allowed Charter to mislead its audi-
tors and issue a false financial statement affecting its stock price, was
not tenable because the investor plaintiffs did not rely on statements or
representations by such secondary actors.13
I now turn to the law on subject matter jurisdiction as found by the
New Jersey District Court in Shell. After Shell petitioned the District
Court to deny jurisdiction over the non-US purchasers of Shell securi-
ties, the Court appointed a retired judge as a special master to determine
if the Court had jurisdiction. He issued his report in September 2007
suggesting the Court did not have subject matter jurisdiction over these
claims. The District Court thereafter adopted his report and dismissed
those claims.
The Securities Exchange Act of 1934 (the ’34 Act) does not in any way
limit the availability of its remedies for foreign purchasers. However,
the courts have applied a standard test of such availability in which
they seek to determine whether it was the intent of Congress to uti-
lize the ‘precious resources of the United States courts to be devoted to
12
Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., No. 06–43, 2008 WL
123801 (U.S. 15 January 2008) (‘Stoneridge’).
13
See also, Regents of the Univ. of California v. Credit Swiss First Boston (USA), Inc., No.
06–1341, cert. denied (US 22 January 2008) (‘Enron’) where the timing of the denial of
certiorari after the decision in the Stoneridge case impliedly rejected the Enron plaintiffs’
contention that the ruling in Stoneridge did not extend to fi nancial professionals like
banks.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 205

such transactions’.14 Although two tests have emerged for determining

whether a federal court has subject matter jurisdiction over a foreign
plaintiff ’s claim under the antifraud provisions of the securities laws, the
‘conduct test’ and the ‘effects’ test, in this case the conduct test was found
to be controlling. The conduct test asks whether the ‘defendant’s con-
duct in the United States was more than merely preparatory to the fraud,
and particular acts or culpable failures to act within the United States
directly caused losses to foreign investors abroad’.15 The effects test ‘asks
whether conduct outside the United States has had a substantial effect on
American investors or securities markets’.16 Since these non-US plain-
tiffs purchased outside the US there was no effect on American investors
or securities markets so the effects test was not applicable.
The conduct test requires detailed attention to the facts. In the Shell
case, the motion to dismiss for lack of subject matter jurisdiction was
denied at the pleading stage of the proceeding,17 but after extensive dep-
ositions and document production, the Special Master was able to deter-
mine that, although he had considered ‘a multitude of boxes overflowing
with transcripts and other exhibits . . . [he could not conclude that the
plaintiffs had] satisfied the “conduct test” under the operative analysis’.18
It is the plaintiff that bears the burden of proof. The primary areas cited
by plaintiffs to support jurisdiction were: (1) Shell’s investor relations
activities in the US; (2) the use of a US-based Shell service organization
in the estimation and calculation of proved reserves; and (3) services
performed by another US-based Shell service organization which per-
mitted Shell operating units either to maintain proved reserves book-
ings or to book additional proved reserves.
Although a limited amount of activity in those three areas was
found, the Court determined that: (a) Shell did not engage in any fraud-
related activity targeted at non-US purchasers within the US by virtue
of its investor relations activities; and (b) that the activities of Shell’s
US-based service organizations were not related to either reporting
of proved reserves or maintaining the reserves. In sum, the District
Court found that plaintiffs had not shown that ‘Shell engaged in con-
duct that amounted to more than mere preparatory acts in furtherance

14
Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir. 1991), cert. denied, 502 US 1005 (1991).
15
Ibid.
16
Robinson v. TCI/US West Commc’n, 117 f.3d 900, 905 (5th Cir. 1997).
17
Royal Dutch Shell I, 380 F. Supp. 2d at 548. (2005).
18
Special Master’s Report, 3.
206 Perspectiv es in compa n y l aw

of the alleged fraud as to the Non-U.S. Purchasers’.19 Put another way,

the Court held that there was insufficient evidence to show that Shell’s
‘conduct occurring within the borders of this nation was essential to the
plan to defraud [the Non-U.S. Purchasers]’.20
Note that nothing in the conduct test relates to whether a finding
of no jurisdiction would leave the foreign plaintiffs without a remedy.
However, the District Court immediately followed its fi nding of ‘no
jurisdiction’ with the observation below:
The Court also emphasizes that this holding does not leave the Non-U.S.
Purchasers without an alternative recourse to address their alleged inju-
ries. Significantly, the Non-U.S. Purchasers can seek recovery through the
[Netherlands] Settlement Agreement entered into before the Amsterdam
Court of Appeals or through procedures available within their respec-
tive jurisdictions. Therefore, the result reached here does not prejudice
the Non-U.S. Purchasers and ultimately serves to preserve ‘the precious
resources of the United States Court’. (Opinion p. 19)21

In short, while the Amsterdam settlement was not a requisite, the

Court’s finding of no jurisdiction under the conduct test, appeared to
have had some influence on that determination. Accordingly, I now turn
to a discussion of the Netherlands Settlement Agreement.

B. The Netherlands Settlement Agreement

The Netherlands Act on Collective Settlement of Mass Damages22 had an
unusual origin. Netherlands pharmaceutical manufacturers were faced
with a flood of individual suits by victims and their families related to
injuries suffered from using a synthetic hormone DES. In many cases it
was not clear which pharmaceutical company’s product was used by a
person.23 The manufacturers and their insurers went to the legislature
19
Royal Dutch Shell Transport Securities Litigation (Royal Dutch II) 2007 US Dist. LEXIS
84434 (D.N.J. 13 November 2007), 19.
20
Citing Sec. and Exch. Comm’n v. Kasser, 548, F.2d 109, at 115 (3d Cir.), cert. denied,
Churchill Forest Indus. Ltd v. Sec and Exch. Comm’n, 431 U.S. 938 (1977).
21
Citing Alfadda, (note 14, above), 935 F.2d, 478.
22
Wet van 23 juni 2005 tot wijziging van het Burgerlijk Wetboek en het Wetboek van
Burgerlijke Rechtsvordering teneinde collectieve afwikkeling van massaschades te
vergemakkelijken (Wet Collectieve Afwikkeling Massaschade).
23
The original claim was made by six daughters whose pregnant mothers had used DES. A
registry was established and 18,000 people signed up out of a possible estimated 440,000
potentially affected. Interestingly, 24,700 people opted out of the settlement although it
was not clear how many of them intended to pursue individual actions.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 207

and asked for an act that would permit them to settle all the suits at
the same time. After the legislature obliged, and seven years of negotia-
tion, they settled for €38 million which was approved, as required, by
the Amsterdam Court of Appeals in June 2006. Since the law was not
restricted to the specific DES case, it was then used to settle a case involv-
ing retail sales of securities by Dexia Bank. That opt-out settlement was
for €400 million and was approved in January 2007. The Shell settlement
was fi led in April 2007. It has not yet been approved by the Amsterdam
Court of Appeals as required by the Act because it was conditioned on
the US Court denying jurisdiction, which only occurred in November.
The Shell settlement was for $352 million plus an agreement with
the US Securities and Exchange Commission to distribute $96 mil-
lion of its $120 million fine to the non-US purchasers. When you add
in the legal fees of $47 million agreed to in the settlement the total
is about $500 million. The Netherlands Act binds all members of
the class (i.e. non-US purchasers) unless they opt out of the settle-
ment. If the deal is approved by the Netherlands court later this year
as expected, it is likely to be enforceable throughout the European
Union under its regulations relating to enforcement of judgments. 24
Moreover, it will establish an important precedent that is quite likely
to attract other large European class action settlements because of the
certainty of recovery of some damages in a relatively short time versus
an uncertain wait in the US action and the cost and uncertainty of
litigation in Europe. 25
The flaw in the Netherlands Act from a plaintiff ’s point of view is that
it only allows for settlements, not class actions for damages. Presumably,
in the negotiations for such settlements, that factor will weigh in the
equation. However, on the other side of the coin, if the US becomes ever
more hostile to such non-US plaintiffs (and generally less open to secu-
rities law actions), the incentive for plaintiffs to settle in Europe will
certainly increase. Equally, for defendants if collective actions become
more prevalent, they will be more open to settlement especially if other-
wise they might have to defend actions in several countries.

24
See Council Regulation on jurisdiction and recognition and enforcement of judgments
in civil and commercial matters EC No 44/2001 [2001] OJ L12/1.
25
In fact in terms of the US Shell litigation for US plaintiffs, Shell announced on 6 March
2008, that it had reached an agreement in principle to settle that action for $79.9 million
plus $2.95 million in interest. The deal is subject to the approval of the District Court of
New Jersey. An additional $35 million would be paid collectively to the participants in
the US class action and the Dutch settlement. See Reuters, 6 March 2008.
208 Perspectiv es in compa n y l aw

III. The Vivendi Case

In addition to the Shell decision of the District Court, there are other
signs of a narrowing of the door for such plaintiffs to participate in
US class actions under the securities laws. Two important decisions of the
US District Court for the Southern District of New York in the Vivendi
class action litigation provide indications, albeit in opposite directions,
for non-US purchasers. In 2003 the Vivendi Court found that despite the
fact that most of the Vivendi shares were traded on European exchanges
and Vivendi was not a reporting company under the ’34 Act (its securities
were traded in ADR form on the NYSE), its conduct in the US26 affected
the American market for their shares which in turn was a substantial fac-
tor in the decisions of foreign investors to purchase abroad. Accordingly,
non-US purchasers were entitled to bring US securities law claims.27
In 2007, in the same litigation, the Vivendi court, having decided it
had subject matter jurisdiction (contrary to the fi nding in Shell ), had
to determine whether the claims of the non-US purchasers could pro-
ceed as part of the class action. The answer to that question was gov-
erned by Sections 23(a) and 23(b) of the Federal Rules of Civil Procedure
which also had to be satisfied as to the US part of the class generally.
The Court first found that the tests under Section 23(a) were satisfied.
That is: numerosity of plaintiffs, commonality of questions of law or fact,
typicality of claims and the adequacy of the class representatives. Under
Section 23(b) the Court also was satisfied as to the predominance of
common issues and generally as to the superiority of class action treat-
ment over other forms. However, it found that the inclusion of non-US
purchasers raised a question under the superiority criterion, namely
whether foreign jurisdictions would preclude shareholders in such juris-
dictions who had not opted out of the US action from pursuing their
claims.28 The Court determined that the standard for exclusion was ‘the
closer the likelihood of non-recognition is to being a “near certainty”,
the more appropriate it is for the court to deny certification of foreign
claimants’.29

26
Including statements made to analysts and investors in New York and the key fact that
the CEO and CFO moved to the US allegedly to better direct operations and to correct
misleading perceptions on Wall Street.
27
In re Vivendi Universal, S.A. Securities Litigation, 381 f.Supp.2d 158 (S.D.N.Y.2003).
28
In re Vivendi Universal, S.A. Securities Litigation 2007 WL. 861147 (S.D.N.Y. 22 March
2007) and 2007 WL 1490466, FN (S.D.N.Y. 21 May 2007).
29
In re Vivendi Universal, S.A. Securities Litigation, 2007 WL 1490466 at 18 (S.D.N.Y., 21
May 2007).
 US-st y le cl ass a nd Eu ropea n collectiv e actions 209

After consideration of competing affidavits by the parties concerning

the foreign law on that subject for France, England, the Netherlands,
Germany and Austria, the Court concluded that Germany and Austria
were not sufficiently certain to enforce such a US judgment for dam-
ages although the other countries would. Therefore it excluded investors
from those two countries from the class in fairness to the defendant.
First, I summarize the Vivendi court’s finding of likely enforceability
in France, England and the Netherlands.

A. France
Given that Vivendi was based in France and the majority of the non-US
shareholders were French, the Court devoted most of its attention to
the law of that country. The Vivendi court’s finding as to France illus-
trates how a US court is likely to approach the issue. The main points the
Vivendi court made in deciding that French courts would give preclusive
effect to a US class action judgment were:
1. While there is no treaty between the US and France for the enforce-
ment of judgments and there has been no decision in France on any
foreign class action judgment, there are French decisions enforcing
foreign judgments generally (p. 38).
2. Before a foreign judgment can be enforced in France it must be sub-
ject to an Exequatur procedure, whereby, if recognized, the foreign
judgment is incorporated in the Exequatur and then enforced.
3. The leading case on the grant of Exequatur is the Munzer case decided
by France’s highest court, the Cour de cassation.30 Pursuant to that
case, the four conditions that must be met are: (1) the foreign court
must have proper jurisdiction; (2) the foreign court must have applied
the appropriate law; (3) the decision must not contravene public pol-
icy; and (4) the decision must not be a result of fraude a la loi (evasion
of the law) or forum shopping.
4. With respect to the jurisdictional prong, among other things, the
defendants’ experts pointed out that in 2002 an association of minor-
ity shareholders (‘ADAM’) petitioned the Paris Commercial Court to
investigate the claimed fraudulent actions of Vivendi. That court found
the claims were ‘ill-founded’ and dismissed them. Subsequently, the
defendants said, the head of ADAM [Mme. Colette Neuville] stated

30
In re Munzer, 7 January 1964, Bull. Civ. 1, °15.
210 Perspectiv es in compa n y l aw

that the dismissal caused her to introduce a class action in the US on

behalf of ADAM’s shareholders. Defendants argued that these events
showed an attempt to evade French law. However, the Vivendi court
ruled that because the French substantive law on securities fraud was
similar to that of the US the jurisdictional prong was satisfied.
5. As to the appropriate law prong, the Court concluded that while there
were procedural differences between French and American law, that
aspect should be considered under the public policy prong. As to
the rest, the Court held that the substantive similarities were suffi-
cient under the doctrine of equivalence to satisfy the appropriate law
prong.
6. The Vivendi court next addressed the public policy issue. It conceded
that the fact that opt-out class actions are not currently permitted in
France was some indication that such actions were contrary to French
public policy. But it said the issue is whether such actions infringe the
principles of universal justice. The defendants’ experts argued that a
number of procedural rules in France gave very clear rights to parties
that required their participation individually (the ‘right to be heard’).
Plaintiffs’ experts countered that France already authorized group
actions by unions on behalf of employees. They also pointed out that
shareholder associations have the right to sue companies and direc-
tors and to solicit proxies from individual shareholders (using mail
and public notice) to act on their behalf.31
The Court said that these types of collective actions ‘do not evince a fun-
damental hostility to the concept of collective actions’.32 Accordingly,
the Court concluded that an opt-out class judgment would not offend
French concepts of international public policy. The Court went on
to say that while such class actions are currently not permitted, ‘it is
equally clear the ground is shift ing quickly’. The Court referred to then
President Chirac’s creation of a commission in April 2005 to study the
introduction of a sort of ‘class action’ for relationships with consumers.
Defendants pointed out that the majority of the commission members
had viewed the opt-out class action as contrary to French law although

31
In fact, during the 1990s, provisions for collective actions were enacted or amended for
consumers (Art. L. 422–1 of the Consumer Code), for victims of environment viola-
tions (Environmental Code L.142–3) and for investors (Financial and Monetary Code
L.452–2). However, in the case of investor associations there has been almost no activity.
ADAM itself is not under that regime but under the general association law of 1901.
32
Vivendi, 49.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 211

some favoured it. The Court concluded that the views of the President
and the debate on the subject ‘is strong evidence that the class action
model is not so contrary to public policy that its use would likely be
deemed an infringement of “principles of universal justice” or contrary
to “international public policy”’.33
The issue of the enforceability in France of a US judgment in a securi-
ties class action is probably academic in the Vivendi case since Vivendi
has substantial assets in the US against which to satisfy any claim for
damages. The situation that would be likely to present that issue would
be where the defendant has insufficient assets in the US but has such
assets in France.

B. England
As there is no convention or statute on the res judicata effect of a US
class action judgment in England, the issue must be addressed under the
common law. The Court concluded that ‘English courts are more likely
to find US courts are competent to adjudicate with finality the claims
of absent class members and therefore would recognize a judgment or
settlement in this action.’34 That determination was based largely on the
fact that English representative actions will bind those on whose behalf a
claim is brought including persons who are not parties to the claim with
the court’s permission.35

C. Netherlands
Based on an unopposed affidavit of Professor Smit that Netherlands
courts would give binding effect to a judgment in or settlement of a US
class action, the Vivendi court included Netherlands investors in the
class. As a further basis for that determination, the Court referred to
recently enacted class action legislation ‘in other contexts’, undoubt-
edly a reference to the Netherlands Act on Collective Settlement of Mass
Damages discussed above in relation to the Shell case.
Now I turn to those countries whose plaintiffs the Vivendi court
excluded from the class because of doubts about enforceability of its
judgment.

33 34
Vivendi, 51. Vivendi, p. 55.
35
Rule 19.6 of the 1998 Civil Procedure Rules and Section 4(b).
212 Perspectiv es in compa n y l aw

D. Germany
The fi rst hurdle for the enforcement of a US opt-out class action judg-
ment in Germany would be Article 103 of the German Constitution,
which establishes the right of a citizen to be heard and to participate
in a legal proceeding. Based on the views of the parties’ experts the
Court concluded that there are reasonable means available to give
actual notice of opt-out rights to class members, but that a US judg-
ment would not be enforced against a class member who did not
receive actual notice. The Court went on to note that, unlike France
and England, Germany does not have collective actions. Even the
recent Capital Markets Model Case Act does not provide for collec-
tive actions.36 Rather, where there are multiple plaintiffs in a securi-
ties law matter, a test case can be used whose outcome will be binding
on the other individual shareholder actions. Non-party shareholders,
however, are not bound by the results. Thus the Court determined that
‘the formalities of German law may well preclude the recognition of a
judgment in the instant case’. 37

E. Austria
Austrian law requires formal reciprocity between the foreign state and
the Republic of Austria as a condition of recognition of a foreign judg-
ment. No such treaty exists with the US, so the Court concluded that
Austrian investors should be excluded from the class.38
The Vivendi court’s voyage into foreign law produced determina-
tive distinctions as to the enforceability of a US opt-out class action
judgment in the five countries examined. However, the differences
relied on between, for example France (would enforce) and Germany
(would not), seemed to be neither apparent nor real. Both countries
respect almost universally the ‘right to be heard’, which is enshrined
in the European Convention for the Protection of Human Rights and
Fundamental Freedom (ECHR) to which Germany and France are par-
ties. Undoubtedly the fact that Vivendi was a French-based entity and
the majority of its non-US shareholders were French, exerted pressure to

36
KapMuG (16 August 2008). The Act was adopted in response to the fact that in 2003,
some 15,000 shareholders of Deutsche Telecom flooded a court in Frankfurt with 2,500
suits brought by 700 attorneys alleging false statements related to its real estate in a share
offering; the stock had fallen over 80%.
37 38
Vivendi, 58. Vivendi, 58.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 213

include its plaintiffs in the class. As noted in part IV, the validity of that
holding has been questioned by a French academic specialist who was
not one of those whose affidavits were proffered by a party.

IV. Selected collective action developments in Europe

It is perhaps useful to offer a few general observations about collective
actions before discussing specific developments by country:
1. The distinction between collective actions and class actions is that
the former are opt-in and the latter are opt-out thus creating a class.
2. The concept of collective actions has existed for varying periods
of time in many European countries. However, (a) such collective
actions almost universally are limited, often to particular subject
matter such as consumer fraud or unfair competition, (b) either
the law itself or the government determines what organizations are
authorized to bring such actions, and (c) such actions are only for
injunctive relief and not damages.
3. Such collective actions for injunctive relief are of limited use and are
regarded as a neither very important supplement to nor a substitute
for government enforcement of the law.
4. In some situations and with increasing frequency, there has been
pressure from organizations and academics to broaden the scope of
collective actions to include claims for damages since government
enforcement generally does not result in restitution to those injured.
5. Almost universally, those seeking to broaden the scope of collective
actions also make plain their desire to avoid the perceived excesses of
the US-style class action system.
6. Two European countries, Italy and Denmark have attacked the mat-
ter head on effective this year: they have enacted class action laws.
What remains to be seen is if a real system for pursuing such actions
will evolve especially in the absence of the contingent fee incentive
which is the engine of the US system.
Some of the more recent variations short of class action laws devised
to overcome the existing obstacles to collective actions include: (1) the
German model case concept currently being employed in actions against
Deutsche Telecom; (2) the Netherlands collective settlement law used in
Shell referred to above; (3) the ad hoc attempt by a Belgium company,
CDC, to pursue in Germany the claims of twenty-nine cement buyers
who have assigned their claims to them; and (4) the launch of a fund in
214 Perspectiv es in compa n y l aw

the UK by Allianz, the German insurance company, to finance certain

kinds of actions. These and other developments are discussed below.

A. Denmark’s new class action law

The Danish law on class actions which went into effect on 1 January
2008, along with the new Italian law referred to next, goes a long way
towards meeting the need for redress of multiple victims without any
of the perceived disadvantages of the US system. Basically the law pro-
vides for a full opt-out class action where a public authority such as the
Consumer Ombudsman brings the claim and an opt-in collective action
by all other authorized representatives of the claimants.39
Thus the Ombudsman ‘can sue a business on behalf of hundreds or
even thousands of consumers . . . where[by] the consumer is [a] member
of the group unless he or she chooses to opt our of the claim’, provided
the court has allowed it.40 The court’s decision in a class action has a
binding effect (i.e. is res judicata) on the class members covered by the
action, that is, all who opt in or who fail to opt out in an action where the
opt-out procedure is authorized. Class actions can be brought in almost
any area of the law including securities, torts, consumer fraud and anti-
competitive behaviour but not family law.
The manner in which the new Act deals with the loser pays risk is
instructive: unless a member of a class action group has insurance or
is entitled to legal aid, the court can decide that participation is condi-
tioned upon each member providing security for costs. However, such
security will be the maximum cost that can be assessed to such mem-
ber (plus any damages received if there is a partial victory). Unlike
England where legal fees of a winning defendant may represent a sub-
stantial risk to plaintiffs, the costs assessed in many Continental coun-
tries such as France tend to be relatively low and more like court costs
in the US.
As to who will take on such class actions in Denmark, Professor
Werlauff notes that one legal chain of over seventy firms as well as one of
the biggest firms have registered domain names looking to be involved
in these new class actions.41

39
See, ‘Class Actions in Denmark – From 2008’, by Professor Erik Werlauff, Aalborg
University, Stanford/Oxford Conference on ‘The Globalization of Class Actions’ (13–14
December 2007, ‘Stanford Conference’).
40 41
Ibid., 3. Ibid., 7–8.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 215

B. Italy’s new class action law

In Italy, a new law goes into effect on 1 July 2008 allowing for collective
actions for damages by consumer organizations.42 A class action can be
brought by an accredited association (there are currently sixteen) against
any commercial, financial or insurance enterprise for damages arising
from (1) standard form contracts, (2) tort liability, (3) unfair trade prac-
tices and (4) anticompetitive practices affecting a group of consumers.
To participate, consumers must opt in by writing to the association
and the court decision will only be binding on those who do so. Since a
consumer can opt in until the last hearing on appeal, there is a possibil-
ity consumers will wait to the last minute creating a potential substan-
tial increase in the damages.
The court in such class actions does not award a specific amount of
damages but it sets out the criteria for determining the amount to be
awarded. The defendant has sixty days from the court’s decision to make
an offer. If either it does not make an offer or the consumers do not accept
the offer, it will go to binding arbitration. One consumer organization,
Adusbef, has already announced it plans to fi le an action against banks
for using compound instead of simple interest on loans which Adusbef
claims violates Italian law.43

C. France
In 2006, bills were introduced in the legislature for a system of collective
actions for consumers. The legislation was abandoned at the end of 2007
in the light of the coming presidential and legislative elections. In July
2007 after he was elected President, M. Sarkozy instructed his Minister
of Economy, Finance and Employment Mme. Lagarde and the Minister
for Consumer Affairs and Tourism M. Luc Chatel (the author of one of
the 2006 bills) to prepare legislation that would permit collective actions
based somewhat on the American model but denominated ‘class actions
à la Francaise’. He did warn against class actions that could lead to the
bankruptcy of an enterprise (perhaps like the asbestos cases in the US).

42
Amendment to Italy’s Consumers Code §140bis enacted 21 December 2007. There is a
story that the law was passed in the Senate only because one of its opponents pushed the
wrong button and voted for it – providing the crucial margin. See, Dewey and LeBoeuf,
L.L.P. Client Alert ‘Class action in Italy’ (4 February 2008) citing ‘Class Action per un
voto’, in II Sole 24 Ore, 16 November 2007, 3.
43
Reuters, 9 January 2008.
216 Perspectiv es in compa n y l aw

President Sarkozy, having asked M. Jacques Attali, a former key

adviser of the late President Mitterrand, to lead a study of ways to
grow the French economy, received his Report on 23 January 2008.
Recommendation 191 was to introduce collective actions for consumers
brought by their associations, provided that only those consumers opt-
ing-in would be included. The Report considered that the introduction
of such actions would contribute to the confidence of consumers while
at the same time avoiding moving to an American class action system.
On 23 January 2008, President Sarkozy seemed to back off somewhat
from such a class action proposal saying that he wanted more reflection
on the subject ‘because I do not want to have all the inconveniences of
American society without all the advantages. I see well the intent but I
see it only for certain enterprises.’44
In a comprehensive analysis of the French law on class actions for
the Stanford Conference,45 Professor Veronique Magnier, commented
on the Vivendi decision holding that French courts would enforce a US
opt-out judgment. She did not specifically dispute the Vivendi court’s
determination that the French concept that the identity of the plaintiff
must be known46 was really for the protection of defendants and should
not apply in a securities fraud case.
However, she did question whether the opt-out procedure would be
sustained in view of the ‘right to be heard’ guarantee under French law47
especially given the 1989 decision of the Conseil constitutionnel.48 There,
the Conseil ruled in a decision regarding labour unions that can bring
actions on behalf of employees, that each employee must be given ‘the
opportunity to give his assent with full knowledge of the facts and that
he remain free to personally conduct the pursuit of his interest’. Professor
Magnier concluded that ‘the freedom of bringing or not bringing one’s
own action lies at the heart of this decision . . . [and] most academics
have interpreted this decision as condemning any opt-out system’.49
An example of the difficulty in France of obtaining damages for
injured consumers is the recent mobile phone case. The Competition
Commission found a conspiracy to allocate market share among three

44
www.20Minutes.fr, 23 January 2008. Remarks made in the course of commenting on the
Report of the Attali Commission.
45
Stanford Conference on ‘The Globalization of Class Actions (2007) (‘Magnier Report’).
46
Ibid., Nul ne plaide par procureur.
47
Ibid., Principe du contradictoire.
48
Dec. Cons. Const. No 89–57, 25 July 1989.
49
Magnier Report, (note 45, above), 12–13.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 217

mobile telephone operators who were fined substantial amounts, but

no provision was made by the Commission for the victims. UFC-QUE
CHOISIR, a consumer group, wanted to recover damages for consumers.
It set up a website where consumers could calculate their damages and
sign up for the action. After investing €500,000, less than 1% of those
affected signed up.

D. Germany
While the Vivendi Court probably correctly excluded German plaintiffs
because of the constitutional right of a citizen to be heard in court, con-
trary to the Court’s summary, Germany does have collective actions, in
one example going back to the nineteenth century.50 In general, however,
suits by consumer groups and other authorized interest groups cannot
seek monetary relief but only injunctive action. There are some minor
exceptions where individual consumers can assign their claims for mon-
etary relief to an association. Under another statute, profits from unfair
competition violations can be claimed from the perpetrators by certain
organizations on behalf of consumers, but the recovery goes to the state
not to those injured.51 In the CDC case mentioned above, a lower court
has upheld the representation of the claimants by the assignee, but there
remain questions under the Legal Advice Act that limits the provision
of legal advice to qualified persons or institutions which may be a stum-
bling block.52 Another special case is where after a squeeze out, one or
more minority shareholders fi le a challenge via a valuation proceeding
(Spruchverfahren). The decision of the court is binding on all sharehold-
ers irrespective of whether they join the proceedings.53
It should also be noted that there are several disadvantages to the
Capital Markets Model Case Act. The first is the time it takes for the

50
Unfair Competition Act, UWG §3.
51
Unfair Competition Act §10.
52
See, Stanford Conference paper of Dr. Dietmar Baetge of the Max Planck Institute for
Corporate and International Private Law, 11.
53
As in other European countries, where a resolution put to shareholders is contested and
a court voids the resolution, all shareholders are affected. In the case of resolutions that
must be fi led in a commercial registry, such as for share capital increases or mergers,
some abuses have arisen in Germany and elsewhere involving significant and potentially
harmful delays (e.g. a Nestlé share increase was delayed for two years in Switzerland
by the action of some shareholders). In Germany, some legislation has aimed to reduce
similar abuses, but not with full success. Here again, the action has a certain collective
aspect, albeit not a collective action for damages.
218 Perspectiv es in compa n y l aw

courts to select the model case and have it confirmed on appeal. The
second is the fact that counsel for the model plaintiff does not receive
any extra compensation albeit has a special burden because it is the
model. The third is that the loser pays regime applies albeit the cost is
split among all plaintiffs and not just the model case plaintiff. The fourth
and possibly most problematic is the fact that once the courts rule in
favour of plaintiffs in the model case, other claimants can fi le their cases
knowing there is a kind of res judicata in their favour and little risk of
having to pay as a loser. One of the advantages of the Model Case proce-
dure is that the court reviews the case at the pleading stage and can shut
out weak claims. That Act was expressly intended as a test of that kind of
procedure. It is set to expire on 1 November 2010, although Dr. Ditmar
Baetge of the Max Planck Institute for Corporate and International
Private Law has predicted that it will not only be made permanent but
extended more broadly to collective actions of all sorts.54
In 1999, Dr Baetge’s Institute proposed allowing claims for compen-
sation in most collective actions and some form of opt-out class action
for securities and product liability cases. To date these proposals have
not been implemented by the legislature.
In March 2007 the German Supreme Court struck down the prohibi-
tion on contingent fees as unconstitutional, holding the prohibition of
such fees hindered a plaintiff from enforcing his rights. The legislature is
supposed to come up with a new law by mid-2008.

E. European Union
EU directives relative to a number of consumer protections include an
obligation of Member States to implement collective action measures but
only for injunctive relief.55 As to the future, the EU’s paper on Consumer
Strategy 2007–2013 included a consideration of collective actions
for damages.56 A Commission Study led by Professor Jules Stuyck on
alternative means of consumer proceedings, found that the economic
54
See, Stanford Conference paper of Dr. Dietmar Baetge of the Max Planck Institute for
Corporate and International Private Law, 8.
55
See, for example, Council Directive 93/13/EEC [1995] OJ L95/29, art. 7.1 (unfair terms
in consumer contracts). The Office of Fair Trading in the UK was able to get an injunc-
tion there against a Belgium catalogue being sent to UK residents, which injunction was
then enforced in Belgium. See, Council Regulation on jurisdiction and recognition and
enforcement of judgments in civil and commercial matters EC No 44/2001 [2001] OJ
L12/1.
56
COM (2007) 99, 13 March 2007.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 219

literature about cost–benefit justification for consumer collective action

did not reach a consensus. The Study identified ECHR Art. 6 and Member
State constitutional guarantees of the right to be heard, as obstacles to
opt-out class actions.57

F. England
In England, two principal methods exist for collective actions: (1) proce-
dural rules, primarily Group Litigation Orders (GLOs);58 and (2) statu-
tory procedures mostly regulatory in nature in the consumer area. There
have been few consumer actions by the organizations authorized to do so
largely because of cost considerations. One such consumer organization,
‘Which?’, brought its first collective action, after a price-fi xing charge by
the OFT against a T-shirt maker. The defendant had been fined for price
fi xing by the Competition Appeal Tribunal and appeals were denied – a
requisite to the commencement of the consumer organization action.
The ‘Which?’ case will be heard by the same Tribunal. If ‘Which?’ is suc-
cessful, consumers will provide proof of purchases to the defendants. If
defendants refuse to pay, claimants will have to fi le their own claims.59
In the securities field, the UK Financial Services Authority (FSA) has
among its available remedies the right to petition a court to order resti-
tution for investors for violations of securities regulations.60
While there is considerable opposition in England to US-style class
actions, success fees are allowed in certain circumstances but limited
to 100% of the base fee and up to 25% of damages awarded.61 A big dif-
ference from the US, however, is that the loser pays the fees of the win-
ner; in collective actions that represents a significant deterrent to join-
ing the action. One solution to that problem is after-the-event insurance
(ATE). ATE is generally sought by claimants and/or third-party funders
to insure the loser pays obligation and may in fact be required in cer-
tain circumstances. ATE insurance does not cover plaintiff ’s’ counsel

57
Commission Study of Alternative Means of Consumer Proceedings, Professor Jules
Stuyck et al., April 2007. See also Professor Christopher Hodges, Summary of European
Union Developments, Stanford Conference (‘Hodges Report’).
58
Civil Procedure Rules, Part 19 III. The GLO is a procedure for centrally managing
numerous cases revolving around similar claims. It is, in effect, an opt-in mechanism of
collective action.
59
The action was brought under the Enterprise Act 2002. See, ‘Which? Takes legal action
on overpriced replica shirt’, The Guardian, 9 February 2007.
60
Financial Services & Markets Act, 2000. ss 382 & 383.
61
Conditional Fee Agreements Regulations 2000, S I 2000/692. reg. 3 (1) (a).
220 Perspectiv es in compa n y l aw

fees although plaintiffs’ counsel will frequently work on the basis of ‘no
win, no fee’.62 While obtaining ATE insurance for a group of claimants
in commercial litigation would require something more bespoke than
standard, there are many providers of such insurance who pride them-
selves on innovative products and pricing including a number of Lloyd’s
syndicates.63
Towards the end of last year, the giant German insurer, Allianz
launched a fund in London to finance litigation in exchange for a per-
centage of the damage proceeds. And, at least one law fi rm has set up
a working party to consider offering funding to clients. A Clifford
Chance partner commenting on the Allianz fund said that third party
funding ‘could give class action activity in the UK and Europe a boost
[and] . . . will start to chip away at the structural differences between UK
and US litigation’.64 Third-party funding in the UK is already becoming
a competitive market that has even attracted hedge funds. It should be
noted that while the ancient torts of champerty and maintenance are
no longer crimes, they still have some viability, despite the lack of strict
enforceability.
The principal advantage of third-party funding over US contingency
fee class actions initiated by lawyers would seem to be that the latter is
lawyer driven and stirs up litigation, whereas the former is claimant
driven. Third-party funding separates the issue of lawyers’ fees from
that of financing the cost of the litigation. Such separation should result
in more transparent and better pricing of the two different services. An
area where third-party funding has been employed both in the US and
England is in insolvency proceedings. There the company liquidator
seeks to recover from creditors, management and professionals such as
accountants of the defunct enterprise but has limited funds for doing so.
There are currently a number of entities in England ready to offer
third-party funding or brokerage services. The latter seek to find the

62
Some countries such as Switzerland prohibit such fee arrangements.
63
At the request of a third-party funder, the Supreme Court of Switzerland struck down
a Zurich cantonal law in 2004 that prohibited third-party funding and lawyers from
accepting such funding with the exception of normal liability insurance coverage. The
court decided that the freedom to make contracts was important for people like plain-
tiffs and only incidentally affected the independence of the lawyers. The court cautioned,
however, that lawyers should serve the interest of the client in any confl ict with third-
party funders. See, L. Gmbh v. Kantonsrat des Kantons Zurich, ATF 131 I 223 (December
2004). A bill (H.R. 5463) was introduced in the US Congress in February 2008 which
would make plaintiffs’ counsel pay for the fees of the defendant if plaintiffs lose.
64
www.legalweek.com, 18 October 2007.
 US-st y le cl ass a nd Eu ropea n collectiv e actions 221

best match for a plaintiff or its counsel with a funder who either has
special expertise in the type of claim or has the most attractive financial
proposal or both. One of the reasons for the activity in third-party fund-
ing in England is the support for it from the OFT65 and the Civil Justice
Council.66 In addition to Allianz, mentioned above, third-party fund-
ing has attracted the interest of private equity and hedge funds who, as
might be expected have introduced sophisticated methods of fi nancing.
In one case, the claimant, a small technology firm suing a larger one for
patent infringement sold a zero-coupon note to a private equity fund,
Altitude Capital Partners, and agreed to provide the fund with a per-
centage of the recovery that would be reduced as the amount increased.67
While a small investor in England would have no incentive to seek out
third-party funding for a collective action for securities fraud, an insti-
tutional investor might.
Is third-party funding of court litigation or arbitration an important
middle-ground solution of the kind Europe has been searching for?
It may well be, although there is not yet enough experience with it in
England, the US and Germany. In other countries like France it may
well not be permissible.68 Moreover, if there is no structure for collective
actions by numbers of claimants, the availability of funding would not
matter.

V. Conclusion
The search for a middle ground between the perceived excesses of the US
class action system and the current generally ineffective collective action
procedures in Europe has accelerated. Class action statutes in Italy and
Denmark are effective this year. While they are very European versions
and are yet to be tested, they offer a useful model for other countries. The
Denmark law goes farthest in (1) providing an opt-out feature if brought
by the Ombudsman and approved by the court, (2) that it is applicable in

65
In late 2007 the OFT, in relation to competition law actions, stated: ‘The OFT takes the
view that third-party funding is an important potential source of funding . . . third-
party funding should be encouraged.’ See, ‘Fighting Funds’ 21 January 2008, at www.
thelawyer.com.
66
The Civil Justice Council in a 2007 white paper stated that: ‘third-party funding should
be recognized as an acceptable option for mainstream litigation.’ Ibid.
67
www.legalweek.com, 18 October 2007.
68
See, Freshfields Bruckhaus Deringer, June 2007 Client Alert, ‘Class actions and third
party funding of litigation’, p. 2.
222 Perspectiv es in compa n y l aw

most areas of the law including securities actions, and (3) that it contains
a method for minimizing the loser pays risk.
Other European countries have taken more indirect paths. Germany
has a model case procedure. The Netherlands has an opt-out provision,
but only for class action settlements not damage actions. England has
adopted procedural rules for collective actions (GLOs) but they have
not seen much use. On the other hand, actions by authorized consumer
organizations for damages have begun and the FSA already has the power
to both sanction persons subject to its jurisdiction and order restitution
to investors with the approval of a court. And, third-party funding of
litigation as well as ATE insurance for the loser pays risk, have become
accepted and available in at least some European countries.
In the European Union the issue of the need for some form of col-
lective action for damages has been raised and other countries such
as France are debating class actions. Meanwhile, in the securities field
France could allow the AMF to affect restitution to investors as proposed
in my wife’s companion essay, next.
As has often happened in the field of securities law, Europe lags
behind the US but sometimes finds different and more moderate solu-
tions. European countries are unlikely to settle on a single model for
collective or class actions despite the efforts of the European Union to
harmonize national laws. However, as more experience is gained with
the variety of approaches already being taken and others that have been
proposed, Europe may develop an effective middle-ground procedure
for multiparty claims while avoiding the pitfalls in the US class actions
system.
 12

Some modest proposals to provide viable damage

remedies for French investors
Mar ie-Claude Robert Hawes 

This chapter describes the limits of investor damage remedies in secu-

rities law actions in France and offers two modest proposals for ame-
liorating them: (1) utilize the existing injunctive powers of the French
securities regulator, the Autorité des Marchés Financier (AMF), to order
restitution to investors in lieu of a sanction; and/or (2) obtain additional
power from the legislature to allow the AMF to determine and require
restitution to investors after the AMF Commission on Sanctions has
sanctioned persons subject to their jurisdiction, using the AMF Mediator
function to make the determination.

I. Background on existing regulation

The first element of the French system that strikes one is that it was
clearly inspired and influenced by the US Securities Act of 1933 and
the 1934 Securities and Exchange Act. Similarly, the AMF itself, whose
predecessor, the Commission des Operations de Bourse, was created in
1967, is modelled on the US Securities and Exchange Commission (SEC).
The AMF has a somewhat broader role than the SEC but with much less
power especially in the early days; it not only enforces, administers and
proposes new provisions of the securities law to take account of the evo-
lution of the fi nancial markets, it is also perhaps more directly involved
in the changes in company and business law. Of course, the integrity of
the markets is the main concern of the AMF, and like the SEC, its main
tool is disclosure.

1
Former member of the International Faculty for Capital Markets and Corporate Law;
retired Mediator of the AMF and former head of the International Department thereof. I
wish to acknowledge the help of Alain Hirsch and my husband Douglas Hawes. However,
the views expressed are solely those of the author.
223
224 Perspectiv es in compa n y l aw

The second notable element of our system is that, under the influ-
ence of the European Union, it is relatively liberal 2 and seeks to provide
freedom of action and choice for companies and investors. Investors
are free to choose the best investment for themselves after receiving the
fullest information and the best advice from investment professionals.
Shareholders are free to elect the directors and dismiss them and vote
at shareholders’ meetings as well as to approve the annual accounting
statements, the amount of dividends, increases in capitalization, and
mergers. If investors are defrauded by executives and/or companies they
are entitled to sue. That is the theory. The reality is: investors have very
few means to affect any of these rights.
Thus, on the one hand shareholders receive from the AMF strong
support relative to most aspects of the life of their company: disclosure
requirements, corporate governance practices, auditing standards, vot-
ing procedures and so on. Most of the rules are designed to discourage
misconduct by executives and companies. But when it comes to problems
such as auditors who fail to completely check financial statements, mis-
use of assets, insider trading, misleading prospectuses or other material
misstatements and any kind of abuse of the market, virtually the only
means of rectification available are administrative or disciplinary sanc-
tions by the AMF or criminal prosecution.
Now, clearly there are such sanctions. They are imposed by the
Commission on Sanctions, a separate organism inside the AMF. In
2007, 28 proceedings resulted in sanctions out of 33 cases – 65 persons
were sanctioned including 26 entities and 39 physical persons and
40 persons were found not culpable. Among the proceedings, 13
involved violations of the disclosure requirements, 5 insider trading
violations, 1 market manipulations; the other proceedings related
to investment services providers (5) and portfolio managers (4). 3
However, none of these proceedings involved financial remedies for
investors. Investors are free to sue individually but it is very expen-
sive to do so, especially to recover relatively small amounts of individ-
ual damages. Moreover, under French jurisprudence, it is practically
impossible for an investor to demonstrate, as the law requires direct
and different damages from that suffered by the company4 – so it is not
2
As opposed to a non-liberal system which is governed by bureaucratic rules.
3
AMF, Annual Report (2007), 197–8, www.amf-france.org/documents/general/8333_
1.pdf
4
That is, plaintiffs must show that a direct and personal damage has been suffered by
them. In practice such proof is difficult, as the decrease in the value of the stock is not
 Prov iding v ia ble da m ages r emedies 225

worth trying. Of course, that is just fine with French executives who
are quite afraid of American style class actions being introduced in
France.
What then should changes in the law provide to better protect inves-
tors? In recent years there have been modest steps to provide collective
actions for consumers and, indeed, for investors. In the case of inves-
tors, these fi rst steps were important because until then investors had
no possibility to collect the funding necessary to commence any pro-
ceeding or to authorize a representative to act on their behalf. The only
chance they had to recover damages was, if there was a criminal pro-
ceeding, they could then attach a civil proceeding to it and seek dam-
ages. But in such cases the investors had to join the criminal proceeding
individually.
Today, two forms of collective actions by investors have become pos-
sible: investor associations and shareholder groups, but they have not
been made easy for fear of abuse. 5 The conditions necessary to form
an association are so restrictive that there are very few of them and no
groups of shareholders (an association is comprised of shareholders in
any number of companies whereas a group consists of shareholders all
in the same company). To be recognized as an association, the entity
must have been in existence for six months and have 200 or more pay-
ing members. In addition, they must be authorized by the judge in
the proceeding to seek proxies from the member/investors before they
can sue.6
As noted by the sponsor of a securities bill in the Senate, Philippe
Marini, during the 2003 legislative process, even his proposed bill would
not solve several problems: (1) how to collect the money necessary for an
action; and (2) how to obtain the necessary evidence.7 Philippe Marini
demonstrated the effect of these obstacles under French law by noting that
between 1966, the date of the new Company law, and 2003, the date of the
new provisions on associations and groups of investors, there were only

enough to constitute adequate proof of such an injury. Most of the time, the courts
decide that the company itself has been injured, but the investors only indirectly. See
also, Stanford/Oxford Conference on ‘The Globalization of Class Actions’ (December
13–14, 2007, ‘Stanford Conference’); Report on France by Professor Veronique Magnier,
14 (‘Magnier Report’).
5
Article L 452–1 of the Monetary and Financial Code.
6
Article L 452–1 of the Monetary and Financial Code. And the association has to be
instructed to sue by two members/investors (Article L 452–2 al. 2).
7
La Loi de securite financiere, un an après, rapport de Philippe Marini, 156, Senat no. 431,
2003–2004, 156 (‘Marini Report’).
226 Perspectiv es in compa n y l aw

fift y cases brought by investors in all. And, the new law would not even
overcome the two obstacles he mentioned.8
Marini also acknowledge that there are two additional obstacles in
the French law in that an investor must still demonstrate personal dam-
ages which cannot include the loss of value of his or her shares (as noted
above) and has to show a fault of an executive which is different and dis-
tinct from the fault of the company.9
Marini has made three proposals to improve the system: (1) allow
proof of personal prejudice more readily; (2) consider that in an action
by shareholders against an executive, the separate fault of the executive
could be implied; and (3) facilitate actions in the name of the company
(ut singuli) (which is similar to the derivative action in the US and the
recovery also goes just to the company) by obliging the company to pay
the expenses of the shareholder in advance.10 However, it is obvious,
even these proposals, which are yet to be incorporated into law, are far
from US-style class actions.
The last but not least obstacle to organizing a class action in France
is linked to the interpretation made of the European Convention on
Human Rights (ECHR), that is, the right of any person to be heard in
court.11 This provision was designed mainly to protect defendants, but
has been interpreted by the French courts as requiring each party to an
action, including plaintiffs to be personally represented and thus pre-
vents the use of any opt-out system of class action.12 It is helpful here to
distinguish a class action from a collective action. The former involves
the opt-out system thus creating a class, whereas a collective action such

8
Since 1992, the date of the creation of the joint representation action, the facility has only
been used five times. See Magnier Report, (note 4, above), 14.
9
The latter point that a distinction must be shown between the fault of the executive and
the fault of the company is difficult because, especially in the case of inaction by execu-
tives, the French jurisprudence was that the company, but not the executives, were at
fault in such case. Now the jurisprudence accepts that executives themselves are liable,
for example, when they disseminate inaccurate information, where there were inade-
quate internal controls or executives did not stop employees from wrongdoing of which
they were aware. And, in 2006, the French Supreme Court held that, at least in an admin-
istrative proceeding brought by the AMF, both the executive and the company could be
found in violation of the securities laws for the same act. See Cass. Com. 11 July 2006
no 05–18728.
10
Marini Report, (note 7, above), p. 158.
11
‘Every person is entitled to a fair and public hearing within a reasonable time by an inde-
pendent and impartial tribunal established by law,’ Art. 6–1 of the ECHR.
12
See D. W. Hawes’s chapter in this volume (chapter 11) and Magnier Report, (note 4, above).
 Prov iding v ia ble da m ages r emedies 227

as one by an association in France requires an opt-in and does not bar a

claimant who does not opt in from bringing his or her own action.
In short, the French securities regulation is strong on prevention and
sanction but weak in the matter of remedies for investors. Because of
all the obstacles to collective civil actions for damages, to date the main
recourse of investors has been to attach a civil complaint to a criminal
case (which is a common practice in most areas of law in France) and
ride on the coattails of the prosecutor. While the investor benefits from
the prosecutor’s resources for marshalling the evidence and the decision
of the court, the process is long, often taking five to ten years or more.
And, most violations of the securities laws do not result in criminal
prosecution. There are signs of change. On the one hand the government
encourages more company initiative and risk taking with less regulation
and a de-emphasis on criminal liability of executives and on the other
hand fostering greater help for investors. Thus the problem is to fi nd a
way for investors to recover damages for securities fraud without going
to the extremes of the American class action system.
The internationalization of companies and of their shareholder
bases and of the securities markets as well as the fragmentation of such
markets, makes it all the more urgent to fi nd a way in which a French
investor won’t be disadvantaged merely because of French law and juris-
prudence limiting collective actions. As shown by the Shell settlement
which involved a Dutch company with investors from different countries
including France and also the Vivendi case involving a French company,
what the French investor is reduced to is seeking remedies in a foreign
country instead of in France, even from a French company.13
One of the reasons it is important for French investors to be compen-
sated for damages, one way or the other, is that if a French investor is a
shareholder and is not included in a foreign class action or in a settle-
ment he loses twice: (1) he gets no damages; and (2) his company has to
pay damages to the other investors. Why should a French investor risk
being treated worse if he buys shares in France than if he bought them
in the US?

II. Some modest proposals for France

All of these arguments support the need for a new approach. Certainly
the French company representatives (MDEF and AFEP) are hostile to

13
See, D.W. Hawes’s chapter in this volume (chapter 11).
228 Perspectiv es in compa n y l aw

class and collective actions and very much worried about them. They are
even opposed to settlements arguing they are also risky for companies
and lobby against encouraging them in the legislature.14
The AMF could certainly do more in the area of remedies. Two ways
for that to happen without the necessity of revolutionizing the French
legal system would be: (1) the AMF could use its existing injunctive
power which has even recently been broadened15; and/or (2) it could
authorize the Mediator of the AMF to obtain restitution for defrauded
investors after a sanction by the AMF Commission on Sanctions – this
latter remedy might require legislation.
The AMF has the power to enjoin any entity or professional under
its jurisdiction to stop any activity likely to jeopardize the protection of
investors or the proper operation of the markets. For example, if a com-
pany wrongly did not respect the pre-emptive rights of shareholders, the
Commission on Sanctions of the AMF, after appropriate proceedings,
could sanction it with a fine. But the fine goes to the public Treasury and
does not compensate the shareholders for the dilution of their shares
and the loss of the value of their rights. Alternatively, before any sanc-
tion proceeding by the Commission on Sanctions, the AMF could enjoin
such a company to: (1) offer the new issue to all the shareholders and
postpone the closing of the issue of shares; or (2) propose compensation
to shareholders for the loss of their rights. If the company agreed to do
so, there would be no sanction proceeding. Thus the injunction, which
is different from a sanction and is done by the main AMF Commission,
would have essentially the same effect as a consent decree in the US in
which the company would agree not to commit such a violation again
and would agree to compensate shareholders for the failure to respect
their pre-emptive rights. If the company refused, then the AMF would
notify the company that it was sending the matter to the Commission
on Sanctions of the AMF where the remedy would be a penalty such as
a fine.16

14
Magnier Report (note 4, above), 19.
15
‘The Commission of the AMF may, after the person concerned has been given the oppor-
tunity to present their defense, enjoin them in France or abroad from violating the obli-
gations imposed by law or regulation or professional rules for the protection of investors
against insider trading, manipulation of prices on the market or dissemination of inac-
curate information or any kind of infringement aiming at jeopardizing the protection of
investors or the good operation of the market.’ See Art. L 621–14 1 of the Monetary and
Financial Code.
16
Some years ago, the Swiss Banking Commission found that a mutual fund management
company had sold shares of the fund to friends and relatives at a significant discount
 Prov iding v ia ble da m ages r emedies 229

Similarly, the AMF could use its jurisdiction over mutual funds
and portfolio management companies to mandate compensation
to shareholders if it determined after a routine inspection or other
investigation that a management company had violated its regula-
tions. These are merely examples of how the AMF could use its exist-
ing powers to provide remedies to investors.
The second suggestion I have is that the AMF authorize its Mediator,
on a case-by-case basis, to determine compensation for investors follow-
ing sanctions by the Commission on Sanctions. Here an amendment of
the law would be necessary to provide that the AMF Mediator is com-
petent to carry out this task and oblige the companies and professionals
subject to its jurisdiction to accept its determination (called a ‘settle-
ment’) which would be binding on both parties.
I suggest giving this function to the Mediator because as a former
AMF Mediator I know the task of calculating the amount of restitution
is similar to what the Mediator does in its traditional function except
that here it would be acting as a binding arbitrator. The Mediator would
have to make it publicly known that restitution would follow the sanc-
tion and that investors would have to present their applications for com-
pensation. If the legislature so chose, the proceeding could very well
involve, as it does in other areas of the law, a judge who could review the
Mediator’s determination and could give the Mediator’s damage deter-
mination binding effect. The Mediator, in its current function has been
remarkably successful in finding solutions. In the fiscal year ended April
2006, out of 667 matters handled, an agreement was arrived at in 435
cases.17 Indeed, if the Mediator was authorized to act following sanc-
tions decided by the Commission on Sanctions, it would have the advan-
tage of an AMF investigation and ruling which is much more than it
generally has today. Thus an investor would simply have to prove he was
such in the relevant time period found by the AMF.
It is possible that such a new power given by the legislature to become
a binding arbitrator would stimulate the AMF to utilize its injunctive

from the price to the public a few days later. The Commission ordered the management
company to put up a significant bond and published a communiqué to inform the share-
holders of their rights to bring an action before a judge or to give a proxy to a representa-
tive to act for them. After the fund management appealed arguing that the Commission
had abused its authority, the Supreme Court of Switzerland upheld the Commission. The
Court said that what the Commission had done was a reasonable exercise of its powers.
See, ATF, ‘judgment of 21 October 1977, Anlagerfonds, BGE 103 Ib 303 (1977), www.
bger.ch.
17
AMF, Annual Report (2006), 261.
230 Perspectiv es in compa n y l aw

power without the risk of being charged with abuse of power. Such a
result could also benefit those subject to investigation in that they could
thus avoid sanction.
In the special case, from a juridical point of view, of insider trading,
a collective fund of profits made by the insiders would be distributed
to the investors who sold or bought securities, as the case may be, dur-
ing the relevant period as established by the investigation. Since the
Mediator function is already funded by the AMF there would be little or
no need for funding for the investors (the AMF might need to provide
additional funding for the Mediator to take on these additional duties).
Another possibility for funding in the case of mutual funds would be for
the AMF to mandate a small percentage of the annual management fee
or other fees paid by shareholders be used to acquire insurance to pay for
processing of claims with the Mediator after an AMF sanction.
There already exists at the European Union level a network, Fin-Net,
designed to help investors in cross-border investments seeking compen-
sation where they have been damaged by violations of national secu-
rities regulations. If the concept of Mediator-facilitated restitution for
investors in France found favour in the EU, perhaps the system could
be adopted by other national securities regulators and harmonized by
EU directive. It should be noted that the solution of third-party funding
suggested in my husband’s companion chapter, does not appear to be
authorized in France at this time.18

III. Conclusion
Using the paths which are already familiar to companies, professionals
and investors seems to me more practical than trying to use the limited
and ineffective collective action procedures that exist or going beyond
my modest proposals to some form of US class action system, which is
neither in our financial culture nor compatible with our judicial sys-
tem. Adopting these modest proposals does not mean that under foreign
influences, especially within Europe, our system is not going to evolve,
but at least as other countries have evolved their own solutions, we would
have set up a method to compensate investors à la Française.

18
See Freshfields Bruckhaus Deringer, ‘Class actions and third party funding of litigation’,
June 2007, 24, www.freshfields.com/publications/pdfs/2007/jun18/18825.pdf
 13

Pre-clearance in European accounting

law – the right step?
Wolfgang Schön

I. The ‘open society’ of accounting law actors

The responsibility for the accuracy and reliability of the annual and
consolidated acounts of a company has for a long time rested with the
members of the board of directors (in some countries also with the mem-
bers of the supervisory board) and with the auditors who are educated and
mandated to scrutinize the financial reports drawn up by the company
itself and to testify as to its accordance with the relevant rules and prin-
ciples under accounting law. This responsibility has been strengthened
in recent European legislation. On the one hand, the establishment of an
‘audit committee’ being part of the company board is held to be necessary
for ‘public-interest entities’ such as listed companies;1 on the other hand,
the standards of auditing for public accountants have been increased by a
recently enacted directive, including new levels of public oversight devoted
to their work.2
Nevertheless, there are additional actors present in the world of
accounting. First of all, there are the standard setters as such. In the
old days, these used to be national legislators or other national bod-
ies; over time, starting with the directive on annual accounts in 1978,
the European Institutions joined this group. Accounting rules were
codified during the 1980s in most European countries. This ‘legaliza-
tion’ of accounting practice led to an increased scrutiny by the courts.
They are competent to decide finally on matters of interpretation of
accounting law, 3 although in some Member States of the European

1
Art. 41 of Directive 2006/43/EC of the European Parliament and of the Council of
17 May 2006 on statutory audits of annual accounts and consolidated accounts, amend-
ing Council Directives 78/660/EEC and repealing Council Directive 84/253/EEC [2006]
05. L 157/87.
2
Art. 26 et seq. of Directive 2006/43/EC (note 1, above).
3
Schön, ‘Kompetenzen der Gerichte zur Auslegung von IAS/IFRS’, Betriebs-Berater, 59
(2004), 763 et seq.

231
232 Perspectiv es in compa n y l aw

Union the interpretation of accounting standards is still regarded as

a matter of fact rather than as a matter of law. The most prominent
example for the examination of accounting issues by the courts is the
judgment of the European Court of Justice in the Tomberger case4
which was echoed widely throughout Europe.
For listed companies, accounting law is more and more shaped by
the London-based International Accounting Standards Board (IASB),
issuing International Financial Reporting Standards (IFRS), 5 and the
European Commission, which endorses these standards, thus mak-
ing them mandatory for listed companies in Europe under the IAS
Regulation of 2002.6 Moreover, the interpretation of these standards is
the task of ancillary bodies like the International Financial Reporting
Interpretation Committee (IFRIC) in London or domestic standard
setters such as the Accounting Interpretations Committee (Deutscher
Standardisierungsrat) in Berlin.
In recent years, another group of actors has appeared on the account-
ing scene: capital market authorities and their auxiliary troops such
as the UK’s Financial Reporting Review Panel or Germany’s Federal
Reporting Enforcement Panel (Deutsche Prüfstelle für Rechnungslegung).
They have been entrusted with the task of ex post review of financial
reports which were disclosed by listed companies. Their work is meant
to fi ll the ‘expectation gap’ which became apparent in some corporate
scandals at the beginning of the new millennium (Enron, Parmalat,
WorldCom, FlowTex, etc.).
The introduction of this new enforcement procedure has – for capital
market oriented companies – increased the danger of being exposed to
a public discussion about the appropriateness of their fi nancial reports.
Whereas intra-corporation issues relating to accounting questions only
seldom come before a court (e.g. in the context of a shareholder suit)
and lawsuits against fi nancial auditors were well nigh unknown till
quite recently, the – more factual than legal – pressure effect of the con-
trol exerted by the public review panels and by capital market authori-
ties has dramatically changed the scope for action for the accounting
of listed companies. It seems understandable against this backdrop,
that the big players of the economy voice the desire, that capital market
4
Case 234/94, Tomberger [1996] ECR I-03133.
5
For further information see www.iasc.org.
6
Art.3 par.2 of Regulation (EC) No 1606/2002 of the European Parliament and of the
Council of 19 July 2002 on the application of international accounting standards [2002]
05. L 243/1.
 Pr e-clea r a nce in Eu ropea n accou nting l aw 233

authorities and their appendices may be enabled – for the sake of pre-
venting accounting law related disputes, i.e. in the run-up to the set-up
and adoption of annual and group accounts or even in the run-up of real-
ising the relevant facts – to make clarifying statements vis-à-vis those
companies, which are obliged to disclose their accounts to the capital
markets.7 Capital market authorities may be asked for defined (future
or already-realized) facts to make individual case-related statements or
indicate via ‘no action letters’, that it would not attack certain account-
ing measures. By doing so, a provisional assessment of the respective
case under the corresponding accounting law rules would take place, in
the run-up to the audit certificate by the financial auditor and before the
internal involvement of the supervisory board and shareholder bodies.

II. The state of ‘pre-clearance’ in the US and in Europe

The method of pre-clearance is not unknown in the US-American and
European context. The organization of the SEC includes the office of
the Chief Accountant, which supports listed companies with clarify-
ing statements8 encountering ambiguous issues in accounting law when
preparing the fi ling. By doing so the competent statutory auditor and if
need be the FASB as standard setter, the Public Company Accounting
Oversight Board or other auditing companies are called in by the SEC.
The ‘no action letter’ is typical for the SEC’s method, i.e. a personal state-
ment by an SEC employee, which is not legally binding, neither for its
commissioners nor for the company in question, but highlights the
prospective course of action by the SEC and therefore has great factual
importance.9

7
See the discussion report on the Schmalenbach-Conference 2006 in Hillmer,
‘Enforcement in Rechnungslegung und Prüfung’, Zeitschrift für Corporate Governance,
1 (2006), 39 ff.; that such a competence does not exist under German law is generally rec-
ognised, see Gelhausen and Hönsch, ‘Das neue Enforcement-Verfahren für Jahres- und
Konzernabschlüsse’, Die Aktiengesellschaft, 50 (2005), 511, at 514.
8
US Securities and Exchange Commission, Guidance for Consulting with the Office of
the Chief Accountant, status quo 17 July 2006, www.sec.gov/info/accountants/ocasub
guidance.htm; see also US Securities and Exchange Commission, Release N°s 33–8040;
34–45149; FR-60, 12 December 2001, www.sec.gov/rules/other/33–8040.htm.
9
T.L.Hazen, Treatise on the Law of Securities Regulation § 1.4[4] 43 (4th edn.2002) offers
a formulation example from the point of view of the competent official in charge: ‘Th is
is my view based on the facts as you describe them. You may not rely on it as if it were
a Commission decision. If you don’t like it, you are at liberty to disregard it and follow
your own construction, subject to the risk that I may recommend appropriate action to
234 Perspectiv es in compa n y l aw

Equally in the context of European capital market supervision,

openness for the introduction of pre-clarifying methods fundamentally
exists. Taking this course of direction, the Standard No.1 on Financial
Information by the Committee of European Securities Regulators
(CESR) recorded that:
Some enforcers offer issuers the possibility to obtain pre-clearance, whose
aim is only to allow knowledge of the competent enforcer’s view on a certain
specific accounting or disclosure treatment. In particular, by means of pre-
clearances the enforcers that are willing to provide for this possibility will
express their view on the fact that a particular accounting treatment may be
considered (or not) an infringement to the reporting framework which may
lead to enforcer’s actions. These pre-clearances should also clearly identify all
the circumstances surrounding the specific case submitted by the issuer. 10

In the meantime the CESR already integrated a few decisions by national

enforcement agencies in pre-clearance procedures in its database and
published them in due course.11
The reaction of the Member States and their domestic authorities
is mixed. France12 is one of the Member States, where the supervisory
bodies use the pre-clearance method, whereas the Financial Reporting
Review Panel (FRRP) in the UK is not readily available to make such
provisional statements and has confirmed this line early in 2008 in its
revised operating procedures.13 In Belgium, there is no general pre-
clearance system for accounting rules, but the financial supervisor
(CBFA) has a limited power to give ‘rulings’ regarding certain matters
of financial law.14 In Germany, currently no pre-clearance mechanism

the Commission and the Commission may institute proceedings or take other steps if
the Commission agrees with my view.’
10
CESR, Standard N° 1 on Financial Information: Enforcement of Standards on Financial
Information in Europe, 12 March 2003, § E, www.cesr.eu.
11
Most recently CESR, Press Release 17 December 2007, 2nd Extract from EEECS’s data-
base of enforcement decisions.
12
Mémento Pratique Francis Lefèbre, Compatble para 249, (2208); Brown and Tarca, ‘A
Commentary on Issues Relating to the Enforcement of International Financial Reporting
Standards in the EU’, European Accounting Review, 14 (2005), 181.
13
FRRP, Operating Procedures, Para.40 (www.frc.gov.uk).
14
The relevant provision is Art.3 of the Royal Decree of 23 August 2004 (Moniteur Belge,
11 Octobre 2004) which refers to Art.12 of the Royal Decree of 31 March 2003 (Moniteur
Belge, 3 Decembre 2003) which covers the fi nancial reporting obligations of listed
companies. Th is legal basis has recently been replaced by Art.12 of the Royal Decree of
14 November 2007 (Moniteur Belge, 3 Decembre 2007). My gratitude for this informa-
tion goes to Michel Tison, University of Ghent.
 Pr e-clea r a nce in Eu ropea n accou nting l aw 235

exists. Yet some accounting academics have pleaded for the introduction
of such a remedy.15 The Federal Reporting Enforcement Panel would be
responsible in a first step; in a conflictual situation the Federal Financial
Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht)
would have to step in, who has the fi nal say in the hitherto practiced
reactive procedures in accounting disputes. One must interpret the most
recent press communication by the Federal Reporting Enforcement
Panel in this direction, who ‘sees itself confirmed to further build the
preventive function of the FREP with additional measures’.16

III. Allocation of competence in the area of accounting

A. Pre-clearance as an intermediary between rule-setting and
application of norms
Even though CESR has indicated in its previous practice a fundamental
openness for a pre-clearance mechanism, the same body however for-
mulated in its first standard already significant concerns about the dif-
ferentiation of the function of such a procedure within the framework
of the general competence on interpreting and applying accounting law
rules. The doubts hereby focus especially on the delineation between
applying and setting norms:
CESR recognizes that it is important that pre-clearance should not result
in enforcers becoming standard setters. 17

This diplomatically embellished reserve is formulated even more dis-

tinctly in the UK. The Institute of Chartered Accountants made clear
already in the year 2000, that a pre-clearance procedure encroaches
upon both the role of standard-setter and the role of the individual
appliers and auditor:
We recognize that there might be occasions, particularly in the case of new
listings, when guidance would be helpful on the compatibility of a pro-
posed accounting treatment with the requirements of the law and relevant
accounting standards. However, we believe that it would be undesirable

15
Böcking, Zur Notwendigkeit eines Pre-Clearance im Rahmen des Enforcement,
Lecture, Cologne, 27 April 2006, www.wiwi.uni-frankfurt.de/professoren/boecking/
downpub/1770.pdf; Böcking and Wiederhold, ‘Mehr Sicherheit für Rechnungsleger’,
Frankfurter Allgemeine Zeitung, 31 July 2006, 16.
16
Deutsche Prüfstelle für Rechnungslegung, Press Communication: Annual Activity
Report 2007, 14 February 2008 (2007).
17
Note 10, above.
236 Perspectiv es in compa n y l aw

for the enforcement agency to provide any form of pre-clearance. This

would dilute and even undermine the perceived responsibilities of direc-
tors and auditors, as well as encroaching on the standard setter’s role by
effectively allowing the enforcement agency to issue interpretations of
accounting standards. 18

The basic policy question is thereby already outlined: how should one
visualize the role of pre-clearance in the overall system of commercial
law and capital market law as a basis for accounting rules and principles?
How does the adoption of statements by a capital market authority or a
review panel interact with the statements by company bodies, auditors
or courts, which are mainly responsible for examining the legality of
annual and group accounts?
Already the first decision published by CESR crystallized the
problem:19 as for the fiscal year 2005, a company already requested in
2004 how one ought to deal with intangibles in the conversion from
national accounting principles to IAS/IFRS, when these intangibles are
completely absorbed by goodwill, for lack of individual tangibility. The
accounting issue was particularly focused on the question whether the
amortizations on this asset would be carried out in accordance with its
effective ‘useful life’ or whether they could be merely considered in the
general impairment test for the goodwill. The domestic review panel
endorsed, within the context of a pre-clearance, already in September
2004 the last-mentioned alternative – thus even before the beginning of
the authoritative accounting period.
By doing so, the review panel made a statement, which could be just
as well formulated within the context of the interpretation of a standard
by the IFRIC or by a domestic standard setter such as (in Germany) the
Accounting Interpretations Committee. Moreover, this question should
be independently assessed by the auditor in the context of the audit cer-
tificate or be conclusively judged by a court ex post. Evidently, the review
panel has made here a general statement on the interpretation of an
accounting standard, which can in many cases claim to be applied – and
for only this reason has been published by the CESR.
On the other hand, the review panel did not only publish an opinion
concerning a question of law. Moreover, at the request of the management

18
Institute of Chartered Accountants in England and Wales (ICAEW), Policy Statement
(Tech 23/00) on the Endorsement and Enforcement of International Accounting
Standards within the EU, www.icaew.co.uk.
19
Note 11, above, 3.
 Pr e-clea r a nce in Eu ropea n accou nting l aw 237

of the applicant company, it subsumed the individual case by doing so

and told the representatives of this company that it would not interfere
if they would proceed according to this standpoint. By doing this, the
review panel also reduced the leeway of the company bodies and other
involved actors virtually to zero: which board of management will dare
take steps against a negative preliminary decision by the review panel,
and which supervisory board, audit committee or fi nal auditor will take
it upon itself, to raise concerns about a positive decision by the review
panel? The pre-clearance by the review panel will – and this is foreseea-
ble – generally represent the final clarification of an accounting problem
and thereby preclude both the interpretation competence of the stand-
ard setters and the courts and withdraw from the hands of the company
bodies and the statutory auditor the concrete application.

B. The institutional framework in the US and in Europe

1. The extensive authority of the SEC in accountancy law
One first important aspect in order to clarify the functional role of a pre-
clearance concerns the localization of enforcement in accounting law
and capital markets law. Whilst accounting law is in general harmonized
in Europe for companies limited by shares (and is equally applied to the
domain of some partnerships controlled by corporations), accounting
law in the US is plainly focussed on capital markets. By doing so, the
SEC’s role is from the beginning designed to be considerably stronger
than that of a European supervisory body.20 This is furthermore reflected
in the fact that the Securities Exchange Act 1934 allocates the role of
standard setting in fi rst instance to the SEC. Although the SEC del-
egated the development of individual rules to the Federal Accounting
Standards Board (FASB) long ago, this did not modify the fundamental
reign of the SEC over standard setting. The SEC is furthermore equally
the central addressee of all accounts drawn up according to US-GAAP.
The enforcement of the SEC inclusive of a pre-clearance therefore cor-
responds with its extensive authority on standard setting, on inter-
pretation and application in individual cases and implementation. The
SEC ‘may make laws, may act as a public prosecutor in enforcing these

20
In detail Kiefer, Kritische Analyse der Kapitalmarktregulierung der US Securities and
Exchange Commission, (Deutscher Universitäts-Verlag, 2003), 50 et seq. and 121 et seq.,
Herwitz and Barrett, Accounting for Lawyers, 4th edition (Foundation Press, 2006),
154 et seq.
238 Perspectiv es in compa n y l aw

laws, and may then determine the guilt or innocence of the person it has
accused’.21
The SEC’s pre-clearance procedure does not face, against this back-
drop, the problem of a separation of powers with another standard set-
ter. The US auditors will equally not be able to moan if the SEC provides
‘authentic’ interpretations, as a high-ranking source of material account-
ing rules. And finally, dealings of the courts with the interpretation and
application of US-GAAP are virtually unknown in the US; in any case
they do not focus on material issues pertaining to correct accounting,
but at the most on the applicability of US-GAAP on its merits.22
The extension of the SEC’s activity in the pre-clearance of account-
ing law related problems is thus a natural consequence of its extensive
decision making and responsibility in the domain of capital markets-
oriented accounting.

2. Division of power in European accounting law

The overall situation is however considerably more complicated in
Europe. This begins with the allocation of standard setting. The
main basics of accounting law are to be found either in the European
Parliament’s and Council’s directives (Annual Accounts Directive,
Group Accounts Directive) or in the IAS/IFRS, enacted by the IASB
and approved by the European Commission in line with Art.3 of the
IAS Regulation. Furthermore, they are fundamentally not founded
on capital markets alone, but can also apply to all companies limited
by shares (including some applications to partnerships). According to
Art.5 IAS Regulation this can also be true for individual and group
accounts of non-listed companies which apply International Financial
Reporting Standards. The capital market supervisory bodies (or subor-
dinated agencies like review panels) are not integrated in this process
of standard setting. At the most, national standard setters – such as the
German Accounting Standards Committee (on the basis of § 342 para. 1

21
Lang and Lipton, ‘Litigating Administrative Proceedings – the SEC’s Increasingly
Important Enforcement Alternative’, in: Phillips (ed.), The Securities Enforcement
Manual – Tactics and Strategies (American Bar Association), 239, 242 (quoted in:
Kiefer, Kritische Analyse der Kapitalmarktregulierung der US Securities and Exchange
Commission, (note 20, above), 121).
22
See for example the decision by the US Supreme Court in: Thor Power Tool Co. v.
Commissioner 439 U.S. (522) on the significance of US-GAAP for the fiscal income
determination or the verdict by the US Supreme Court in: Shalala v. Guernsey Memorial
Hospital 514 U.S. 87 on the relevance of US-GAAP for refunds in the health sector.
 Pr e-clea r a nce in Eu ropea n accou nting l aw 239

Nr.3 German Commercial Code) – are somehow included in the work of

international standardization bodies.
Against this backdrop a Member State enforcement unit will not be
able to invoke a natural authority for ‘authentic’ interpretation like the
SEC when applying accounting standards. Neither the company bodies
nor the statutory auditor will be relieved from making independent and
autonomous assessments and the later invoked courts cannot be tied to
the statements by the review panel. This is clearly accepted for Belgium
and has to be seen in the same way in other countries of the European
Union. This problem will not go away if the company bodies or the audi-
tors are given the opportunity to be heard by the review panel in the
pre-clearance procedure.
However the factual normativity which would be attributed to the
objective content of a pre-clearance statement seems problematic. Th is
is due to the fact that such decisions – as easily apparent in the above-
mentioned example from CESR’s publication practice – will be attributed,
beyond the judged individual case, the effect of a precedent.
As far as the competence of the courts is damaged by such a pre-
clearance procedure, it should not go unnoticed that in some European
states – such as in the United Kingdom – the introduction, interpreta-
tion and application of accounting standards is not considered a task
of the courts.23 Courts must in the tradition of these legal systems treat
questions pertaining to correct accounting not as an application of law,
but as a factual matter, which in turn refers to the evidence given by
experts. Also in Germany, the assessment of ‘accounting principles’
has for decades followed the prevalent usage of business people in
Germany.24 Th is line of thinking has not only become obsolete through
the juridification of accounting law as a result of the accounting direc-
tives of the European Community, but equally through the transfer of
the IAS/IFRS to the main body of EC law in the context of the endorse-
ment procedure. Accounting rules – according to general accounting
law and capital market oriented IAS/IFRS – are nowadays objective
legal rules, whose interpretation is carried out by national courts and
the ECJ.25

23
See for example Freedman, ‘Aligning Taxable Profits and Accounting Profits: Accounting
Standards, legislators and judges’, Journal of Tax Research, (2004) 71, 84 et seq.
24
On the development see Moxter, Grundsätze ordnungsgemäßer Rechnungslegung
(Düsseldorf: IDW-Verlag, 2003), 10 et seq.
25
Schön, ‘Kompetenzen der Gerichte zur Auslegung von IAS/IFRS’, (note 3, above), 764.
240 Perspectiv es in compa n y l aw

Neither the capital market authority or the review panel have a

decisive function with regard to ensuing lawsuits about the correctness
of a balance sheet. Their own later intervention in the enforcement pro-
cedure can be resolved by such a pre-clearance, but not other conten-
tions within the company bodies, vis-à-vis auditors or with regard to
shareholders. If one follows the US practice, not even the panel itself
would be bound by a ‘no action letter’ issued by one of the employees.
However, a company’s board of directors will in case of a preparation of
balance sheets rely on the panel’s statement as a tool to deny any fault of
its own in order to fend off ensuing litigations and to neutralize the vul-
nerability of accounting.26 The problem of the reliability and tenability
of such pre-clearance statements would be thereby again carried over
into the ensuing contentions.
Even though the interest of companies in a prompt pre-clearance of
individual issues in accounting law cannot be denied, one has to there-
fore be sceptical about a further extension of pre-clearance mechanisms
in European capital market law. Said proposal does not fit into the insti-
tutional framework, in which neither the standard setting in accounting
nor the legal responsibility for the individual application are to be found
with the review panel (or the supervisory body). Factual efficiency and
legal competence would not correlate. Therewith, the individual attribu-
tion of responsibility to the review panel and the company bodies would
be dissolved, which is of paramount importance in the context of effi-
cient corporate governance.

IV. Practical issues of pre-clearance en route towards a

new expectation gap
The establishment of review panels in recent years has been legiti-
mized with the necessity of confronting glaring violations of recog-
nized accounting rules with greater fierceness. The new enforcement
units should work as an ‘accountancy police’, which control ‘randomly
and when suspecting manipulation of accounts’27 the books of listed
companies. The context were ‘company scandals at domestic level and
abroad’, which had shattered ‘the trust of investors in the correctness
26
On the characteristic of the ‘subjective correctness’ of a balance sheet see Schön in:
Canaris et al. (ed.), 50 Jahre Bundesgerichtshof – Festgabe aus der Wissenschaft (München:
Beck, 2000), 153 et seq., 155 et seq.
27
Draft of a law on the control of companies’ accounts (Bilanzkontrollgesetz), 24 June 2004
(BT-Drs.15/3421, preliminary 1).
 Pr e-clea r a nce in Eu ropea n accou nting l aw 241

of important capital market information’28. The review panels have

honoured this task with growing success. In a considerable number of
addressed cases the panels could correct mistakes; there is in addition
a considerable preventive effect, if somewhat difficult to put a number
on it.
In contrast, the internal structure as well as the extent of the activity
of these review panels would substantially change, if they would receive,
alongside the reactive control of individual accounts of selected com-
panies the task of pre-clearance in individual questions pertaining to
accounting law. In order to develop the analogy with the police force: it
is not easy to transform a criminal investigation unit, operating for spe-
cial purposes, into a citizen’s advice bureau for lawful conduct in road
traffic. This begins with the circumstance that the review panels – like
also other enforcement units – are designed for their main task of sanc-
tioning evident violations of central accounting rules. The ‘scandalous
cases’, which constitute the actual historical legitimization of the review
panels, do not distinguish themselves by difficult issues on the inter-
pretation of accounting standards, but by the glaring non-observance
of basic requirements of correct accounting at the level of appreciating
facts. The most significant cases in Germany and abroad such as Enron,
WorldCom, Balsam, Comroad or Flowtex may be described as mere cases
of accounting fraud, whose clarification does not require an innovative
development of accounting rules, but necessitates in the first instance a
clear improvement in the ascertainment of facts. The ‘expectation gap’
of the general public related in the run-up to the new legislation not to a
further detailing of legal delimitation questions by way of a new inter-
preting institution, but related to a factual and effective ascertainment
and prosecution of deceiving accounting failures. The Supreme Regional
Court (Oberlandesgericht) Frankfurt defined most recently, in this vein,
the target of accounting control: ‘to preventively thwart irregularities
when drawing up a listed company’s financial statements and compiling
the report, and to expose irregularities, insofar they still occur and to
inform the capital market thereof. Reaching this goal requires a prompt,
effective and accelerated review procedure.’29
Against this background it was not doubted that the interpretation
of accounting rules in the Member States of the European Union would
be carried out by companies and their auditors correctly to the largest

28
Statement of reasons, (above, note 27), 18.
29
OLG Frankfurt, 29 November 2007, Der Betrieb (2008), 629 et seq., 631.
242 Perspectiv es in compa n y l aw

extent possible. In other words, a gap in enforcement is something dif-

ferent than a gap in standard setting and one would misallocate the
professional know-how concentrated in the review panels (and their
supervisory capital market authorities) if one deployed in future the
manpower more to formulate accounting standards and their interpre-
tation and less to prosecute evident accounting violations.
The review panels would also not be able to remedy this, by concen-
trating on selected cases as already during their control activity. As the
responsible body under capital market law, they would be obliged to
provide information vis-à-vis all requesting companies in a way which
suffers no discriminatory fashion. The same would apply to the liberty
of giving information or ‘no action letters’ as one pleases and without
justification.
Against this backdrop it would be difficult for the review panel to shun
a factually justified information request, with the allusion to lacking per-
sonal capacities. If one considers furthermore that companies subject
to disclosure requirements have strict statutory periods for submitting
their annual financial reports, a great number of requests can accumulate
in the review panels in short periods of time. Boards of management of
stock corporations will include in their duties of care a request for infor-
mation to the review panel to address in time in ambivalent accounting
issues. These requests can either only be worked off through a massive
increase in personnel (and costs), or a quantitatively high share of ‘cus-
tomers’ are not served. A new expectation gap would be foreseeable. Also
one cannot simply say, according to which criteria a discretion-conform
differentiation between processed and non-processed requests ought to
be carried out: within the context of the actual control mission of the
review panel, the cases with the highest financially quantitative relevance
ought to have priority (in the case of accounting failures, the most exten-
sive damages threaten to arise for investors), whereas the development
of accounting rules would suggest a treatment of the legally most sig-
nificant questions. Finally, the review panel would not have an easy task
within the context of its central activity – the reactive control – to take
on accounting issues, whose assessment it refused for capacity reasons
in the pre-clearance proceedings. The actual ‘customers’ of the ‘account-
ing police’ however, that is those companies who contribute with evident
false statements to the deception of financial markets, disappeared at the
pace of this development progressively from the focus of the inspection
unit, and would probably also not deign to come to a preliminary exami-
nation of their fraudulent actions.
 Pr e-clea r a nce in Eu ropea n accou nting l aw 243

In any case, any pre-clearance procedures should be restricted to the

correct representation of given facts, from an accounting point of view.
Any preliminary information on future facts, which could apply as a
basis of business and accounting decisions of the respective company,
would go far beyond the target of an adequate hedging of issuers from
retroactive accounting claims.

V. Conclusion
The ‘open society of accounting law actors’ is on the verge of bursting at
the seams. The extensive introduction of pre-clearance by capital market
authorities and their ancillary bodies – the review panels – would influ-
ence the institutional structure within the companies subject to dis-
closure requirements, their rapport with the statutory auditors and the
courts’ control function in a sustainable and disadvantageous way. At
the same time the accounting ‘police’ would master less and less its genu-
ine task of effectively persecuting clear violations of rules in the fi nancial
statements of listed companies. The SEC’s practice can be no example in
this case – this body is regarded to be ‘omni-competent’ both for stand-
ard setting and application of standards in US accountancy law and can
therefore act as an authentic interpreter of US-GAAP. From the point of
view of the European legal system the lasting refusal of the British FRRP
to damage the personal responsibility of issuers, their agencies and their
statutory auditors by way of an advance clearance seems exemplary.
 14

International standards on auditing and

their adoption in the EU: legal aspects and
unsettled questions
Han no Merkt

I. Introduction
The Audit Directive of May 20061 enforces the use of ‘International
Standards on Auditing’ (ISA) for all statutory audits to be performed
in the EU. Aiming at a consistently high quality for all statutory audits
required by Community law, the Audit Directive has given imple-
menting powers to the European Commission to adopt the ISA in
accordance with the so-called ‘comitology procedure’. Moreover, the
Commission has recently commissioned a Study on ‘The Evaluation
of the possible Adoption of International Standards on Auditing (ISA)
in the EU’. 2 The object of that Study is to address the incremental
direct and indirect costs for EU companies and audit fi rms, as well
as the benefits resulting from the possible adoption by the European
Commission of the ISA.
Improving audit quality through the adoption of ISA within the
EU has a number of fundamental legal implications that need to be
considered in order to comprehensively cover the subject. The follow-
ing article outlines some of the most important of these issues after an
introduction into the genesis of the harmonization process and a brief
look at the competence of the EU to adopt ISA.

1
The Directive 2006/43/EC of the European Parliament and of the Council of 17 May 2006
on statutory audits of annual accounts and consolidated accounts, amending Council
Directive 78/660/EEC and 83/349/EEC and repealing Council Directive 84/253/EEC
[2006] OJ L 157/87, (hereafter, ‘the Audit Directive’).
2
Tender Markt/2007/15/F – Study on International Standards on Auditing, Lot 1:
Evaluation of the Possible Adoption of International Standards on Auditing (ISAs) in
the EU.

244
 Inter nationa l sta n da r ds on au diting 245

II. History of internationalization of auditing standards

A. From IAG to ISA
Not surprisingly, the harmonization of standards of auditing is closely
linked to the harmonization of accounting standards.3 The histori-
cal starting point of international harmonization of financial report-
ing was in October 1972, when during the tenth international congress
of accountants in Sydney the International Coordination Committee
for the Accountancy Profession (ICCAP) was founded.4 This congress
laid the foundations for the genesis of the International Accounting
Standards Committee (IASC), the predecessor of the International
Accounting Standards Board (IASB). During the ninth international
congress of accountants in 1967 an international working party had been
created dealing with the convergence of international best practice in
auditing.5 This decision followed the discussions back in 1962 during the
eighth international congress of accountants on the necessity of creating
a higher degree of uniformity in accounting and auditing standards.
In October 1977, ICCAP took the initiative, during the eleventh inter-
national congress to create the International Federation of Accountants
(IFAC).6 IFAC is the organization that took over the tasks of ICCAP,
thereby serving the accounting profession worldwide and having the
public interest in mind. The decision to create the International Auditing
Practices Committee (IAPC) was taken by the Board of IFAC in 1977.7
Being one of the most important committees of IFAC, the IAPC devel-
oped the International Auditing Guidelines (IAG), which were in fact
the predecessors of the International Standards on Auditing (ISA).
The IAG represented the best practice within the major audit firms at
that time, within the field of auditing and review of historical financial
3
P. Wong, ‘Challenges and Successes in Implementing International Standards: Achieving
Convergence to IFRSs and ISAs’, September 2004, www.ifac.org.
4
For the following, see D. Schockaert and N. Houyoux, ‘International Standards
on Auditing within the European Union’, Revue bancaire et financière/Bank- en
Financiewezen, 8 (2007), 515.
5
IFAC, News (February 2007), 12, www.ifac.org.
6
Sixty-three member bodies signed the official protocol, see Schockaert and Houyoux,
‘International Standards on Auditing’, (note 4, above), 515 footnote 4; for a critical analy-
sis of IFAC’s role in the Internationalization of Auditing Standards see C. Humphrey,
A. Loft, S. Turley and K. Jeppesen, ‘The International Federation of Accountants: Private
Global Governance in the Public Interest’ in G. F. Schuppert (ed.), Global Governance
and the Role of Non-State Actors, (Baden-Baden: Nomos Verlag, 2006) 245–72.
7
Cf. IFAC, The First Fifteen Years. 1977–1992; IFAC, News (May 2007), 9, available on
www.ifac.org.
246 Perspectiv es in compa n y l aw

information. The first IAG (IAG-1) dealt with the purpose and scope
of an audit and was approved in October 1979; they replaced by ISA-1
Objective and General Principles Governing an Audit of Financial
Statements in 1992 which in 1994 became renamed ISA 200.
After a period of increased internationalization of business activities
and capital markets during the 1980s, the IFAC counted 106 member
bodies within 78 countries by the end of 1991, compared to 78 bodies
within 55 countries by the end of 1978. In the context of this evolution
and the expectation that IAG would shortly be recognized by official
securities organizations, IAPC reformed its framework of standards,
following IFAC’s Constitution created in November 1991. From then on,
the ‘International Auditing Guidelines’ were renamed as ‘International
Standards on Auditing’. Doing so, the IAPC acknowledged that its
standards had obtained a benchmark status8 for the audit and review
engagements related to historical fi nancial information. Therefore,
IAPC, being one of the committees of IFAC, had become the auditing
standard setter in the international marketplace. In October 1992 the
International Organization of Securities Commissions (IOSCO) pub-
lished a resolution whereby ISA was recognized on capital markets as
an acceptable alternative for national auditing standards, in the context
of cross-border offerings of continuous reporting by foreign issuers.9
In July 1994, IAPC laid the foundations for the structure of an ISA,10
consisting of basic principles and essential procedures, which were
indicated by bold-lettered paragraphs, and explanatory and inform-
ative guidance, which were indicated by grey-lettered paragraphs.
Furthermore, the ISA were numbered per topic, thereby following the
logical sequence of the performance of an audit of financial statements
(series 200 on the responsibility of the auditor, until the series 700 and
800 on reporting). In November 2001, IPAC was reformed by the general
assembly of IFAC in order to become the ‘International Auditing and
Assurance Standard Board’ (IAASB).11 Using its new name, this Board
intended to spend more time on standards for ‘assurance agreements’,
which from January 2004 on, were named ‘International Standards

8
IFAC, Annual Report (1993), 1; and IFAC, Annual Report (1995), 2.
9
Following the reform of the ISA in July 994, IOSCO suspended the resolution. IOSCO
never officially withdrew this resolution. Until today, IOSCO discusses within the
Consultative Advisory Group (CAG) of IAASB on the evolution of auditing standards in
the context of IAASB’s Clarity Project.
10
IFAC, Annual Report (1994), 3.
11
IAASB, Annual Report (2002), 8.
 Inter nationa l sta n da r ds on au diting 247

on Assurance Engagements’ (ISAE). At the same time, a rigorous due

process had been set up within IAASB regarding its standard-setting
function. By the end of 2004, IFAC counted 163 member bodies within
119 countries, which represented twice the membership from 1978. In
the years from 2004 to 2008, IAASB has taken care of its ‘Clarity Project’
(see infra).

B. From minimum guidelines to benchmark status

The creation of IFAC’s constitution in November 1991 had impact on
the obligation of member bodies. In the period before November 1991,
IAG constituted the ‘minimum guidelines’ to be followed and pro-
moted by bodies at the national level.12 After November 1991, IAPC
stated that, as far as there was consistency between the IAG and the
domestic law and regulations, compliance with these national laws and
regulations immediately resulted in compliance with IAG. At that time,
IFAC accepted that there were differences between domestic legislation
and international standards. When IAG confl icted with national law
or regulation, the member bodies needed to comply with the obliga-
tions as set out in IFAC’s constitution: each member body, in its qual-
ity of standard setter, should use its best endeavours to incorporate the
international standards (renamed as ‘ISA’) within the national auditing
standard.
In April 2004, the ISA received a benchmark status for the audit of
financial statements, namely through the new member obligations13
imposed by the Statements of Membership Obligations (SMO). In par-
ticular, paragraph 4 of SMO 3 stated that member bodies should use their
best endeavours to establish convergence with the international stand-
ards, thus contributing towards the elimination of the differences of con-
tent between national and international auditing standards. Following
these obligations, the member bodies of IFAC have considered the ISA as
a basis for the national auditing standards. In the European Union, e.g.,
Belgian, Dutch, Luxembourg, French, and German auditing standards
have been subject to a process of transformation (‘transposition’) of the
international ‘guidelines’ or ‘standards’.

12
IFAC, Towards the 21st Century: Strategic Decisions for the Accountancy Profession, 3,
www.ifac.org.
13
IFAC, Handbook of International Auditing, Assurance, and Ethics Pronouncements
(2005), 119–25.
248 Perspectiv es in compa n y l aw

C. The Clarity Project

The so-called ‘Clarity Project’ of the IAASB has been created following
the comments in 2003 on the exposure draft (ED) ‘Operations Policy
no 1 – Bold Type Lettering Exposure Draft’. In this ED, the need to use
black and grey lettering within the ISA was debated. Significant com-
ments were given by the IOSCO. Th is project was set up to deal with the
comments on the setting of auditing standards that, back in 1994, regard-
less of IAPC’s consideration of these comments, were not followed by a
corresponding modification of the ISA.
In September 2004, IAASB issued a Policy Statement ‘Clarifying
Professional Requirements in International Standards Issued by the
IAASB’, followed by a Consultation Paper ‘Improving the Clarity and
Structure of IAASB Standards and Related Considerations for Practice
Statements’.14 Already in October 2005, four EDs were issued, namely ED
ISA 300 on planning an audit of financial statements, ED ISA 315 on
the auditor’s risk assessment, ED ISA 330 on the reduction of the audit
risk to an acceptable low level by performing audit procedures further
to the auditor’s risk management,15 and ISA 240 on the auditor’s respon-
sibilities regarding fraud during an audit of financial statements. In
mid 2006, the comment period expired and in December 2006 IAASB
issued the final ISA 240, 300, 315 and 330, which, for the first time, were
named ‘Clarified ISA’. In July 2006, the IAASB approved ISA 600, ‘Audit
of Group Financial Statements’.
The other ISA will be subject to a ‘clarification’ process until the
presumed final date of the project in 2009. The essence of the ‘Clarity
Project’ can be summarized as follows:
1. The ISA and ISQC 1 are based on clear principles and objectives.
2. The objectives should be met on the basis of a number of require-
ments representing the essential procedures to be performed by the
auditor in ‘virtually all’ circumstances of the audit engagement.
3. The necessary guidance (application guidance) is given to the audi-
tor in order for him to apply these requirements in all circumstances
of the audit engagement, i.e., small and less complex entities, public
sector entities, larger entities, public interest entities, etc.

14
Available from the IAASB’s website www.ifac.org/iaasb; ‘Exposure draft s’.
15
These standards are the revised versions of the IAASB standards approved in October
2003.
 Inter nationa l sta n da r ds on au diting 249

4. In order to clearly distinguish between requirements and appli-

cation material, IAASB decided in October 2005 to use the word
‘shall’ within the requirements section, and to use the present tense
when dealing with explanatory material within the application
guidance. IOSCO’s comments, dating back from 1992, have proven
to be significant. The difference between requirements and applica-
tion material will replace the previous difference between bold and
grey lettering.
5. Each ‘clarified’ ISA is set following a uniform structure consist-
ing of a purpose, a requirements section and fi nally the applica-
tion material. A short introduction and a set of defi nitions of key
words will be provided at the beginning of each single ISA. Thus,
the former ‘bold lettering’ paragraphs are regrouped at the begin-
ning of each ISA.
All ISA will be subject to this new structure in a progressive way. The
more recent standards will be dealt with in the fi rst stage of the project,
and the older standards will follow. IAASB will check which of the exist-
ing bold and grey lettering paragraphs correspond with the newly cre-
ated requirements and application guidance sections. A paragraph in a
‘to be clarified’ ISA will be considered part of the requirement section
if: 1) the requirement is necessary to achieve the objective stated in the
standard; 2) the requirement is expected to be applicable in virtually all
engagements to which the standard is relevant; 3) the objective stated in
the standard is unlikely to have been met by the requirements of other
standards; and finally 4) the requirement of an ISA as a whole is propor-
tionate to the importance of the subject of the ISA, in order to realize the
objective of an audit.
The ISA including ISQC-1 will be clarified following the planning
provided by the Clarity Project: eleven standards are to be revised com-
pletely (clarified structure and full revision of the content, i.e. ‘clarified
and revised’, namely ISA 260,320 (and 450), 402, 450, 505, 540 (and 545),
550, 580, 600, 620, and 800. The other standards will only be clarified.
Part of those standards have been recently rewritten and will thus only
be subject to the clarification exercise (e.g. ISA 230, 240, 300, 315, 330,
500, 700 and 701). In the context of the presumed deadline of the Clarity
Project in 2009, the remaining standards will only be clarified with-
out the content of those standards being subject to a complete revision
(e.g., ISA 210, 510, 520, 530, 710 and 720).
250 Perspectiv es in compa n y l aw

III. Harmonization of auditing standards within

the European Union
After a number of fi nancial reporting scandals like Enron and Worldcom
in the US and Parmalat in Europe, investors’ confidence in capital markets
worldwide has weakened considerably and public credibility of the audit
profession has been impaired, finally leading to what is widely known as
an ‘expectation gap’. In response to those scandals and in order to close
that expectation gap, the US adopted the Sarbanes–Oxley Act in 2002.
Already from 1996, the European Commission developed an approach
regarding the statutory audit function, which has been accelerated after
these scandals and ultimately led to the approval in the EU of the Audit
Directive, ten years later.16 The initiative of a harmonized approach to
statutory auditing in the EU was started by the EC’s 1996 Green Paper
titled ‘The Role, Position and Liability of the Statutory Auditor in the
EU’.17 The policy conclusions which the EU drew from these reflections
were included in the 1998 Communication ‘The Statutory Audit in the
European Union: The Way Forward’.18 That Communication proposed
the creation of an EU Committee on Auditing which would develop
further action in close cooperation between the accounting profession
and Member States. The objective of this Committee was to improve the
quality of the statutory audit by promoting quality assurance, the use of
international auditing standards and auditor independence. On the basis
of the work of this Committee, the EC issued the 2000 Recommendations
on ‘Quality Assurance for the Statutory Auditor in the EU’19 and the
2002 Recommendation about ‘Statutory Auditors’ Independence in the
EU’.20 In its Communication in 2003 on ‘Modernising Company Law
and Enhancing Corporate Governance in the EU – A Plan to Move
Forward’,21 the Commission defined as its priorities
strengthening public oversight of auditors at Member State and EU level,
requiring ISA for all EU statutory audits … and the creation of an EU
Regulatory Committee on Audit, to complement the revised legislation
and allow the speedy adoption of more detailed binding measures … The

16
D. Schockaert, ‘ISA – Een antwoord op de vertrouwenscrisis’, Revue bancaire et finan-
cière/Bank- en Financiewezen, (2004), 219.
17
Green Paper of 28 October 1996, [1996] OJ C 321/1.
18
Commission’s Communication of May 1998, [1998] OJ C 143/12–16.
19
Recommendation of 31 March 2001, [2001] OJ L 091/91.
20
Recommendation of 19 July 2002, [2002] OJ L 191/22.
21
Commission’s Communication of 21 May 2003, COM (2003) 284 fi nal, [2003] OJ C
236/2–13.
 Inter nationa l sta n da r ds on au diting 251

Commission envisaged the use of ISA as a requirement for all EU statu-

tory audits … However, a successful implementation of a binding require-
ment to apply ISAs in the EU … requires the completion of a number of
preliminary actions: the update and completion of the analysis of differ-
ences between ISAs and national audit requirements; the development
of a set of principles (‘framework’) for the assessment of ISAs; the avail-
ability of high quality translation into all Community languages. As for
audit reporting, the Commission plans to use the forthcoming revision
of ISA 700 (audit reporting) as a starting-point for analyzing differences
between national audit reports by EU professional bodies, facilitated by
the European Federation of Accountants (FEE).

Despite those non-binding measures, the Commission required

further initiatives in order to reinforce investor confidence in capi-
tal markets and to enhance public trust in the statutory audit func-
tion in the EU taking into account that auditing is an important part
of good corporate governance practice. In May 2006, the European
Parliament and the Council adopted the new Directive on statu-
tory audits of annual accounts and consolidated accounts, the ‘Audit
Directive’, 22 which replaces the Eighth Council Directive of 1984. The
Audit Directive of 2006 reflects a principles-based approach on audit-
ing matters and aims at reinforcing and harmonizing the statutory
audit function throughout the EU. The purpose of the Directive is to
reinforce the confidence in the functioning of the European Capital
Markets by: 1) clarifying the duties of statutory auditors, the inde-
pendence and other ethical requirements; 2) by introducing a require-
ment for external quality assurance; 3) by ensuring public oversight
over the audit profession by improving cooperation between compe-
tent authorities in the EU; and 4) by enforcing the use of ISA for all
statutory audits to be conducted in the EU, through a process of adop-
tion of the ISA, named ‘endorsement’.

IV. Competence of the EU to adopt ISA

A core issue in the discussion of adoption of the ISA is the competence
of the EU to implement ISA as binding upon Member States. Pursuant
to the Audit Dirctive of 2006, statutory audits of annual and consoli-
dated accounts (financial accounts) should be carried out on the basis

22
Directive 2006/43/EC (note 1, above).
252 Perspectiv es in compa n y l aw

of international auditing standards. This, in fact, does imply the adoption

of those standards in accordance with Council Decision 1999/468/
EC (Comitology Decision).23 The Audit Directive of 2006 is impor-
tant in order to ensure a high quality for all statutory audits required
by Community law and provides that all statutory audits be carried out
on the basis of ‘all’24 international auditing standards.25 The Directive
has given implementing powers to the Commission in order to adopt
‘en bloc’26 the ISA 27 in accordance with the Comitology Decision of the
Council dated 28 June 1999. Within this context, the EC will need to be
satisfied: 1) that the ISA have been developed with proper due process,
public oversight and transparency, and are generally accepted inter-
nationally; 2) that they contribute to a high level of credibility and qual-
ity in relation to the true and fair view of the annual or consolidated
accounts; 3) that they are conducive to the European public good.
In the context of ISA, the basic act is the Audit Directive of 2006,
which confers on the Commission implementing powers to adopt ISA
(article 26) in accordance with the comitology procedure. Furthermore,
the Commission can dispose of the assistance of a committee. According
to article 48 (1), the ‘Audit Regulatory Committee’ (AuRC), composed of
the representatives of the Member States and chaired by the Commission,
has been set up. Under the comitology procedure it is mandatory for the
Commission to consult with the AuRC in relation to the adoption of ISA.
The AuRC is then expected to form an opinion on the measures proposed
by the Commission. The Audit Directive also introduces a requirement
for Member States to organize an effective system of public oversight
for statutory auditors and audit firms and to establish coordination of
public oversight systems at the community level.28

23
See Schockaert and Houyoux, ‘International Standards on Auditing’, (note 4, above),
521.
24
It also refers to related standards such as ISQC-1, Legislative Resolution from the
European Parliament regarding the proposal for a directive on statutory audit of annual
accounts and consolidated accounts and amending Council Directive 78/660/EEC and
83/349/EEC [2005], 5.
25
Recital 13 of the Audit Directive (note 1, above).
26
ISQC-1, Legislative Resolution from the European Parliament regarding the proposal
for a directive on statutory audit of annual accounts and consolidated accounts and
amending Council Directive 78/660/EEC and 83/349/EEC [2005], 5.
27
Art. 26 (2) of the Audit Directive (note 1, above).
28
Art. 33 of the Audit Directive (note 1, above); Recital 1 of the Commission Decision of
14 December 2005 setting up a group of experts to advise the Commission and to facili-
tate cooperation between public oversight systems for statutory auditors and audit fi rms
[2005] OJ L 329/38.
 Inter nationa l sta n da r ds on au diting 253

In order to reach the goals outlined in the Audit Directive, the

Commission needed to call an expert group, which would contribute
to the coordination and the development of public oversight systems
within the EU as well as to the technical preparation of the imple-
menting measures.29 Following the Decision of 14 December 2005, the
Commission set up an ‘Expert Group of Auditors Oversight Bodies’
(EGAOB). The EGAOB is composed of high-level representatives from
the entities responsible for public oversight of statutory auditors and
audit firms in Member States or, in their absence, of representatives from
the competent national ministries.30 Only non-practitioners are allowed
to become members of the EGAOB. The Commission may consult with
this group on any question relating to the preparation of implementing
measures provided for by the Audit Directive.31 Furthermore, the task of
this group is to contribute to the technical examination of international
auditing standards, including the processes for their elaboration, with
a view to their adoption at the community level.32 The EGAOB also cre-
ated a subgroup dealing with ISA (‘ISA subgroup’).33 The objective of
this subgroup is to provide technical expertise to the EGAOB and the
Commission on items and issues encompassing the need to consider the
draft ing, the adoption and the use of ISA, and to allow the EC to pro-
vide a proactive input into the standard-setting process set up within
the IAASB. A small delegation of practitioners is regularly invited to
the meetings of EGAOB’s ISA subgroup, e.g., representatives from the
European Federation of Accountants (FEE).

A. Article 26 of the Audit Directive

According to article 26 (1) of the Audit Directive, Member States may
apply a national auditing standard as long as the EC has not adopted
an international auditing standard covering the same subject matter.
When the EC will adopt the ISA, all standards related to the same sub-
ject matter dealt with by the ISA are no longer applicable. However,

29
Recital 2 of the Commission Decision of 14 December 2005 setting up a group of experts
to advise the Commission and to facilitate cooperation between public oversight systems
for statutory auditors and audit fi rms [2005] OJ L 329/38.
30
Art. 3 of the Commission Decision of 14 December 2005 (note 29, above).
31
Art. 2 of the Commission Decision of 14 December 2005 (note 29, above).
32
Ibid.
33
Art. 4 (3) of the Commission Decision of 14 December 2005 (note 29, above).
254 Perspectiv es in compa n y l aw

Member States always dispose of the possibility to adopt a stand-

ard on a subject matter that is not related to an ISA adopted by the
Commission.
According to article 26 (3)–(4) of the Audit Directive, Member States
may impose audit procedures or requirements in addition to – or in
exceptional cases, by carving out parts of – the ISA, but only: 1) if the
procedures or requirements have not been covered by adopted ISA;34 2)
if these stem from specific national legal requirements relating to the
scope of statutory audits, meaning that those (i) comply with a high level
of credibility and quality to the annual or consolidated accounts in con-
formity with the principles of true and fair view and with the European
public good and (ii) shall be communicated to the Commission and the
Member States before their adoption.35 The Directive also provides for a
time-limit on 29 June 2010 for the Member States to impose these addi-
tional requirements (but not for the carve-outs).36 If the adopted interna-
tional auditing standards contain audit procedures that would create a
specific legal conflict with national law, stemming from specific national
requirements related to the scope of the statutory audit, Member States
may carve out the confl icting part of the international auditing standard
as long as these confl icts exist,37 provided that: 1) they communicate the
specific national legal requirements, as well as the ground for maintain-
ing them, to the EC and the other Member States at least six months
before their national adoption, or in the case of requirements already
existing at the time of adoption of an international auditing standard, at
the latest within three months of the adoption of the relevant ISA;38 2) the
carve-outs comply with a high level of credibility and with the European
public good.39 In general, however, carve-outs provide for a dangerous
tool in the context of the harmonization of auditing standards within
the EU.40 Carve-outs will impair the credibility of auditing standards as
well as the harmonization of auditing standards on a European level. The
objective of the Commission is to analyse the content of the ISA in order
to determine whether the conditions specified by the Audit Directive

34
Recital 13 of the Audit Directive (note 1, above).
35
Art. 26 (3) of the Audit Directive (note 1, above).
36
Art. 26 (4) of the Audit Directive (note 1, above).
37
Recital 13 of the Audit Directive (note 1, above).
38
Art. 26 (3) of the Audit Directive (note 1, above).
39
Recital 13 of the Audit Directive (note 1, above).
40
Ibid.
 Inter nationa l sta n da r ds on au diting 255

have been met, e.g. the fact whether these standards ‘are conducive to
the European public good’. In late 2007, the Commission commissioned
a study regarding a cost–benefit analysis related to a possible implemen-
tation of ISA as well as a study on the differences between the ‘clarified
ISA’ and the PCAOB Auditing Standard.

B. Article 28 (2) of the Audit Directive

As long as the Commission does not adopt ISA 700 and 701 relating to the
auditor’s report, the Directive confers the powers on the Commission to
adopt a common standard for audit reports for (annual or consolidated)
accounts which have been prepared in accordance with IFRS as adopted
by the Commission.41 This option for the Commission could provide for
the creation of an auditor’s report for fi nancial statements prepared in
accordance with IFRS that could be different from the auditor’s report
on other financial reporting framework, other than IFRS as adopted by
the EU. This conclusion leads to the question whether an audit will still
be an audit after the adoption of ISA. Moreover, the ISA are to be consid-
ered as a set of standards, as ISA build on each other, starting with the
ISA on the auditor’s responsibilities (ISA-series 200–260) and ending
with the ISA on reporting by the auditor (ISA-series 700–805). Finally,
ISA 700 clearly states that in order to report on the true and fair view
of the financial statements in accordance with ISA, all ISA should be
applied during the audit.
Therefore, not adopting even one ISA within the European context
would necessarily lead to the non-adoption of ISA 700. One might ques-
tion such a ‘non-adoption’ by the Commission, in the context of the
objective of the Audit Directive to quest for a high level of quality of all
statutory audits within the EU, including the audit of financial state-
ments of small entities.

V. Unsettled regulatory issues

Improving audit quality through adoption of International Standards
on Auditing within the EU has a number of fundamental legal implica-
tions that need to be considered in order to comprehensively cover the

41
Art. 28 (5) of the Audit Directive (note 1, above).
256 Perspectiv es in compa n y l aw

subject. The following text outlines some of the most important of these
issues.

A. General legitimacy of harmonizing regulation

First, the discussion of harmonizing auditing standards forms part
of the general debate on harmonization of regulation.42 Accordingly,
harmonization of auditing standards, like any regulatory harmoniza-
tion, requires a careful analysis of arguments in favour and against.
Harmonization in general may save costs on one side but, at the same
time, may cause new costs because it terminates competition among
regulators as an inventive process to steadily improve regulation.
Hence, mutual recognition of audits may serve as a viable alternative
to full harmonization of auditing regulation.43 Moreover, it is said that
harmonization in general bears the risk of ending up with standards
that are not optimal. Harmonized standards, like harmonized regula-
tions in general, tend to petrify and become resistant against reform.
Experience shows that it usually turns out to be very hard and complex
to change harmonized regulation. Having gone through cumbersome
and lengthy negotiations in order to reach harmonization the parties
are not really willing to reopen the negotiation process. Also, the role of
interest groups in the process of harmonization, like lawyers, the judi-
ciary, members of involved professions and politicians, has to be taken
into consideration. All of these groups have individual interests that
might be influential in the process of keeping traditional standards or
adopting harmonized ones. Accordingly, it is necessary to analyse the
specific relevance of the regulatory debate for harmonizing auditing
standards.
42
For a comprehensive overview over the subject see the contributions in G. F. Schuppert
(ed.), Global Governance and the Role of Non-State Actors, (Baden-Baden: Nomos
Verlag, 2006); G. Hertig and J. McCahery, ‘Optional rather than Mandatory EU
Company Law: Framework and Specific Proposals’, European Company and Financial
Law review, 3 (2006), 341; W. Mattli and T. Büthe, ‘Global Private Governance’: Lessons
from a National Model of Setting Standards in Accounting’, Law & Contemporary
Problems, 68 (2005), 225; R. Michaels and N. Jansen, ‘Private Law Beyond the State?
Europeanization, Globalization, Privatization’, American Journal of Comparative
Law, 54 (2006), 843; K. Bamberger, ‘Regulation as Delegation: Private Firms,
Decisionmaking, and Accountability in the Administrative State’, Duke Law Journal,
56 (2007), 377.
43
See M. Trombetta, ‘International regulation of audit quality: full harmonization
or mutual recognition? An economic approach’, European Accounting Review, 12
(2003), 3.
 Inter nationa l sta n da r ds on au diting 257

In addition to these general considerations on harmonization of reg-

ulation, there are specific arguments regarding harmonization of audit-
ing regulation that deserve closer investigation.

B. The particular problem of legitimacy of

non-governmental regulation
The most important change regarding the adoption by the Commission
of ISA is the fact that these standards will become part of a legal sys-
tem which provides for auditing duties under domestic or harmonized
European law. In other words, by adoption through endorsement,
ISA will change from voluntary standards to mandatory regulations.
However, ISA aren’t drafted from a legislative point of view. They rep-
resent a benchmark status but not a comprehensive set of rules cover-
ing the wide range of possible issues to be regulated in the context of
mandatory auditing. The situation is comparable to the adoption of
IFRS by the Commission.44 Accordingly, elevating ISA in their sta-
tus from benchmark to law requires careful standard-by-standard
analysis. At the same time, it is of course of paramount importance
for the Commission to communicate its comments as early as pos-
sible to the IAASB. It is essential for the success of the harmonization
process that ISA do not interfere with corporate law applicable in the
individual jurisdictions, such as harmonized European or domestic
company law.45
While in a more technical sense, endorsement of promulgated inter-
national standards by the EU may serve as a suitable mechanism in order
to implement those standards into national law, the fundamental ques-
tion of democratic legitimation of those standards in the process of their
development and creation is still open and deserves further research.
Specific questions have to be tackled:
• First, who is standing behind the International Standards on Auditing?
Who is responsible for selecting and appointing the individuals that

44
See Humphrey, Loft, Turley and Jeppesen, ‘The International Federation of Accountants’,
(note 6, above); R. Delonis, ‘International Financial Standards and Codes: Mandatory
Regulation without Representation’, New York University Journal of International Law
and Politics, 36 (2004), 563.
45
European Commission, Comment on Exposure Drafts Improving the Clarity of IAASB
Standards’ (October 2005).
258 Perspectiv es in compa n y l aw

actually formulate the standards? To what extent is independence of

standard setters guaranteed?
• Second, do the procedural rules for developing and setting the stand-
ards on auditing in fact satisfy basic legal due process requirements
with regard to transparency, options for the public to comment,
minority protection, and quality assurance?46

C. One-size-fits-all versus segmented approach

At the moment, ISA follow a one-size-fits-all approach: all entities, whether
listed or not, are audited under the same set of auditing standards. To the
extent ISA have not already been adopted in EU Member States or trans-
posed into national auditing standards in those States, adopting ISA in
the EU may have significant effects on small and medium-size account-
ing firms that are mostly involved in rendering accounting services for
non-listed entities. Like in the case of International Financial Reporting
Standards, the question is whether the audit of small and medium-size
entities, i.e., non-listed entities, requires specific ISA for SMEs.47 In order
to answer that question, it is necessary to substantially draw upon the
corresponding discussion on IFRS. In the US, the Sarbanes–Oxley Act
effectively introduced different standards on auditing for listed entities
(PCAOB Auditing Standards) and non-listed entities (US-GAAS).

D. Principles versus rules-based approach

The fundamental ‘cultural’ difference between the traditional European
auditing approach based on principles and objectives and the more rule-
and checklist-based auditing approach of ISA mirrors the general diver-
gence between Continental law and Anglo-American statutory law.48

46
FEE Issues Paper, Principles of Assurance: Fundamental Theoretical Issues with Respect
to Assurance in Assurance Agreements (April 2003).
47
For Denmark see, e.g., Erhvervs- og Selskabsstyrelsen, Report on the Auditing
Requirement for B Enterprises (March 2005).
48
For a general reference to the topic see D. Alexander, ‘A True and Fair View of the
Principles / Rules Debate’, Abacus, 42 (2006),132; B. Bennett, ‘Rules, Principles and
Judgments in Accounting Standards’, Abacus, 42 (2006), 189; G. Benston, ‘Principles-
versus Rules-Based Accounting Standards: The FASB’s Standard Setting Strategy’,
Abacus, 42 (2006), 165; J. Braithwaite, ‘Rules and Principles: A theory of Legal Certainty’,
Australian Journal of Legal Philosophy, 27 (2002), 47; W. Bratton, ‘Enron, Sarbanes–oxley
and Accounting: Rules versus Principles versus Rents’, Villanova Law Review, 48 (2003),
1023; L. Cunningham, ‘A Prescription to Retire the Rhetoric of ‘Principles-Based System’,
 Inter nationa l sta n da r ds on au diting 259

This difference can cause problems in the process of adopting ISA within
the EU. If, as proposed, each ISA has an objective that the auditor must
demonstrably achieve, there is a very real risk that the objectives will
inevitably become input-orientated, detailed and procedural. Only then
would auditors be able to defend their actions when judged in hindsight.
Therefore, the tendency would be for objectives to focus on procedures
and process rather than the aims of the ISA and overall objective of the
audit. That risks leading auditors into a tick-the-box mindset – with the
risk of negative consequences for audit quality and for the quality of the
auditing profession.

E. Single standard objective versus overall objective

The IAASB’s Clarity Project started with the modest goal of agreeing
on writing conventions that would make auditors’ professional require-
ments abundantly clear – identifying what it is that auditors ‘must’ or
‘shall’ do and rewriting ‘present tense’ sentences so that it is clear whether
they are requirements or illustrative guidance only. Very quickly, how-
ever, the discussion extended to the structure of the ISA too. In future,
ISA are likely to have separate sections for requirements and application
guidance. The IAASB’s October 2005 exposure draft (ED) on Clarity
proposed that each ISA should have a stated objective. The auditor would
be expected to achieve the objective of each ISA relevant to the engage-
ment. To do so, the auditor would comply with the requirements set out
in the ISA, but would also be expected to perform any other procedures
that, in the auditor’s professional judgement, were necessary in the cir-
cumstances. The IAASB’s intention was to focus the auditor’s attention
on the aims of the engagement, rather than on procedures alone, and
to reinforce the need for professional judgement in determining what
procedures are necessary in the circumstances. The requirement for
the auditor to judge whether all procedures that are ‘necessary in the
circumstances’ to achieve a particular objective, is intended to embrace
professional judgement and avoid a tendency for the ISA to try to com-
prehensively cover all circumstances. However, as drafted, the require-
ment places strong emphasis on the procedures to be performed rather
than the evidence obtained. From a European perspective, the question

in Corporate Law, Securities Regulation and Accounting, Vanderbilt Law Review, 60

(2007), 1411; R. Kershaw, ‘Evading Enron: Taking Principles too Seriously in Accounting
Regulation’, Modern Law Review, 68 (2005), 594.
260 Perspectiv es in compa n y l aw

should be ‘Have I obtained sufficient appropriate evidence and, if not,

what can I do to obtain the necessary evidence?’ rather than ‘Have I per-
formed enough steps?’
Since the beginning of the Clarity Project, regulators, investors,
auditors and other stakeholders have been debating the style and
structure of the ISA. At stake is not only how the ISA are drafted, but
also what is expected to comply with them, including the documenta-
tion required. Hence, it is necessary to address the issue of how the
objectives of the different ISA fit together to meet the overall objec-
tives of an audit. It might appear helpful for users in understanding
how the objectives of the ISA relate to the objective of the audit. It also
would be helpful to ensure that the body of the ISA is complete and not
duplicative.

F. Sole responsibility versus division of responsibility

Liability for auditing services is another important issue in the context
of internationalization of auditing standards. In the Parmalat case, divi-
sion of responsibility among those auditing firms that participated in
the audit of the entire corporate group was permissible. As a contrast,
German law prohibits division of responsibility and provides for sole
responsibility of the auditor even if he or she explicitly relies on the work
of other auditors. Unsurprisingly, the reform of ISA 600 ‘Using the Work
of Another Auditor’ has triggered a flood of comment letters. Exposure
Draft ISA 600 now provides for sole responsibility, whereas under US law
division of responsibility is permitted. Note that as a sort of counterbal-
ance, US law prohibits limitation of auditor liability. From a European
perspective, it is important to see whether the US will give in on that
point and accept sole responsibility.

G. Understandability
Following the Clarity Project of the IAASB, ISA are restructured in
order to incorporate an Objective, a Requirements Section and an
Application Material section. The authority of the Application Material
is described in paragraph 22 of the redrafted preface of ISA: ‘While
the professional accountant has a responsibility to consider the whole
text of a standard, such guidance is not intended to impose a require-
ment for the professional accountant to perform the suggested proce-
dures or actions.’ The adoption of ISA in the EU should not change the
 Inter nationa l sta n da r ds on au diting 261

authority of the Application Material. Furthermore, the text of an ISA

should be read as a whole, including the Application Material, in order
to create a consistent application of ISA within the EU. On the other
hand, it is obvious that from the perspective of continental law juris-
dictions the inclusion of Application Material in the text of ISA might
pose questions with respect to the binding force of the ISA as well as
the hierarchy between the various parts of ISA. The Clarity Project in
that regard is but one fi rst step in order to improve the understand-
ability of ISA.
Another issue in that context is the variable use of words within
the auditing standards. For example, in some cases the equivalent
requirements in PCAOB-Auditing Standards and ISA use differ-
ent words: the impact of this different usage needs to be examined.
Furthermore, even when the same words are used, the words may
have a different meaning due to different definitions or because the
words used in the PCAOB-Auditing Standards have a meaning that
is commonly understood in US jurisprudence, but for which no such
a common understanding exists in ISA. It should also be recognized
that the PCAOB-Auditing Standards and US GAAS are written
within a certain legal and cultural environment, which means that
these factors will be taken into account when evaluating the meaning
of the differences between the standards and their impact on audit-
ing practice.

H. Objectives of harmonization of auditing standards

1. Legal security and public trust in auditing
First and foremost, it is said that harmonization of auditing standards
would contribute considerably to reduce the current standard overload
(PCAOB Auditing Standards / US GAAS, ISA, German IDW-PS and
other domestic standards) and, thereby, generally improve legal secu-
rity and public trust in auditing. At present, the multitude of auditing
standards applicable throughout Europe and the world makes it dif-
ficult for the auditing profession as well as for professional and non-
professional investors alike to apply and understand auditing standards.
As in the case of International Financial Reporting Standards (IFRS),
International Standards on Auditing would tremendously simplify ren-
dering and understanding the relevant services. This, in turn, would
finally reduce capital costs for auditing clients.
262 Perspectiv es in compa n y l aw

2. Improving quality of auditing

Harmonized auditing standards would reduce the complexity of audit-
ing and, thereby, reduce the likelihood of incorrect or incomplete
auditing. Differing auditing standards are a most prominent source of
problems and mistakes in the course of auditing across borders. This is
particularly true in the case of large corporate clients with affi liations
and branches in many different countries.

3. Reduction of civil liability risk

Harmonization of auditing standards would reduce the risk of civil as
well as criminal liability for auditors. Hence, it would render auditing
as a profession more attractive. Accordingly, it would become easier for
auditing firms to recruit the personnel required to render in particular
large-scale or cross-border complex auditing services.

I. Adaptability of ISA to common European auditing standards

As a precondition for any adoption of International Standards on Auditing,
it is necessary to ask for the underlying principles of these Standards.
What are the core regulatory subjects, what is the regulatory approach
(in terms of regulatory method)? Do these Standards mandate or merely
recommend specific action? Do they spell out the regulation in all detail?
Do they operate on the basis of sanctions like civil liability? Moreover, the
question has to be answered whether and to what extent these principles
correspond to traditional Auditing Standards in force within the EU.

J. Problems of transition
On the downside, like in the case of any harmonization, adopting newly
introduced uniform auditing standards inherently causes problems of
transition. It will definitely take some time until the harmonized stand-
ards are applied in a uniform as well as correct manner. Hence, for a
transitory period the advantages of harmonized standards have to be
counterbalanced against the disadvantages of untested standards.

VI. Conclusion
The European Commission pointed out the need for high quality in all
statutory audits required by Community law in order to contribute to the
 Inter nationa l sta n da r ds on au diting 263

prevention of corporate and financial malpractice. For that purpose, the

Audit Directive approved by the European Parliament and the Council
in 2006 states clearly that statutory audits be carried out based on ISA.
The Audit Directive reflects a principles-based approach on auditing
matters and aims at reinforcing and harmonizing the statutory audit
function throughout the EU, thereby building up confidence in the func-
tioning of the European capital markets. To that extent, the Directive
provides for the application of ISA for all statutory audits to be con-
ducted in the European Union. For ISA to become part of a legal system,
the Commission has to apply the comitology procedure. This procedure
sets out the authority of the Commission, the European Parliament and
the Council for taking the necessary steps in order to adopt ISA for all
statutory audits to be performed within the EU.
ISA are subject to a clarification project of the IAASB, which is one
of the most important committees of the International Federation of
Accountants, as well as a private body setting international standards.
The Clarity Project is an ambitious undertaking designed by the IAASB
in order to clarify what exactly is required under the ISA, which pur-
poses are being envisaged within the ISA and how the required audit
procedures could be applied in different circumstances of the audit
engagement. This article identified a number of issue and questions that
deserve closer analysis in order to make sure that harmonizing statutory
auditing throughout the EU by adopting ISA will become a success.
 15

Corporate governance: directors’ duties,

financial reporting and liability – remarks from
a German perspective
Peter Hommelhoff

I. Introduction
The impossible is happening in Germany these days. The management
board of Siemens, the jewel in the crown of the German economy, is
preparing compensation claims against former management and super-
visory board members of the company and thereby supplementing the
criminal law investigations which the Munich public prosecutor has
instigated against these former executives. That is very embarrassing
for those involved! These events are shocking for two reasons: fi rstly,
because management board or supervisory board members have so far
hardly ever been made liable in Germany (The sarcastic comment of the
former chairman of Deutsche Bank, Hermann Josef Abs comes to mind:
‘It is easier to catch a pig by its slippery tail than to make a supervi-
sory board liable.’); and secondly, these proceedings involve Siemens,
an icon of the German economy. The former chairman of the supervi-
sory board Heinrich von Pierer was, up to a few days ago, chairman of
the Innovation Council, which advises Federal Chancellor Merkel on
research strategies of economic significance.
From the point of view of company law, we can here discern the
effects of corporate governance and the way it has continued to work
better in Germany. And the events at Siemens will certainly significantly
increase the already wide acceptance of corporate governance and its
mechanisms. In my view, there will soon be a breakthrough in Germany
(including a psychological breakthrough) and the regulatory discipline
of corporate governance will meet with general approval.
That provides an occasion to trace back the development of corporate
governance in Germany and to recall its essential structural elements.
This enterprise is dedicated to Eddy Wymeersch with all good wishes.

264
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 265

Years ago, in a group of friends, he introduced me to the still so unfamiliar

system of corporate governance; I would like to thank him for that.

II. Development of corporate governance in Germany

Germany initially regarded the concept of corporate governance, as
originally developed in Anglo-American circles, with more reservation
than interest. The ‘principal agent conflict’ and its resolution appeared
to us to be ‘old hat’.

A. Investor protection in company law

In fact, the German legislator, i.e. the Reichsjustizamt and the Reichstag,
had considered the economic and therefore highly significant problem
of the protection of investors more than one hundred and twenty years
ago. Thousands of investors had, in the years after the Franco-German
war, invested – and lost – their savings in highly speculative operations.
The famous legal scholar Rudolf von Ihering was moved to remark indig-
nantly that there were more criminals gathered together on the boards of
German banks than in all the prisons. The German Reichstag responded
by passing the major company law amendment of 1884, which is still
valid today, making the two-tier system characteristic of German com-
pany law.
Even then, the German legislator was concerned to establish the nec-
essary framework for the management structure of listed companies
and the effective control of their board members. According to the 1884
amendment, the supervisory board was intended to compensate for the
weak position of the numerous investors who were not in a position to
genuinely monitor the activities of the management board. That was,
and is, investor protection by company law or, in today’s terminology,
internal corporate governance.

B. Auditor as additional monitor

After 1884, German legislation continued at regular intervals to improve
the rights of supervisory boards (and thereby internal corporate govern-
ance) in the light of experience gained in practice. The greatest impetus
was provided by the Emergency Order of 1931 in reaction to the company
failures after ‘Black Friday’ on the New York stock exchange – one of
the major contributors to the growth of National Socialism in Germany.
266 Perspectiv es in compa n y l aw

The Emergency Order converted the ‘Liaison Council’ or Organ of the

hidden Higher Management of the Company into the supervisory board
of the company with precise directions on these functions. In addi-
tion, so that the supervisory board could effectively perform its tasks,
the Emergency Order provided it with especially effective support – the
auditor – who pre-audits the accounts of the management board for the
supervisory board and reports to the latter on the findings of the audit.
The double function of auditors as guarantors of openness and sup-
porters of the supervisory board, which characterizes their position in
Germany, was thereby established. For decades then, auditors permit-
ted themselves in practice to be guided by a third function supplemen-
tary to the double function or at least more or less overlapping with it.
This consisted of giving friendly advice to the management board, so
that the bonds of trust developing between the board and the auditors
encroached extensively on their work for the supervisory board. An
experienced supervisory board member accurately described the situ-
ation regarding the auditor’s report: if you compared the draft report
discussed in advance with the management board and that presented by
the auditor to the supervisory board, you often had the impression that
you were dealing with two completely different companies.
The German legislator emphatically remedied this situation in 1998
and ensured by a variety of precisely targeted measures that auditors
in their internal company function were entirely directed towards the
supervisory board and their bond of trust to the management board was
largely loosened. This regime has, in fact, led to change in corporate and
auditing practice – not least because the auditor has been recognized
as the internal agent of corporate governance. The auditor is now ines-
capably charged with both functions of reviewing the performance of
the management: as guarantor of publicity, and supporting the moni-
toring by the supervisory board. Advice to the management board has
been considerably reduced in importance. Th is may also be seen from
the annual financial statements in the German banking industry at the
moment, which, in spite of audits and certificates, still often need to be
corrected.

C. German Corporate Governance Code

The auditor and the audited accounts are functional elements of cor-
porate governance in Germany. Th is is acknowledged in the German
Corporate Governance Code of 2002 (now the 2007 version). This Code
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 267

is the outcome of a carefully graduated process, initiated by private

committees of practitioners and academics, and subsequently taken up
by the federal government with the appointment of two governmen-
tal commissions in 2000 and 2001. The legislator linked the Corporate
Governance Code with company law by means of the declaration of
conformity: while companies are not bound by the recommendations
and suggestions of the Code, if the management board and supervisory
board do not wish to accept a recommendation, this must be disclosed.
Both organs must make an annual declaration of what recommendations
of the Code have been complied with and what not (comply or explain).
The declaration must be published along with the separate company or
group accounts.
With the German Corporate Governance Code the legislator pur-
sues two objectives: firstly, foreign investors, in particular, are to be
made aware of the characteristic duality of the corporate structure of
German companies with their management board and supervisory
board, and secondly, the legislator sees in the Code the opportunity to
ameliorate the extremely strict company law – testified a hundred years
ago to have ‘the clunking severity of a Prussian senior public prosecutor
(Oberstaatsanwalt)’. But together with the deregulation and the legisla-
tor’s retreat from mandatory statutory impositions, another story must
also be told. Where companies are resistant and unmoved by mere rec-
ommendations, the legislator does not hesitate to strike, and has now
forced even Porsche SE to reveal the individual earnings of Wiedeking
and other board members in the finest detail in the annual accounts; in
Germany, this adds fuel to the flames of political debate on social justice.

D. Corporate governance and shareholder value

All in all, the recommendations of the Code and consequently also its
suggestions, enjoy increasing acceptance among companies, in par-
ticular the DAX companies, i.e. the top German companies on the
Frankfurt stock exchange. The German Corporate Governance Code is
contributing significantly to change in the corporate governance prac-
tices of German companies. Only four recommendations have met with
wide resistance among the DAX companies: the excess in D&O insur-
ance policies; discussing the remuneration structure of the management
board in the full supervisory board; ruling out a transfer from the chair
of the management board to the chair of the supervisory board; the
performance-related remuneration of supervisory board members.
268 Perspectiv es in compa n y l aw

Acceptance by the broader public lags a good way behind this increas-
ing acceptance of the Code among companies. In Germany this is mainly
due to the fact that ‘corporate governance’ is viewed as being linked to
‘shareholder value’ and that means to the single-minded direction of the
management board’s actions to the interests of the shareholders and the
growth of share value. Such single-mindedness conflicts with widely
held values in Germany which are rather aimed at various stakeholder
interests and thereby, in particular, those of company employees. In a
fairly widespread German view, it is the task of the management board,
even of a listed company, to reconcile the various stakeholder inter-
ests again and again. That also corresponds to the OECD Principles of
Corporate Governance.
It is true that the temperature of this controversy, initially conducted
very fundamentally in Germany, has meanwhile noticeably cooled.
Even without the one-sided exaggerated pursuit of shareholder interests,
increasing company value equally benefits the stakeholders – namely
the employees and the security of their jobs. The general approval of cor-
porate governance in Germany is increasing little by little, but the per-
formers are skating on thin ice. The recent description of institutional
investors as ‘a plague of locusts’ is ever present.

III. Duties of organs under the Code

Now let us take a brief look at the obligations, as organs, of the man-
agement board and supervisory board as embedded in the German
Corporate Governance Code.

A. Interplay between the management board and

supervisory board
After a preamble and the first section on shareholders and general meet-
ings, the Code does not immediately go on to deal with the management
board and supervisory board: it turns instead to the administrative organs
(this strikes German corporate lawyers as unusual) with an introduc-
tory section on the interaction between management board and super-
visory board. The general prescription of close cooperation of the two
organs in the interests of the company is repeatedly broken down into
concrete situations: consultation on the strategic direction of the com-
pany, and the common concern that the supervisory board is provided
with adequate information or the joint corporate governance report of
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 269

the management board and supervisory board, in which any deviations

from the recommendations of the Code over and above company law
requirements, must be explained.
For this unusual ‘trailer’ the members of the commission engage in
some self-praise. It is the first time in ‘official’ regulations that the sig-
nificance of proper cooperation of both organs for the quality in a two-
tier system is so emphatically highlighted. At the same time – and this
may be of special interest to British readers – it describes the practical
convergence of monistic and dualistic governance models. Well! I have
my doubts whether that would convince Paul Davies. Marked out by
German company law, the jurisdiction of each of these organs is fenced
off from that of the other: management by the management board and
supervision by the supervisory board; logically, the supervisory board
does not participate in meetings of the management board. Th ird-party
monitoring and division of powers are maintained in the German public
company and in the resultant narrowing of the information channels
between both organs and their members.

B. Rejection of commandments
Many readers of the Code will expect to find a list of specific duties
for the management board, in the manner of ‘the ten commandments
for proper corporate management’ revealing details about the general
statutory duty to exercise the care of a proper and conscientious busi-
ness concern. But they will be disappointed. The detailed duties of the
management board referred to by the Code are those stated in any event
in the Stock Corporation Act, or they are a matter of course – including
the obligation to ensure compliance with the legal provisions and the
company guidelines. Instead, the German Corporate Governance Code
concentrates intensively on the remuneration of management board
members and their conduct in possible confl icts of interest.
The reluctance to give a detailed list of commandments for proper
management is to be welcomed. Rules of conduct applicable to all
companies in all situations cannot realistically be drafted beyond
more or less general platitudes. Management of a company is, in many
respects, specific to that company but also specific to the individual.
The Code therefore describes and emphasizes for both organs, i.e.
equally for the management board and the supervisory board, the
application of the business judgement rule – even this is merely the
adoption of the statutory provision.
270 Perspectiv es in compa n y l aw

C. Improved supervisory board performance

In principle, these observations apply equally to the Code’s recom-
mendations and suggestions to the supervisory board. The statutory
provisions are here also repeated – surrounded, however, by many
helpful additions and extensions. For example, for the election of
supervisory board members, for which the supervisory board itself
has, according to statute, to make proposals to the general meeting
(AGM), it sets down a qualification profile, compliance with which
has already considerably improved the level of German supervisory
boards and will continue to do so. Gone are the days when at a general
meeting of a major energy company someone could seriously be nom-
inated for the board on the grounds of having successfully worked
as a cashier in a church institution. The Code also recommends that
each supervisory board member must make sure of having sufficient
time to carry out their functions. Logically, it is also recommended
(admittedly not mandatory) that the report of the supervisory board
to the AGM should state whether a supervisory board member has
participated in less than half of the supervisory board meetings in a
financial year.
It may be predicted that the quality of the work of the supervisory
boards of German listed public companies will improve even more. The
proposal in the Code that the supervisory board should regularly review
its own efficiency will also contribute. Even today, a remarkable number
of supervisory boards have adopted the practice of obtaining the assess-
ment of external third parties. Management consultants and auditing
companies offer this evaluation as a well-remunerated service. They
apparently find enough retired supervisory board members to conduct
the evaluation.

IV. Role of accountancy in the system of

corporate governance
In the system of corporate governance, accountancy is in the weld
between internal and external corporate governance, i.e. between
the company statutes and the capital market. Supplemented and
enriched by the specific information instruments of the law of the
capital markets, accountancy (meanwhile internationalized) in its
published form is designed to support investors’ decision-making
processes.
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 271

A. Function of the intermediaries

Granted, it would be politically false to assume that every small inves-
tor could derive and evaluate the necessary information from annual
accounts, in particular the figures, in the manner needed to provide a
basis for investment decisions. They will not have the necessary exper-
tise and experience which are, at most, the domain of the institutional
investors, and even they obtain expert external advice. On the capital
markets, and thereby for external corporate governance, the interme-
diaries are of central importance. Finance intermediaries with their
broad range of the most varied services as well as the mere information
providers – the fi nancial press, which makes company information,
namely the figures in the annual accounts, intelligible for readers. The
special significance of the fi nancial press precisely for accountancy was
already recognized in Germany almost fi ft y years ago.

B. Investor information in the management report

Nevertheless, the German and European legislators have not completely
lost sight of the small investor, the individual shareholder with special
need of information. The management report, setting out the position of
the company or the group – independently of the figures in the annual
accounts and notes, but nevertheless in conformity with them – is an
important element in accountancy both under the EU Directives and
the German Commercial Code. The aim of both legislators was that a
degree in accountancy law should not be necessary in order to be able to
understand the position of the company or the group from the accounts:
some financial knowledge must suffice.
The German legislator in 1998 already raised the significance of the
verbal element in the annual accounts and logically considerably tight-
ened the standards to which the report and the reporting are subject –
admittedly only vis-à-vis the supervisory board and not really in the
direction of the shareholders or the general public. The review of the
management report therefore affects internal and not external corporate
governance.
The EU legislature treats the verbal part of the accounts with even less
care – and that in two directions. Firstly, listed companies are completely
exempt from providing a management report because international
accountancy according to IFRS does not provide for it and the European
legislature, in the IAS Regulation, made this form of accountancy
272 Perspectiv es in compa n y l aw

mandatory for listed companies. Small investors and the general public
are thereby to a great extent excluded from any role in corporate govern-
ance. Against this background, it is, secondly, hardly surprising that the
remaining verbal section has recently become overloaded with all sorts
of additional disorganized information thus weakening even further its
effects in relation to corporate governance.

C. Audit committee
None of this means that the European legislator has completely lost
sight of the relevance to corporate governance. With the obligatory audit
committee in all companies, which (irrespective of their securities) are
present on the capital market, the European legislator emphatically
strengthened internal corporate governance in the amendment to the
Eighth Directive because, apart from prescribing the formation of the
audit committee, the Directive imposes special quality requirements
on its members: at least one member must be experienced in interna-
tional accountancy and must also be independent. In German compa-
nies without a supervisory board, but which, nevertheless, wish to avail
themselves of the capital market (for example, a fi nancing limited liabil-
ity company without a supervisory board but with listed securities) the
audit committee is an additional company organ. A draft Transformation
Act dealing with this issue has existed in Germany for some time now.
At the same time, the mandatory audit committee will affect the work
of the auditor who has, in the committee, a permanent contact centre
with which he or she can discreetly have preliminary discussions about
specific ‘discoveries’ made in the course of the audit. In addition, the
audit committee is also in a position to review the quality of the pre-
liminary work provided by the auditor to the supervisory organ. All of
this, and more, improves the internal corporate governance and proves
generally that, according to the conception of the European legislator,
corporate governance in companies accessing the capital market should
primarily be further developed internally and emphasis placed on its
further professionalization.

V. Mechanism of responsibility
The picture of corporate governance painted up to now would remain
incomplete without the mechanisms of individual manager responsibil-
ity, based on what I would like to term Sesselhaftung (the attachment
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 273

of board members to their seats). Th is applies to management board

and supervisory board members even before the statutory liability of
organs.

A. ‘Political’ management board responsibility

As is well known, statutory law bars the appointment of a management
board member of a German public company for an unlimited period:
the appointment can be for five years at most. In addition, the German
Corporate Governance Code suggests that, on a first appointment to
the management board, this five-year period should not be the rule. On
the other hand, a management board member once appointed can be
removed prematurely only under specific conditions and not freely, at
any time or without grounds. Reappointment then becomes the focus of
this provision. A management board member in office will do all in his
power to convince the supervisory board by his work, his performance
and his success, that his reappointment is in the interests of the company
and appropriate in the interests of his stakeholders. This mechanism is
backed up by the compulsory annual account the board must give of its
work and the obligation to have confidence in it voted on by the general
meeting on this basis. If the shareholders withhold their confidence from
the management board or one of its members, the supervisory board can
remove the member concerned prematurely.
Reappointment and threatened removal are, in the system of alloca-
tion of powers in German company law, central pillars of a corporate
governance designed to have permanent effects. That applies in the
first place to the monitoring of, and feedback from, management board
members, but also in a legally less-concentrated form to members of the
supervisory board.

B. Enforcement of organ’s liability

In comparison to this Sesselhaftung, claims for compensation against
management board and supervisory board members who may have over-
looked some of their obligations, had hardly any practical legal signifi-
cance in Germany until recently. While the German Stock Corporation
Act contains onerous liability provisions, the problem lay rather in their
application and enforcement. The enforcing organ, the supervisory
board (and management board for former organ members) have had
understandable inhibitions against suing their colleagues: ‘A crow does
274 Perspectiv es in compa n y l aw

not pick out the eye of another crow’ (or in an English version: ‘dog does
not eat dog’). The German Federal Supreme Court, in its programme of
action in the Garmenbeck judgment, did not significantly change this.
The German legislator first brought about a legal U-turn by facilitat-
ing the power of shareholders to compel action and logically to initiate
a special audit. It enables a relatively small (and achievable) minority of
shareholders to ensure that measures are actually taken against manage-
ment board or supervisory board members who have overlooked some
obligation. Politically, this was from the outset discussed primarily from
the point of view of a really effective corporate governance. In corporate
practice, this is beginning to take effect and has, above all, produced a
mental transformation: claims for compensation against management
board and supervisory board members are no longer taboo. The current
debate is proof of that.

C. Role of criminal law

The criminal justice system is developing into a player (admittedly
one viewed with reserve and mistrust) in German corporate govern-
ance, with proceedings for misappropriation of company assets. The
Vodaphone/Mannesmann case already has a place in German legal his-
tory. The participation of the prosecution services in the monitoring of
company organs is problematic above all because public prosecutors and
criminal judges do not rely on typical reasoning processes of civil law or
company law but develop these specifically for criminal law. In extreme
cases, what is quite permissible in company law may be an offence in
criminal law. The discussion of these issues is in full swing in Germany.

VI. Summary
The concept of corporate governance has been adopted widely in German
company, accountancy and capital markets law and enjoys general and
continuously increasing acceptance among listed companies. But the
respect for corporate governance will increase among the public all the
more when it is disconnected from the one-sided, exaggerated concept
of shareholder value. Outside the circle of listed companies, the major
family companies have meanwhile developed a Corporate Governance
Code tailored to their specific concerns away from the stock exchange,
and the public state companies will follow.
 Dir ectors’ duties, fina ncia l r eporting & lia bilit y 275

In Germany, corporate governance leads to success. Gone are the days

of the banker Fürstenberg with his view that shareholders are stupid and
cheeky: stupid because they give their money to companies, and cheeky
because, on top of that, they then want dividends in return. Today it
is different. Shareholders and their interests have never been taken so
seriously in Germany as they are today.
 16

Some aspects of capital maintenance law in the UK

John Vella and Dan Pr entice

I. Introduction
The corporate form is used pervasively in the United Kingdom. In 2005
there were 1,968,000 private companies (‘Ltd’)1 and 11,600 public com-
panies (‘Plc’)2 on the companies’ register.3 In the year 2004–2005 there
were 332,700 new private companies incorporated and 1,100 public com-
panies.4 In 2005, 43,600 companies were struck off the register and 4,200
were wound up.5 The rate of new incorporations has been significant: it
is estimated that since 1997 new incorporations have risen by over 60%
and the number of foreign firms incorporating in the UK has more than
quadrupled.6 A salient feature of UK company law is ease of access to
the corporate form. No barriers of any substance are placed in the way
of obtaining corporate status.7 There is a ‘free market’ rationale for ease
of incorporation – provided parties are aware that they are dealing with
1
Th is is the default category, unless a company adopts the public company form it will be
a private company: Companies Act 2006, s. 4 (hereafter ‘the 2006 Act’).
2
A company must explicitly provide for public company status in its constitution: 2006
Act, s. 4(2).
3
See DTI, Companies 2004–2005, Report for the year ended 2005 (DTI, October 2005),
Table A2.
4
See DTI, Companies 2004–2005, (note 3, above), Table A2, 14.
5
The Companies Act 2006, sections 1000–1002, enables the regulatory authorities to have
a company struck off the register, normally this is for non-compliance with the regula-
tory provisions of the Companies Act 2006. Th is is by far the most common way in which
companies are removed from the register. Such companies can be restored to the regis-
ter: see Companies Act 2006, ss. 1024–34. In 2005, 300 companies were restored to the
register (see DTI, Companies 2004–2005 (note 3, above), Table C1).
6
Hansard, House of Lords, Vol. 677, at 180 (2006).
7
The Registrar of Companies offers a one-day incorporation service. It is not uncommon
for the large London law firms to incorporate companies in batches so that when the
need arises they can take the company off the shelf, hence the common reference to shelf
companies. Such companies are treated as ‘dormant’ companies and are exempted from
the regulatory provisions of the 2006 Act until they commence trading; see the 2006 Act,
(note 1, above) s. 1134.
276
 Some aspects of capita l m aintena nce l aw in the U K 277

a limited liability company they can protect their own interests.8 To the
extent that the corporate form can be abused, control of abusive practices
is by means of a liability rule applied ex post and by an ex ante rule that is
designed, for example, to ensure economic viability.9 Occasionally, UK
company law will use a property rule to protect the interests of the dra-
matis personae of company law. One example of this are the provisions
on shareholder pre-emption rights,10 which use a property protection
rule, the conferral of a right of pre-emption, rather than a liability rule,
that is, an ex post legal remedy where a shareholder has been unfairly
treated by a particular allotment.11 Other than in the area of capital
maintenance,12 UK law relies on ex post liability rules to curb the misuse
of the corporate form, rather than ex ante quality control rules.13
A second feature of English company law is that it is enabling; that is,
it leaves considerable autonomy to the draftsman of a company’s consti-
tution as to how the central matters of a company’s activities, namely,
distribution of profits, allocation of losses, and allocation of control are
dealt with.14 The draftsman of the corporate constitution does not have a
completely free hand but there is a larger measure of freedom in drafting
a company’s constitution that the vast bulk of the Companies Act 2006
would suggest.15

8
See Companies Act 1985, s. 349; Griffi n, ‘Section 349(4) Of The Companies Act 1985:
An Outdated Victorian Legacy’, Journal of Business Law, (1997), 438. Th is justification
is not without its difficulties: it does not address the issue of involuntary creditors (tort
victims) or day-to-day normal trade creditors.
9
For example, the Insolvency Act 1986, s. 212 (misfeasance proceedings by liquidator),
s. 213 (fraudulent trading), and s. 214 (wrongful trading) are all ex post sanctions. There
is no ex ante requirement such as minimum capitalization. See D. Prentice, ‘Corporate
Personality, Limited Liability and the Protection of Creditors’, in Rickett and Grantham,
Corporate Personality in the 20th Century (Hart, 1998), Ch. 6.
10
2006 CA, ss. 574–593. These implement the Second Directive on Company Law (79/91/
EEC), Article 29.
11
See DTI, The Impact of Shareholders’ Pre-Emption Rights on A Public Company’s Ability
to Raise New Capital (3 Nov. 2004), DTI, www.dti.gov.uk/cld/current.htm; DTI, Pre-
Emption Rights: Final Report (Feb. 2005), www.dti.gov.uk/cld/public.htm.
12
The capital maintenance rules are relaxed for private companies: see 2006 Act, s. 656
(reduction of capital); s. 691 (fi nancial assistance); see infra.
13
It is interesting to note that when limited liability was introduced in 1855 it was initially
proposed that limited liability companies should possess a nominal capital of £50,000,
but this was rejected: see R.R. Formoy, The Historical Foundations of Modern Company
Law (1923) at 117.
14
Th is assumes that the company is solvent. Insolvency law is prescriptive as regards
hierarchy of claims and asset distribution where a company is insolvent.
15
Th is Act has 1300 sections and 16 Schedules. There is also subordinate legislation.
278 Perspectiv es in compa n y l aw

The topic of capital maintenance under English law embraces what

are standard issues in this area: (i) initial capitalization, (ii) payment for
shares, (iii) the acquisition of shares using the company’s capital, (iv)
reductions of capital and (v) share buy backs. It is proposed to deal with
these issues seriatim.
It must be emphasized, at the very outset, that the provisions in
the recent Companies Act 2006 (hereafter ‘the 2006 Act’) dealing
with capital maintenance do not fully ref lect the preferences of the
UK Government. Given the ex ante control imposed by this regime
and its very prescriptive nature, which as seen does not follow the
general approach of UK company law to possible abuses of the corpo-
rate form, this might not come as a complete surprise. Reform in this
area was in fact constrained by the Second Company Law Directive
of 1976 (hereafter ‘the SCL Directive’) which prescribes a set of mini-
mum requirements Member States must adopt in their national leg-
islation. The UK Government’s hands were not, however, completely
tied. The Directive only applies to public companies, meaning there
was no restriction on the Government’s ability to amend the law for
private companies; furthermore, it could also remove elements in the
previous Act, namely the Companies Act 1985 (hereafter ‘the 1985
Act’), which went beyond the requirements of the SCL Directive.
Due to this limited room for legislative manoeuvre, one cannot view
the provisions in the 2006 Act in isolation. When considering these pro-
visions we shall thus also look at the extensive consultation that pre-
ceded the adoption of the 2006 Act as well as the SCL Directive and the
recent work carried out on and around it. The aim, in each instance, will
be to present the options that were available to the UK Government and
the rationale behind the choices that were made. This exercise should
also give us an indication as to what the law might have been if the
Government had a completely free hand.
Before dealing with these provisions, we shall set the scene by
brief ly outlining the processes that led to the production of the
2006 Act and by providing an update on the state of play on the SCL
Directive.

II. Reform processes in the UK and the EU

The Company Law Review that led to the 2006 Act was kick-started in
1998 with the publication of the consultation paper Modern Company
 Some aspects of capita l m aintena nce l aw in the U K 279

Law for a Competitive Economy.16 An independent Steering Group

composed of company law experts was given the lead, and its remit was
to carry out a thorough and wide-ranging review of core company law.
The Steering Group consulted widely and produced a number of consulta-
tion documents and reports over a three-year period culminating in the
production of its Final Report in 2001.17 The Government’s response was
contained in a White Paper published in 2002,18 which was followed by
more consultation and the publication of another White Paper in 2005.19
Following quite an eventful parliamentary process that saw a considerable
number of last minute amendments, the new Companies Act was finally
enacted in 2006 after no less than eight years of consultation and delay.20
It is worth highlighting at this juncture one of the main guiding prin-
ciples followed by the CLRSG in its review, as this will inform much
of what will follow. Rather than adopting prescriptive rules that hinder
transactions, the CLRSG preferred granting more freedom and allowing
market and other forces, buttressed by transparency requirements, to
induce regulation through contract or other means. The CLRSG acknowl-
edged, however, that this presumption against prescription could only
be a starting point which would have to yield in circumstances where
market and other forces coupled with transparency requirements would
not work. Even then, prescriptive intervention must be justified in terms
of the costs, benefits and effectiveness. The capital maintenance regime
was thus examined under this light, and the proposals made, which we
shall examine further on, were thus fashioned by this principle.21
As noted, the reform of the capital maintenance regime within the
more general company law review process took place in the shadow of
the SCL Directive. Under this directive Member States are required to
put in place for public companies a regime which regulates the raising
of capital, and, once raised, precludes its return to shareholders unless

16
DTI, Modern Company Law for a Competitive Economy, (London, March 1998).
17
DTI, Final Report, (London, 2001, URN01/942).
18
White Paper, Modern Company Law, (London, July 2002, Cm. 5533), (hereafter ‘White
Paper 2002’).
19
White Paper, Company Law Reform, (London, March 2005, Cm. 6456), (hereafter ‘White
Paper 2005’).
20
For a succinct account of this process see G. Morse (gen. ed.), Palmer’s Company Law:
Annotated Guide to Companies Act 2006, (London: Thompson, Sweet & Maxwell, 2007),
49–51.
21
DTI, The Strategic Framework, (London: February 1999, URN 99/654), paras. 2.21–2.23;
DTI, Final Report, (note 17, above), paras. 1.10–1.11.
280 Perspectiv es in compa n y l aw

specified procedures are followed. This regime, which is meant to protect

the interests of creditors, thus links the possibility of a return of value to
shareholders to the amount of capital they contributed. In principle, and
subject to exceptions, since the capital they contributed is meant to act
as a cushion to safeguard creditors’ interests, value can only be returned
to shareholders to the extent that the company’s net assets exceed its
capital.
Efforts to amend the SCL Directive were running parallel to the
Company Law Review in the UK, however their result ultimately proved
to be fairly modest. The first proposals to simplify the directive were made
by the SLIM Group in 1999.22 SLIM was followed by the consultation
and work carried out by the High Level Group of Company Law Experts,
(hereafter ‘Winter Group’), appointed by the European Commission in
2001 to make recommendations on a modern regulatory framework in
the EU for company law. In their 2002 report they concluded that reform
of the SCL Directive should, as a matter of priority, be carried out along
the lines suggested by the SLIM Group with the modifications and sup-
plementary measures suggested by them. They also recommended the
undertaking of a feasibility study of an alternative regime that could be
offered as an alternative to Member States.23 The Commission followed
these recommendations as it indicated it would in its May 2003 Action
Plan for Company Law and Corporate Governance.24 It thus issued a
‘moderately deregulatory’25 proposal to amend the Directive in October
2004 and finally amended it in September 2006.26 These amendments
did not generate much excitement in the UK. After consultation led
by the Department for Business Enterprise and Regulatory Reform
(hereafter ‘BERR’ – formerly the ‘Department of Trade and Industry’

22
Company Law SLIM Working Group, The Simplification of the First and Second Company
Law Directives, Brussells, October 1999, (hereafter ‘SLIM Report’).
23
High Level Group of Company Law Experts, Report on a Modern Regulatory Framework
for Company Law in Europe, Brussels, 4 November 2002, (hereafter ‘Winter Report’), 16,
81 and 88.
24
As signalled in European Commission, Modernising Company Law and Enhancing
Corporate Governance in the European Union – A Plan to Move Forward, COM (2003)
284 fi nal, Brussels 21 May 2003, 17–18. Most of the EU documentation on this matter can
be found at http://ec.europa.eu/internal_market/company/index_en.htm
25
European Commission, Proposal for a Directive amending Council Directive 77/91/EEC,
as regards the formation of public limited liability companies and the maintenance and
alteration of their capital, COM (2004) 730 fi nal, Brussels, 21 September 2004, 16.
26
For a critical assessment of this proposal see E. Wymeersch, ‘Reforming the Second
Company Law Directive’, Financial Law Institute Working Paper No. WP2006–15,
November 2006.
 Some aspects of capita l m aintena nce l aw in the U K 281

(hereafter ‘DTI’)),27 the Minister for Industry and the Regions declared
that one change would be implemented and further consultation would
be carried out on another.28
Also in line with the proposals of the Winter Group, the Commission
engaged KPMG to produce a report on the feasibility of an alternative
regime and the impacts of IFRS on profit distribution in October 2006.
Prior to the production of this report however, the Commission adopted
an updated simplification programme in a bid to reduce administra-
tive burdens and boost Europe’s economy. Company law was identified
as one of the priority areas within this initiative and the Commission
asked in this context, amongst other things, whether the SCL Directive
should be partly or wholly repealed or simplified.29 In December 2007
the Commission produced a synthesis of the reactions it received,30
which revealed that whilst most respondents took the view that further
action should not be taken prior to the completion of the report, a large
majority of the respondents who expressed a view on the matter opposed
repealing the SCL Directive.31
The KPMG report was finally published in January 2008. This report,
inter alia, compared administrative burdens under the current regime
with those under different regimes extant in other jurisdictions or pro-
posed in the literature. One conclusion reached is that the compliance
costs of the different regimes, including therefore the regimes based on
the SCL Directive, is generally not overly burdensome and so reduction
of these costs is unlikely to be a motivation for the transition to an alter-
native regime. Even if one accepts these fi ndings as robust and signifi-
cant, it must be emphasized that the focus here appears to be fi rmly on
administrative costs and not on other important considerations which
could justify repealing the SCL Directive (such as allowing enhanced
27
DTI, Directive Proposals on Company Reporting, Capital Maintenance and Transfer
of the Registered Office of a Company: A consultation document, (March 2005). DTI,
Implementation of Companies Act 2006: A Consultative Document, (February 2007).
Most of the UK documentation on this matter can be found at www.berr.gov.uk/bbf/
index.html
28
Written statement – Companies Act 2006: Government response to consultation, 6 June
2007. Th is is available on the BERR website.
29
European Commission, Communication from the Commission on a simplified business
environment for companies in the areas of company law, accounting and auditing, COM
(2007) 394 fi nal, Brussels, 10 July 2007, 5–6.
30
European Commission, Synthesis of the reactions received to the commission commu-
nication on a simplified business environment for companies in the areas of company
law, accounting and auditing, COM (2007) 394, Brussels, December 2007.
31
Ibid., p.5.
282 Perspectiv es in compa n y l aw

flexibility and removing regulation that has a redundant purpose or a

purpose that is achieved more efficiently by other means). The report
also examined the impacts of IFRS on profit distribution and explained
the effects of the introduction of a new regime.
On the basis of this report, the Directorate General Internal Market
and Services concluded, rather disappointingly, that:
the current capital maintenance regime under the Second Company Law
Directive does not seem to cause significant operational problems for
companies. Therefore no follow-up measures or changes to the Second
Company Law Directive are foreseen in the immediate future.32

The momentum for substantially altering or even repealing the SCL

Directive thus seems to have been brought to a grinding halt by this
report of massive proportion yet narrow conclusions.
The latest developments at an EU level will be met with dismay by
many33 in the UK where a general sense of hostility towards the capi-
tal maintenance regime seems to prevail. The dismissive views of many
prominent academics are well documented,34 as are those of the influ-
ential Rickford Group.35 Indeed out of the four regimes proposed in the
literature and discussed in the KPMG report,36 that proposed by the
Rickford Group represented the most radical departure from the cur-
rent regime. More importantly, the UK Government has been clear in its
32
DG Internal Market and Services, Results of the external study on the feasibility of an
alternative to the Capital Maintenance Regime of the Second Company Law Directive
and the impact of the adoption of IFRS on profit distribution, Brussels, January/February
2008, 2.
33
Clearly not by all – see the response of the Association of British Insurers, and to a
lesser extent, the Confederation of British Industry to the Communication from the
Commission on a simplified business environment for companies in the areas of com-
pany law, accounting and auditing, http://ec.europa.eu/internal_market/company/
simplification/index_en.htm
34
J. Armour, ‘Share Capital and Creditor Protection: Efficient Rules for a Modern
Company Law?’, 63 Modern Law Review (2000), 355; J. Armour ‘Legal Capital: An
Outdated Concept?’, European Business Organisation Law Review, 7 (2006), 5; E. Ferran,
‘The Place for Creditor Protection on the Agenda for Modernisation of Company Law in
the European Union’, European Company and Financial Law Review, 3 (2006), 178.
35
Th is group was established on the joint initiative of the Accounting Standards Board
and the Company Law Centre at the British Institute of International and Comparative
Law. The group produced a report that considers and makes recommendations about
reform of the law and practice relating to company capital maintenance regimes. J.
Rickford (ed.), ‘Reforming Capital: Report of the Interdisciplinary Group on Capital
Maintenance’, European Business Law Review, 15 (2004), (hereafter ‘Rickford Report’).
36
See also the FEE’s informative discussion paper: FEE, FEE Discussion Paper on
Alternatives to Capital Maintenance Regimes, September 2007, at www.fee.be.
 Some aspects of capita l m aintena nce l aw in the U K 283

view that the SCL Directive should be repealed.37 In a recent publication

the BERR in fact explains that ‘the existence of outdated and ineffec-
tive provision in the Directive significantly constrained the scope for
simplifying the capital maintenance and distributions provisions now
contained in the 2006 Act’.38 As will become clearer in the following sec-
tion, this does not mean that the UK would have completely dismantled
the capital maintenance regime if it were not for the Directive. Further
relaxations would undoubtedly have been made but these might not
have been as extensive as some, especially those viewing the UK debates
from the Continent, seem to believe.39

III. Initial capitalization

As stated earlier, English company law places no significant barriers to
obtaining corporate form. The statistics on initial capitalization of com-
panies in Tables 1–3 graphically illustrate this.40
These figures will not, of course, reflect the true ‘economic’ capital of
a company, as opposed to its legal capital, as capital in the form of debt,
particularly in the form of bank loans supported by directors’ guarantees,
plays a major role in the corporate financing of small and medium-sized
companies.
As a requirement for registration of a company, the application
must in ‘the case of a company that is to have a share capital, a state-
ment of capital and initial shareholdings’.41 The statement of capital
must state, inter alia , the total number of shares which are to be taken
by the subscribers to the company’s memorandum42 and the aggre-
gate value of those shares.43 This gives a snapshot of the company’s
capital and the point of registration and it is intended to implement

37
BERR, European Commission consultation on the simplification of EU company law
and accounting and audit regulation: Note and Request for Views by the Department
for Business, Enterprise and Regulatory Reform. August 2007.
38
Ibid. para. 16. See also White Paper 2005, (note 19, above), 42–3.
39
Ferran notes, for example, that some Continental commentators have tended to errone-
ously assume that the UK Government is in favour of radical deregulation on distribu-
tions. E. Ferran, Book Review of Legal Capital in Europe edited by Martin Lutter, Journal
of Corporate Law Studies, 7 (2007), 357.
40
DTI, Companies 2004–2005 (note 3, above), Tables A2, B1 and B2.
41
CA 2006, s. 9(4)(b).
42
A company can be formed by one person subscribing to its memorandum: CA 2006, s. 7.
43
CA 2006, s. 10(2).
Table 1. Analysis of companies on the register at 31 March 2005 by issued share capital (from Table A7 in DTI,
Companies 2004–2005)

England & Wales Scotland Great Britain

No. of Issued No. of Issued No. of Issued

companies capital companies capital companies capital
Issued share capital 000s £m 000s £m 000s £m
No issued share
capital 82.0 0.0 4.9 0.0 86.9 0.0
Up to £100 1,509.5 48.8 80.1 2.4 1,589.7 51.2
£100 to £1,000 87.2 29.0 3.9 1.3 91.1 30.3
£1,000 to £5,000 150.2 204.2 7.7 11.3 157.9 215.4
£5,000 to £10,000 25.2 157.8 2.1 13.2 27.3 171.1
£10,000 to £20,000 39.7 462.7 3.8 44.6 43.5 507.3
£20,000 to £50,000 32.9 965.3 3.7 108.9 36.6 1,074.1
£50,000 to £100,000 30.2 1,862.0 2.7 172.9 32.9 2,035.0
£100,000 to £200,000 24.3 3,016.0 2.4 296.3 26.6 3,312.3
£200,000 to £500,000 20.2 6,049.7 1.7 516.1 21.9 6,565.8
£500,000 to £1m 11.1 7,332.9 0.9 605.5 12.0 7,938.4
£1m + 31.8 1,697,378.0 1.8 79,847.8 33.6 1,777,225.8
Total 2,044.4 1,717,506.5 115.7 81,620.3 2,160.0 1,799,126.9
Table 2. New incorporations of companies with share capital: analysed by amount of nominal capital, 2000–1
to 2004–5 (from Table B1 in DTI, Companies 2004–2005)

Nominal share capital 2000–1 2001–2 2002–3 2003–4 2004–5

England and Wales
Up to £100 61.4 57.0 89.8 135.5 112.8
£100 to £1,000 1.2 1.2 2.2 2.4 3.0
£1,000 to £5,000 122.7 117.0 166.6 180.8 154.1
£5,000 to £10,000 0.9 0.8 1.2 1.2 1.7
£10,000 to £20,000 12.8 12.2 17.1 17.7 14.2
£20,000 to £50,000 1.1 0.9 1.5 1.8 1.6
£50,000 to £100,000 2.9 2.3 2.8 2.9 2.4
£100,000 to £200,000 10.2 10.0 13.0 13.2 10.6
£200,000 to £500,000 1.2 0.9 1.4 1.3 1.0
£500,000 to £1m 1.1 1.0 1.4 1.3 1.2
£1m + 5.7 4.6 5.6 5.8 6.4
Companies with share
capital 221.2 207.9 302.6 363.9 309.0
Companies without share
capital 5.0 5.3 6.2 7.5 8.4
Table 3. Analysis of companies incorporated in 2004–5 by issued share capital (from Table B2 in DTI, Companies
2004–2005)

England & Wales Scotland Great Britain

Issued No. of Issued No. of Issued No. of Issued
share companies capital companies capital companies capital
capital 000s £m 000s £m 000s £m

No issued share capital 22.2 0.0 0.6 0.0 22.7 0.0

Up to £100 265.0 5.7 14.6 0.3 279.6 6.0
Over £100 & under 2.7
£1,000 8.4 2.5 0.4 0.1 8.8
£1,000 & under £5,000 16.5 17.9 0.7 0.7 17.2 18.7
£5,000 & under £10,000 0.6 3.4 0.0 0.2 0.6 3.6
£10,000 & under 15.0
£20,000 1.3 14.4 0.1 0.6 1.4
£20,000 & under 18.3
£50,000 0.6 16.7 0.1 1.6 0.6
£50,000 & £100,000 0.8 47.7 * 1.8 0.8 48.9
£100,000 & over 1.9 29,532.6 0.1 123.6 2.0 29,656.2
Total 317.3 29,640.4 16.5 128.9 333.7 29,769.3

* Fewer than 50 companies

 Some aspects of capita l m aintena nce l aw in the U K 287

Article 2 of the SCL Directive.44 A public company must possess the

minimum capital of £50,000 or the Euro equivalent;45 this is needed
to comply with Article 6 of the SCL Directive. What is interesting is
the figure has not been altered since the Directive was introduced in
1991. Given the figure was settled over a quarter of a century ago, it
is clear is that neither the EU nor the UK makes any serious attempt
to ensure that when a company starts life it possesses any significant
shareholder capital.
The CLRSG had noted that it was obliged to retain this requirement
by the SCL Directive but initially asked whether the amount should
be increased, reduced or retained.46 After consultation, it proposed
to retain the same amount subject to the power to vary it. The Winter
Group noted that the only function this requirement has is to prevent
the light-hearted setting up of public companies, but concluded that
since there is no evidence that this constitutes much of a hurdle to
business activity it would be wise not to spend too much time consid-
ering it. It thus proposed not to alter it.47 The Rickford Group rightly
attacked this approach arguing that useless provisions are always worth
repealing.48
Under the 1985 Act, public companies were not only subject to min-
imum capital requirements, they were also required to adopt a limi-
tation on the number of shares they could issue. Indeed, both public
and private companies were required to state their authorised share
capital in the memorandum of association, and this acted as a ceiling
on the number of shares they could issue. The CLRSG proposed abol-
ishing this requirement,49 and this was taken up by the Government in
the White Paper 2005 which noted that this amount is usually set at a
higher level than the company will ever need and thus serves no use-
ful purpose. The White Paper also pointed out that companies would
still be able to include such a ceiling in their constitutions if it was so
desired. 50

44
77/91/EC.
45
CA 2006, ss. 761–7.
46
DTI, Company Formation and Capital Maintenance (London, October 1999, URN
99/1145), para. 3.17.
47
Winter Report, (note 23, above), 82.
48
Rickford Report, (note 35, above), 13.
49
DTI, Completing the Structure (London, November 2000, URN 00/1335) para. 7.6 and
DTI, Final Report, (note 17, above), para. 10.6.
50
White Paper 2005, (note 19, above), 43.
288 Perspectiv es in compa n y l aw

IV. Payment for shares

A. Par value – no discount rule
Under the 1985 Act both private and public companies were required to
have a fi xed par (or ‘nominal’) value for their shares. Shares could not be
issued at a discount to their par, and if they were issued at a price higher
than their par, the difference between the two, known as the share pre-
mium had to be placed in a share premium account that would be treated
for most purposes in the same way as share capital.
These measures are retained in Chapter 17 of the 2006 Act. Section 580
thus prohibits a company from allotting its shares at a discount, a prohi-
bition that was considered to be part of the common law.51 In Ooregum
Gold Mining Co Ltd v. Roper52 a company had gone into liquidation but
application was stayed because fresh capital was to be introduced into
the company. Subscribers were found for 120,000 £1 preference shares.
The shares were allotted for 5 shillings (25p in today’s currency) with the
remaining 15 shillings (75p in today’s currency) being treated as having
been paid up. The company proved successful and a holder of ordinary
shares brought an action broadly to have the allotment declared invalid
and that the holders of the preferred shares should be obliged to pay the
15 shillings that had been credited on the preference shares. The action
was successful. This, of course, was greatly to the benefit of the ordinary
shareholders.53 However, the price at which the shares were issued was
the only realistic one attainable because of the precarious fi nancial state
of the company. The ordinary shareholders could have argued, but did
not, that it was against their interests in that the dividend payable on
the preference shares would be related to the nominal value of the share
and not the amount paid up on the preference share;54 this, however, is
an issue relating to dividend policy and not capital maintenance. The
reasoning of the court was that the relevant legislation55 required a com-
pany to state in its memorandum ‘the amount of capital with which the
company proposes to be registered divided into shares of a certain fixed
51
Walworth v. Roper [1892] AC 125 at 145. The courts also held that a company could not
purchase its own shares: Trevor v. Whitworth (1887) 12 App Cas 409.
52
[1892] AC 125.
53
There was evidence to suggest that the money was to be used to pay off a debenture.
54
Th is was undoubtedly the reason why the shares were issued as £1 shares and not as
shares with a nominal value of 5 shillings. Modern draft ing of the dividend rights of
preference shares normally relates the dividend payable to the amount paid up on the
shares. However, partly paid shares of any class are very uncommon in the UK.
55
Companies Act 1862, s.7 (italics added).
 Some aspects of capita l m aintena nce l aw in the U K 289

amount’ and this entailed that the ‘fi xed amount’ had to be fully paid.
The case thus turned on a tightly technical analysis of the relevant statu-
tory language. There was no analysis of the principle. However, the court
clearly appreciated that the rule would make it difficult for a company
to raise capital where its shares are trading at a discount. More impor-
tantly, the court did not address the point that where shares are issued
at a discount this cannot ever cause prejudice to creditors as in the event
of a company’s insolvency shareholders come last so that creditors will
inevitably benefit from any shareholder contribution.56
This point was noted, however, by the CLRSG in the recent review.
The CLRSG also noted that par values rapidly cease to have any signif-
icance (as the true economic value of the shares can rise or fall) and
merely tended to confuse the layman. It viewed par value requirements
as an anachronism and favoured their abolition for both public and pri-
vate companies,57 thus allowing companies to issue no par value (NPV)
shares, the value of which would simply correspond to a fraction of the
economic value of the company as a whole. If such shares were allowed,
the no discount rule would obviously also be discarded as would the
concept of share premiums. Removing par values could be the first step
in dismantling the capital maintenance regime, but, significantly, the
CLRSG did not go so far. In fact, it favoured placing the funds subscribed
for NPV shares, less the amounts paid out in expenses and commission
on the issue of those shares, into an undistributable reserve account.
The CLRSG recognized that the SCL Directive, which indirectly
requires shares of public companies to have par or fractional values
(‘accountable par’), stood in the way of the adoption of this proposal for
public companies. It thus proposed the abolition of par value require-
ments for private companies.58 Many respondents were ‘sympathetic’
to this proposal but a large majority opposed it on the ground that it
could not be extended to public companies. The CLRSG thus dropped
the proposal whilst reiterating its preference for NPV shares59 and rec-
ommending that the DTI (now the BERR) continues to pursue change
56
Existing shareholders may be prejudiced by the potential dilution effect but this is not a
concern of capital maintenance rules.
57
DTI, The Strategic Framework, (note 21, above), para. 5.4.27. The possibility of abandon-
ing the par value requirement was raised in the very fi rst document produced in the UK
review in 1998. DTI, Modern Company Law, (note 16, above), 7.
58
DTI, The Strategic Framework, (note 21, above), paras. 5.4.26–5.4.32; DTI, Company
Formation and Capital Maintenance, (note 46, above), para. 3.8.
59
DTI, Company Formation and Capital Maintenance, (note 46, above), para. 7.3; DTI,
Final Report, (note 17, above) , para. 10.7 and 338.
290 Perspectiv es in compa n y l aw

on this issues in the appropriate EU fora.60 Both the SLIM Group61 and
the High Level Group62 found NPV shares worthy of further investi-
gation, indeed, the latter noted that wide demand for such shares was
being expressed by the financial industry and the legal professions.63
Unfortunately, however, this did not lead to any amendment of the SCL
Directive in this respect.

B. Share premiums
As seen, shares can be issued at price above par, i.e. at a premium;
however, the no-discount rule does not require a company to allot its
shares at a premium where they are trading in the market at a premi-
um.64 Directors who fail to obtain the maximum price from subscribers,
namely a price that includes any available premium, may be in breach
of duty and liable to pay the premium which could have been obtained
as damages.65 Obviously directors can forego a premium in the case of
a rights offer, an employees’ share scheme, or in offering share options
to senior management. All these are seen as providing corporate benefit
and can for this reason be defended as providing directors with the nec-
essary flexibility to structure the company’s capital. However, it is this
very flexibility that the no-discount rule denies.
Curiously, the SCL Directive is silent as to how share premiums are to
be treated if shares are issued at a premium. As a result, Member States
that did not adopt the UK’s logical but gold-plating approach of treat-
ing share premiums in almost the same manner as share capital have a
much more flexible, if not fully coherent system in place.66 The Rickford
Group appeared to favour taking full advantage of this by allowing more
freedom in the use of share premiums,67 yet the CLRSG actually pro-
posed tightening the regime to make it more coherent. In fact, it pro-
posed removing the possibility available under the 1985 Act of using
share premiums for the payment of the initial expenses of the com-
pany, commissions or discounts paid or allowed on the issue of other

60
DTI, Final Report, (note 17, above), 340.
61
SLIM Report, (note 22, above), 5–6.
62
Winter Report, (note 23, above), 82–3.
63
Ibid., 82.
64
Hilder v. Dexter [1902] AC 474.
65
Lowry v. Consolidated African Selection Trust Ltd [1940] AC 648 at 679.
66
See the Rickford Report, (note 35, above), 20–3.
67
Ibid., 21.
 Some aspects of capita l m aintena nce l aw in the U K 291

shares or debentures, or to the premium payable on the redemption of

debentures,68 and this was accepted by the Government in the White
Paper 2005.69

C. Non-cash consideration
One final aspect of the no-discount rule that is worthy of mention relates
to the issue of shares for a non-cash consideration, for example, goods
or services.70 Under the common law, this was allowed provided there is
no bad faith71 or the directors failed to place any finite value on the non-
cash consideration being exchanged for the shares.72 As was stated in Re
Wragg Ltd:73
Provided a limited company does so honestly and not colourably, and pro-
vided that it has not been so imposed upon as to be entitled to be relieved
from its bargain it appears to be settled . . . that agreements by limited
companies to pay for property or services in paid-up shares are valid and
binding on the companies and their creditors.

There remains the critical issue of how the non-cash consideration is to

be valued. On this the courts deferred to the valuation by the parties:74
The value paid to the company is measured by the price at which the com-
pany agrees to buy what it thinks it worth its while to acquire. Whilst the
transaction is unimpeached, this is the only value to be considered.

Thus price is value. While it was understandable that courts would not
wish to leave embroiled in assessing the commercial merits of a trans-
action, their severe hands-off approach undermined the no discount
principle.75 Directors are under a duty:
to consider very carefully how few shares they can issue to achieve the
desired acquisition of any particular asset, and, of course, for that purpose,

68
DTI, Company Formation and Capital Maintenance, supra n. 46, para. 3.12. DTI,
Completing the Structure, supra n. 49, 7.8.
69
White Paper 2005, (note 19, above), 42.
70
See CA 2006, s. 482.
71
Hong Kong and China Glass Co. v. Glen [1914] 1 Ch 527; Re White Star Line Ltd [1938] 1
All ER 607.
72
Tintin Exploration Syndicate Ltd v. Sandys (1947) 177 LT 412.
73
[1897] 1 Ch 796, at 880.
74
[1897] 1 Ch 796, at 831.
75
Public companies must now have non-cash consideration valued by an independent
valuer. CA 2006, Part 17, Chapter 6.
292 Perspectiv es in compa n y l aw

to have a very firm idea of what are the respective values of the property
being acquired and their own company’s shares.76

However this does not have the same imperative effect as a capital main-
tenance rule.
The above still represents the law for private companies. Public com-
panies, on the other hand, are subject to a much stricter regime. Article
7 of the SCL Directive prohibits shares to be issued for an undertaking
to perform work or supply services, article 9 prohibits the issue of shares
for an undertaking to be performed in more than five years time, and
articles 10 and 27 require independent experts to value non-cash con-
sideration received as payment for shares. The CLRSG did not devote
much time to this issue. In one of its early consultation documents, it
noted that the provisions dealing with these matters in the 1985 Act
implemented the requirements of the SCL Directive, and it proposed
some minor simplifications and modifications.77 Th is issue was not
pursued further in the later documents it produced. In contrast, there
have been noticeable developments on the EU front. The SLIM Group
argued that expert opinions ‘were not always useful or necessary, and
that the number of cases in which they are not required should be
increased’.78 They thus proposed eliminating this requirement when
the consideration consisted of shares traded on a regulated market or a
recent valuation was present. The High Level Group agreed, adding that
these valuations are expensive and do not offer a total guarantee of the
asset’s real value.79 They thus supported the SLIM Group’s recommen-
dations to eliminate this requirement in the above instances, adding
that it should also be eliminated when the values could be derived from
audited accounts.
The Commission followed these recommendations and thus the
SCL Directive was amended by eliminating the need for an expert
valuation in the above three instances. Minority shareholders are,
however, given the right to require a valuation in these instances if

76
Shearer v. Bercain [1980] 3 All ER 295, at 307.
77
DTI, Company Formation and Capital Maintenance, (note 46, above), 25–26.
78
SLIM Report, (note 22, above), 5.
79
Winter Report, (note 23, above), 83. See also the criticism made by the Rickford Group,
Rickford Report, (note 35, above), 16–18. The Winter Group also recommended that the
Commission review the possibility of allowing, with appropriate safeguards, the provi-
sion of services as contribution in kind, which is banned by article 7 of the SCL Directive,
as it might be particularly useful for start-ups and technological or professional compa-
nies and other companies in which specialized services are important assets.
 Some aspects of capita l m aintena nce l aw in the U K 293

certain conditions are met. 80 The UK Government welcomed these

proposals, yet voiced concerns about the fact that some of the terms
used in the proposed relaxations were not defined. It thus believed
that there would be uncertainty as to whether the conditions for
being exempt from valuation requirements were met, which, when
coupled with the possibility that the minority shareholders could
still require a valuation, would reduce the take-up of the relaxed pro-
visions. 81 Thus there is no intention to introduce these relaxations in
the UK.

V. Financial assistance by company in

acquisition of own shares
Since the Companies Act 1929, the companies legislation has prohibited
the providing of financial assistance by a company in connection with
the acquisition of its own shares or that of its parent company. The pro-
hibition was enacted ‘as a result of the previous common practice of pur-
chasing shares of a company having a substantial cash balance or easily
realizable assets and so arranging matters that the purchase money was
lent by the company to the purchaser’.82 The prohibition is designed to
prevent the resources of a target company or its subsidiaries in a takeo-
ver are not ‘used directly or indirectly to assist the purchaser fi nancially
to make the acquisition’.83 Obviously, financial assistance could take
the form of a gift84 but normally in a commercial context it would be a
breach of director’s duties to make gifts. The prohibition is also directed
against the entering into of imprudent transactions which could preju-
dice creditors and minority shareholders who were not participants in
the transaction.85
The UK ban on financial assistance thus pre-dated the SCL Directive,
which requires the imposition of a ban under article 23, but has since
become one of the most controversial and criticized parts of UK com-

80
See Directive 2006/68/EC Article 1 (2).
81
DTI, Directive Proposals on Company Reporting, Capital Maintenance and Transfer of
the Registered Office of a Company: A consultation document, London, March 2005. It
would also not lead to a simplification of the law. DTI, Implementation of Companies Act
2006 Consultative Document, (London, February 2007), para. 6.23.
82
Chaston v. SWP Group plc [2003] BCC 140, at 150 citing Re VGM Holdings [1942] Ch 235,
at 239.
83
Chaston v. SWP Group plc [2003] BCC 140, at 151.
84
See CA 2006, s. 677(1)(a).
85
See CA 2006, s. 677(1)(b)–(d) for other forms of financial assistance.
294 Perspectiv es in compa n y l aw

pany law.86 The 1985 Act thus curtailed the strength of the ban for private
companies by allowing them to provide financial assistance with respect
to the acquisition of their shares but only on restricted conditions. In
particular the directors of the company giving the financial assistance
had to make a statutory declaration87 broadly to the effect inter alia that
the company would be able to pay its debts as they fell due during the
year immediately following the provision of the fi nancial assistance.88
Also, in addition the auditors had to make a report that they were not
aware of anything to indicate that the director’s declaration of solvency
was unreasonable.89 The importance of the Companies Act 1985 provi-
sions on financial assistance is that they embodied two techniques for
protecting creditor interests: a solvency declaration of directors which
places the responsibility on them for ensuring there is no creditor preju-
dice and external verification (the auditor’s report) that the views of the
directors were reasonable.
Despite the relaxation found in the 1985 Act, the provisions dealing
with financial assistance were singled out right from the start of the UK
review. Financial assistance was in fact targeted in the document that
kick-started the review as being ‘notoriously difficult’; it was also noted
that ‘legal and auditing fees are often incurred to ensure that innocent
and worthwhile transactions do not breach these rules’.90 This is not
surprising given that the ban on fi nancial assistance was criticized – to
varying extents – in reports prepared by various committees in the UK
going back to 1961.91
Initially, the CLRSG thought the complete removal of the ban for pri-
vate companies too radical and thus proposed simplifying the white-
wash procedure. It also proposed making some minor changes for public
companies by, essentially, broadening the exceptions to the prohibition
and creating new ones.92 Emboldened by the responses it received, the

86
See E. Ferran, ‘Corporate Transactions And Financial Assistance: Shift ing Policy
Perceptions But Static Law’, Cambridge Law Journal, 63 (2004), 225, and Rickford Report,
(note 35, above), 25–7.
87
CA 1985, s. 155(6).
88
CA 1985, s. 156(2)(b). Th is declaration of solvency had to include contingent and pro-
spective liabilities: s. 156(3).
89
CA 1985, s. 156(4).
90
DTI, Modern Company Law, (note 16, above), para. 3.3. See also DTI, Developing the
Framework, (London, March 2000, URN 00/656), para. 7.19.
91
Jenkins Committee. For a history of the ban see E. Ferran, ‘Company Law and Corporate
Finance’ (Oxford University Press, 1999), 374–6.
92
DTI, Company Formation and Capital Maintenance, (note 46, above), para. 3.42.
 Some aspects of capita l m aintena nce l aw in the U K 295

CLRSG eventually came down in favour of the complete removal of

the ban for private companies,93 whilst also retaining its proposal for
minor changes for public companies.94 In the White Paper 2005 the
UK Government accepted the CLRSG’s proposal to remove the ban for
private companies, agreeing that abusive transactions could be control-
led in other ways, e.g. directors’ duties, wrongful trading and market
abuse provisions.95 It declined the proposals to carry out minor changes
for public companies, saying that it would give priority to the CRLSG’s
overarching recommendation for fundamental reform through reform
of the SCL Directive.96 Section 678 of the 2006 Act thus continues the
proscription of financial assistance but only with respect to a public com-
pany or the subsidiary of a public company providing such assistance.
The two regulatory features for protecting creditor interests in private
companies (a solvency declaration of directors and external verification)
were both jettisoned in the 2006 Act.
Reform at the EU level has also been forthcoming. The SLIM Group
proposed that the ban should be reduced to a practical minimum, sug-
gesting that this could be done by either limiting financial assistance
to the amount of the distributable net assets or by limiting the ban to
assistance for the subscription of new shares.97 The High Level Group
favoured the former solution subject to the introduction of a number
of safeguards.98 The 2004 proposal thus allowed for financial assistance
to be given up to its distributable reserves if considerably demanding
conditions were met. Once again, the UK Government did not respond
enthusiastically to this proposed amendment. It opined that due to the
complexity and onerous nature of these conditions, it was unlikely that
companies would utilize such a gateway procedure.99 These conditions
have been watered down in the actual amendment to the SCL Directive,100

93
DTI, Developing the Framework, (note 90, above), para. 7.25; DTI, Completing the
Structure, (note 49, above), paras. 2.14 and 7.12 and DTI, Final Report, (note 17, above),
para. 10.6.
94
DTI, Completing the Structure, (note 49, above), paras. 7.13–7.15; DTI, Final Report, (note
17, above), para. 10.6.
95
White Paper 2005, (note 19, above), 41. See also DTI, Developing the Framework, (note
90, above), paras. 7.18–7.25.
96
White Paper 2005. (note 19, above), 43.
97
SLIM Report, (note 22, above), 7.
98
Winter Report, (note 23, above), 85.
99
See also E. Ferran, ‘Simplification of European Company Law on Financial Assistance’,
European Business Organization Law Review, 6 (2005), 93.
100
Article 1 (6).
296 Perspectiv es in compa n y l aw

however, this has not been sufficient to move the UK Government to

adopt this gateway procedure.

VI. Reductions of capital

Under the 1985 Act companies, both private and public, could reduce
their capital by means of a special resolution of shareholders and confir-
mation by court. Courts were thus entrusted with the role of protecting
creditors. Creditors were given a right to object to a reduction even if it
would not imperil their claim and they could block the reduction unless
their debt or claim was discharged, determined or secured.101 Courts,
however, could dispense with this requirement, and in practice they gen-
erally did when reductions were structured to ensure that the creditors’
interests would not be adversely affected by the reduction.102 The CLRSG
deemed this procedure inefficient since it could unjustifiably improve a
creditor’s position (e.g. by obtaining security). It was also known to be
costly and time-consuming.103
The CLRSG thus proposed a simpler and more efficient approach,
which would allow companies to reduce their capital by means of a spe-
cial resolution of shareholders and a declaration of solvency by direc-
tors. Essentially, therefore, this proposal sought to replace an onerous
creditor protection mechanism with a less onerous one. Once again
the SCL Directive stood in the way of the adoption of this approach for
public companies, yet this time only partially so. In fact, the UK had
gold-plated the provisions on reductions of capital by requiring court
approval for every reduction of capital. Under article 32 of the SCL
Directive on the other hand, Member States are required to give credi-
tors whose rights antedate the publication of the reduction a right to
obtain security for their claims, but this can be set aside if the creditor
has ‘adequate safeguards’ or the latter are not necessary in view of the
assets of the company. It is only if a creditor is not satisfied with the
above that he must he given a right to apply to a court.104 Furthermore,
under article 33, Member States are not required to apply these credi-
tor protection mechanisms if the reduction is carried out to offset losses

101
CA 85 ss. 136, 137.
102
E. Ferran, ‘Company Law and Corporate Finance’, (Oxford University Press, 1999), 368.
103
DTI, Modern Company Law, (note 16, above), para. 3.2. White Paper 2005, (note 19,
above), 41.
104
There has been a recent change in Article 32 of the SCL Directive which shall be dis-
cussed further on.
 Some aspects of capita l m aintena nce l aw in the U K 297

incurred or create an undistributable reserve of not more than 10% of the

reduced capital. The CLRSG thus proposed allowing reductions of capi-
tal for both private and public companies to take place by means of a
special resolution and the production of a solvency statement, subject
to the right of creditors of public companies to object. This right would
not be available if the reduction was being made to write of losses or to
create an undistributable reserve of not more than 10% of the reduced
capital. In effect, therefore, the CLRSG was suggesting simplifying this
procedure for public companies by dismantling the gold-plating.
At first it was proposed that this procedure would simply replace the
old court approval procedure. Following the views expressed by most
respondents to the consultation, however, the CLRSG proposed to retain
the court approval procedure alongside the new procedure, as an option
for companies.105
Government put forward the CLRSG’s proposals in the White Paper
2002 but in the light of the mixed responses it received, it chose only to
proceed with the proposals for private companies.106 In its White Paper
2005 it explained that whilst many were in favour of simplifying the pro-
cedure for reductions, concern was expressed that due to the additional
safeguards put in place for public companies few would actually make
use of it.107
Under the 2006 Act, therefore, a private company may carry out a
reduction of capital either by obtaining court approval or by the mere
expediency of producing a directors’ solvency statement. These two
routes involve very different creditor protection mechanisms. In the lat-
ter case, the protection will be limited to a mere directors’ solvency state-
ment. Initially, it was suggested that solvency statements should here
be supported by an auditors’ report.108 Auditors’ reports increase time,
costs and administration, but provide creditors with greater reassurance.
They were required by section 156 of the 1985 Act in support of solvency
statements made in connection with financial assistance provided by
private companies, and are also required by section 714 of the 2006 Act
in support of solvency statements made in connection with a purchase

105
DTI, Completing the Structure, (note 49, above), para. 7.9; DTI, Final Report, (note 17,
above), para. 10.5. For a list of reasons as to why a private company might want to use
the court approval procedure see B. Hannigan and D. Prentice (eds.), The Companies Act
2006 – A Commentary (London: LexisNexis Butterworths, 2007), 175.
106
The new procedure is found in ss. 642–646 of the 2006 Act.
107
White Paper 2005, (note 19, above), 42.
108
DTI, Company Formation and Capital Maintenance, (note 46, above), para. 3.30.
298 Perspectiv es in compa n y l aw

of own shares by a private company out of capital. Following its review

of responses, the CLRSG came to doubt the need for this requirement
and thus dispensed with it, proposing that reductions should take place
under these less onerous conditions.109 Furthermore, one notes that the
2006 Act requires companies to publicize purchases of own shares out of
capital in the Gazzette and a national newspaper or by written notice to
each creditor,110 but no such requirement is imposed when carrying out
a reduction.
One minor change has, however, taken place for public companies. The
1985 Act required authorization in the Articles for a reduction to take
place both for private and public companies.111 The CLRSG proposed
abolishing this requirement given that shareholder approval was neces-
sary and that companies could include additional restrictions in their
constitutions.112 Under s. 641 (1) of the 2006 Act, the position has thus
been reversed as it simply allows companies to restrict or prohibit reduc-
tions by means of a provision in their articles. Further change is also in
prospect following the amendment of the SCL Directive. In line with the
suggestion of the High Level Group, the SCL Directive was amended to
shift the burden of proof that the reduction will prejudice creditors onto
creditors themselves.113 As a result of this amendment, which is meant
to avoid creditor hold-ups, the SCL Directive now requires Member
States to give creditors the right to apply to court only if they can cred-
ibly demonstrate that due to the reduction their claim is at stake and
no adequate safeguards have been obtained from the company. The UK
Government welcomed this change,114 yet at first considered its imple-
mentation unnecessary. It was noted, in fact, that companies that are
concerned that a creditor cannot demonstrate that a reduction would
affect the satisfaction of his claim, can ask the court to take this factor
into account.115 Presumably a court would then use its discretion and
dispense with the requirement of obtaining the creditor’s consent. In
the response it received, however, many indicated that an amendment

109
DTI, Developing the Framework, (note 90, above), para. 7.26; DTI, Completing the
Structure, (note 49, above), para. 7.10.
110
CA 2006, s. 719.
111
CA 2006, s. 135.
112
DTI, Completing the Structure, (note 49, above), para. 2.15.
113
Article 1 (9).
114
DTI, Directive Proposals on Company Reporting, Capital Maintenance and Transfer of
the Registered Office of a Company: A consultation document, March 2005, London 40.
115
Implementation of Companies Act 2006 Consultative Document, February 2007, London,
para. 6.24.
 Some aspects of capita l m aintena nce l aw in the U K 299

should be made nonetheless for the purposes of clarity, and so the UK is

now in the process of adopting this change.116

VII. Repurchase of shares and redeemable shares

Under the 1985 Act public companies could purchase their own shares,
whether redeemable or not, out of distributable profits or the proceeds of
a fresh issue of shares, a system of capital substitution. Private companies
could do so out of capital if a prescribed procedure, which included the
production of a declaration of solvency, was followed. The CLRSG pro-
posed to retain the substance of these rules subject to technical improve-
ments and the following more significant changes.117 Firstly, they proposed
abolishing, for private companies, the requirement under the 1985 Act for
authorization in the Articles to issue redeemable shares. Public companies
alone would be subject to this requirement. Secondly, they proposed abol-
ishing the requirement for authorization in the Articles for companies to
purchase their own shares.118 Thirdly, under the 1985 Act the terms and
manner of redemption had to be included in the Articles, but the CLRGS
proposed that these could be determined by the directors.119 Finally, they
proposed removing the special procedure for purchase of own shares out
of capital for private companies given that a much simplified procedure for
capital reduction was now being proposed.120 The Government accepted
all proposals save for the last,121 which was dropped on the grounds that
there could still be instances when this procedure would be available but
the new reduction procedure would not.

VIII. Conclusion
UK Company Law puts in place a number of mechanisms to protect
against abuse of the corporate form. The capital maintenance regime,
which is primarily meant to protect creditors, stands out as being the

116
BERR, Companies (Reduction of Capital Regulations) 2008, Draft Regulations October
2007. These came into force on 06/04/08.
117
DTI, Completing the Structure, (note 49, above), para. 7.16.
118
DTI, Completing the Structure, (note 49, above), para. 2.15.
119
DTI, Completing the Structure, (note 49, above), para. 7.17.
120
DTI, Completing the Structure, (note 49, above), para. 7.18; DTI, Company Formation
and Capital Maintenance, (note 46, above), para 3.62; DTI, Final Report, (note 17, above)
para. 10.6.
121
The rules on purchase of own shares out of capital are found in CA 2006 Part 18 Chapters
3–6.
300 Perspectiv es in compa n y l aw

one area in which substantial reliance is placed on ex ante quality con-

trol rules rather than ex post liability rules.
At least four types of mechanisms employed in the capital mainte-
nance regime to protect creditors can be identified. The first is the impo-
sition of mandatory rules, such as minimum capital requirements, the no
discount rule, the prohibition of certain types of non-cash consideration
and the ban on financial assistance. These rules should provide strong
protection for creditors due to their mandatory nature; however, their
lack of flexibility could, ultimately, have a deleterious effect on creditors.
Moreover, as seen, such rules can also be hopelessly misguided, again
doing more harm than good.
The second type of mechanism is that of court approval, such as that
employed in reductions of capital. Such a mechanism should clearly pro-
vide comfort for creditors; however the time and expense entailed for
the company might outweigh the benefits for the creditors. On the other
hand, companies which obtain court approval then enjoy certainty and
finality.
The third type of mechanism employed is that of solvency require-
ments and statements of solvency. Under the 1985 Act this was used, for
private companies, in the context of financial assistance and acquisition
of own shares out of capital. The 2006 Act has extended the use of this
mechanism to reductions of capital by private companies. This type of
mechanism is also found in other related areas of the law, such as in the
voluntary winding up of companies.122 As seen, this mechanism can be
tweaked to be more or less onerous on companies, and hence more or
less protective of creditors. Further protection can thus be provided by
requiring an auditors’ report in support of the statement of solvency and
imposing publicity requirements. One must not forget that the ex ante
control provided by statements of solvency are buttressed by rules that
impose ex post civil and even criminal liability123 in the event of default
by directors in making such statements.
The final protective mechanism is that of directors’ duties towards
creditors. Directors in the UK do not have a duty to take the interests of
creditors into account unless the company is insolvent or on the verge of
insolvency,124 however, certain duties that arise in the context of capital

122
Section 89 Insolvency Act 1986.
123
See CA 2006 ss. 643 and 715.
124
West Mercia Safetyweaer Ltd v. Dodd [1988] B.C.L.C. 250 C.A. The exact position under
the common law is somewhat controversial. See now also CA 2006 s. 172 (3).
 Some aspects of capita l m aintena nce l aw in the U K 301

maintenance might indirectly benefit creditors, such as those relating to

the issuing of shares for a non-cash consideration.
As seen, the UK legislator’s hands were tied when carrying out the
changes now found in the 2006 Act. The consultation documents and
the two White Papers reveal that there would have been further changes
if the SCL Directive did not stand in the way. There would not have
been a complete dismantling of the capital maintenance regime as some
might think, but there certainly would have been further relaxations.
The balance would probably have shifted towards ex post liability, cou-
pled, in some instances, with some light ex ante control, particularly in
the form of solvency statements. That appears to be the preferred way
forward in the UK.
 17

Luxembourg company law – a total overhaul

Andr é Prüm

I. Introduction
After many years of reacting only to new European directives – the best
analyses of which are by Professor Eddy Wymeersch, in whose hon-
our the present contribution is made – Luxembourg company law is
now undergoing major modernization, as demonstrated by the series
of innovative laws that have been adopted over the last two years. The
25 August 2006 Act on the European company (the Societas europaea or
SE), sociétés anonymes (public limited companies or SAs) with manage-
ment and supervisory boards and single-person private SAs, together
with the fi rst Act of 23 March 2007 reforming the mergers and divisions
(M&D) regime, and introducing partial asset contributions, transfers
of all assets and liabilities, arms of business and professional assets are
the key changes in the overhaul. The creation by the 11 May 2007 Act
of a separate framework for companies managing family assets is just
one further step intended to encourage the formation of companies
under Luxembourg law. At the margins of company law, the 19 May
2006 Act on takeover bids transposes Directive 2004/25/EC of the
European Parliament and of the Council of 21 April 2004. More mod-
estly, the second Act of 23 March 2007 on international mergers stops
a loophole in commercial company law while we await transposal into
Luxembourg law of the directive of 26 October 2005 on cross-border
mergers of companies with share capital. Of varying scope, these laws
all deal with specific matters but do not yet address company law as
a whole.
The Luxembourg government is now seeking to move beyond these
reforms and to modernize company law in its entirety. It has therefore
recently produced a bill amending the 10 August 1915 Act on com-
mercial companies along with several provisions in title IX of the Civil
Code that deal with companies. The bill (the Bill), which was submitted
to the Chamber of Deputies on 8 June 2007 under number 5730 and is

302
 Lu x embou rg compa n y law – a tota l over hau l 303

the result of a long-term project by the Ministry of Justice, supported

by the Laboratoire de Droit Economique,1 proposes a large number of
changes to the Act with the aim of making it clearer and more attractive.
The plan for codification à droit constant 2 will round off the ambitious
reform programme3. The Bill consequently adopts the realistic, consen-
sual approach typical of Luxembourg legislative intent in the field of
business law.
The small amount of Luxembourg case law, an obvious result of the
low number of disputes and limited quantity of doctrine such a small
country can produce, denies Luxembourg the luxury of total original-
ity in its approach to the law. Yet while Luxembourg law can of course
seek to differentiate itself from other legal systems through its generally
liberal philosophy and innovative solutions, natural caution prevents it
cutting itself off entirely from Belgian and French law. The Bill recog-
nizes this connection and in the comments on its various sections takes
care to point out the inspiration for the new provisions so that their
interpretation can benefit from the analyses and decisions that inspira-
tion provides.
The Ministry of Justice has been particularly careful to find out what
the legal professions want and to test their reactions to the solutions
provided. The dedicated Commission d ’ études legislatives (Legislation
Studies Committee) working group within the Ministry, which includes
representatives from the government, public authorities and the legal
professions that prepared the reform, has been the focal point for all
work. The consultation process was further enlarged by canvassing the
opinions of a number of eminent lawyers when work began and before
the Bill was finalized.
To prevent the huge number of changes involved in a full over-
haul of the 10 August 1915 Act producing just a jumbled patchwork
of results, the Bill is firmly anchored to the founding principle of the
Act, which Professor Nyssens, one of the originators of the initial text,
has summarized as, ‘contractual freedom for partners and protection
for third parties’. This dual objective, along with the aim of achieving

1
Created under the auspices of the Centre de Recherche public Gabriel Lippmann
and now attached to the Faculty of Law, Economics and Finance of the University of
Luxembourg.
2
Codification à droit constant subsumes the content of all previous relevant laws that are
not obsolete and then abrogates the laws themselves.
3
In the wake of Belgium and France, article IV of the Bill provides the legal basis for
statutory codification.
304 Perspectiv es in compa n y l aw

a delicate balance between the sometimes contradictory solutions it

can produce, are the key guidelines of the proposed reform and for its
analysis.

II. Greater freedom

The overarching purpose of company law is to provide economic
operators with a framework in which to share resources – tradition-
ally production resources – so that they can run a commercial or civil
business. The framework itself can be more or less flexible in deter-
mining authorized formats, the way in which a collective will can be
formed and expressed in those formats and how those formats are
financed. A liberal approach allows future members the widest possi-
ble choice on how their company will be structured, the organization
of the powers on which it is based and the ways in which it can issue
debt securities.
In these three areas (choice of structure, internal organization and
type of finance) the Bill opens new doors.

A. Greater choice of structures

In line with recent reforms, the Bill increases firstly the range of com-
pany formats available and secondly the number of ways in which an
existing company may be transformed or restructured.

1. Increased range of company formats to include the

société par actions simplifiée
The Bill proposes to introduce, in addition to the traditional company
formats and the SE introduced by the law of 26 August 2006, a société
par actions simplifiée (SAS). The idea is clearly of French inspiration and
derives from European company law in particular, which enables opera-
tors to avoid the constraints of the 2nd Directive on company law by
setting up an SAS. Since their introduction in 1994, French sociétés par
actions simplifiées have been a major success.
With the same objective, the Bill defines the société par actions simpli-
fiée as a company ‘whose capital is divided into shares and that is formed
by one or more persons who accept liability up to a limited sum only’.4
The main characteristic of an SAS is not so much this definition as the

4
Bill: art. 101–18 of the 1915 Act.
 Lu x embou rg compa n y law – a tota l over hau l 305

very significant freedom it gives shareholders to negotiate and create

both its organization and their own inter-relations.
The Bill thus gives shareholders free rein in the articles of association
to decide how their company is to be managed,5 which decisions must be
taken collectively by the shareholders and which by management alone.
In the case of shareholder decisions, the manner and terms of adop-
tion can also in principle be set out without restriction in the articles of
association.6
As regards relations between shareholders, the Bill allows the articles
of association to prohibit the disposal of shares for up to ten years and
to make disposals subject to prior approval by the company or to pre-
emptive right. The articles of association may also provide that in some
circumstances a member may be required to sell his shares.
These rules, which illustrate the significant freedom allowed to
shareholders, should ensure the SAS has a rosy future in many different
fields.

2. New transformation solutions

The 27 March 2007 Act has revolutionized merger and demerger law
by introducing new, additional ways of restructuring companies.
Previously applying to sociétés anonymes only, mergers and demerg-
ers can now be undertaken by any company with a legal personality
of its own and by economic interest groups. A long time coming, full
and partial contributions or transfers of assets and liabilities, includ-
ing of business arms, are a new addition to the range of restructuring
techniques allowed. Luxembourg company law therefore now permits
companies to use demerger law to transfer assets in the form of a single
transfer of all assets and liabilities. They no longer have to make separate
transfers of debts and receivables, which are often impossible in prac-
tice. At the same time, Luxembourg law has sought inspiration in Swiss
law to allow companies, groups and also single-person undertakings to
transfer professional assets. No time has been wasted in implementing
these new laws, particularly those relating to the transfer of business
arms, indicating that they are the answer to what was a pressing need.

5
Bill: art. 101–21 of the 1915 Act, ‘the articles of association set out the terms under which
the company will be managed’.
6
Bill: art. 101–25 of the 1915 Act, ‘the articles of association set out the decisions that must
be taken by the shareholders collectively and the terms and conditions under which this
shall be done’.
306 Perspectiv es in compa n y l aw

To complete the picture, the Bill proposes a reform of the com-

pany transformation regime which up to now has applied only to the
transformation of one commercial company into another and of civil
companies into commercial companies but not the reverse, or the trans-
formation of commercial companies into economic interest groups or
vice versa.7 Such restrictions have no justification. The Bill also allows
the transformation of any private entity with a legal personality (com-
pany or economic interest group) into any other form of company or
economic interest group.
The change would be accompanied by a proposed new transforma-
tion regime that is largely drawn from Belgian law (which takes quite
a liberal approach to the subject).8 The new measures are specifically
intended to protect members against increased liability to which they
have not agreed and third-party rights.9 For example, the Bill would pro-
tect capital if the transformation were from a type of company to which
the legal definition of ‘capital’ does not apply to a company based on
that very concept.10 Majority or unanimous voting rules would apply for
such decisions, depending on company type. A unanimous vote would
always be required to change from a general partnership to another
type of company or from a company with limited liability to one with
unlimited liability.11

B. Greater freedom to organize power within the company

Until the recent reforms, Luxembourg law took a traditional, not
particularly innovative approach to the organization and sharing
of power within the company. This can be seen firstly in its continu-
ing attachment to the principle of one share, one vote, where the only
7
Bill: art. 3 of the 10 August 1915 Act.
8
At present the only legislation in the area (apart from that allowing an SE to transform
into an SA or vice-versa, as allowed under articles 31–2 and 31–3 of the 10 August 1915
Act) is articles 3 (‘The rights of third parties are protected’), 46 (holders of shares that
do not carry voting rights acquire them for decisions on whether the company should
be transformed), 69(5) (‘If the capital reduction would bring the capital below the legal
minimum, the meeting of shareholders must at the same time decide either to increase
the capital by the appropriate amount or to transform the company’) and 137–1(4)
(‘The provisions relating to the formation of sociétés coopératives organised as sociétés
anonymes apply to the transformation of companies with other forms into sociétés
coopératives organised as sociétés anonymes’) of the 10 August 1915 Act.
9
Bill: art. II, 105, introducing arts. 308bis-15 to 308bis-27.
10
Bill: art. 308bis-16 to 308bis-20 of the 10 August 1915 Act.
11
Bill: art. 308bis-21(5), of the 10 August 1915 Act.
 Lu x embou rg compa n y law – a tota l over hau l 307

exception is non-voting shares that were introduced about twenty years

ago, and the system of non-equity parts bénéficiaires (income certifi-
cates) that do not necessarily carry voting rights. However, the total free-
dom with which the founders and shareholders of a société anonyme can
decide the extent of any voting rights and the number of votes attaching
to parts bénéficiaires, a freedom that distinguishes Luxembourg law from
Belgian law, can have a significant effect on the one share, one vote prin-
ciple. The reductive approach to management structures within sociétés
anonymes, which ignores the management committees that exist in all
major companies, is another example of the rather outmoded style of the
1915 Act.
By giving greater scope to the methods for organizing shareholders’
rights and powers and to modern types of management within sociétés
anonymes, while at the same time making it easier for decisions to be
taken using modern communication techniques, the Bill increases
members’ freedom in these areas.

1. Freedom to organize shareholders’ rights and powers

The main aims of the Bill are to make it easier to raise capital, to allow
more sophisticated allocation of power among shareholders and to allow
measures that will encourage a stable share register.
Allowing sociétés anonymes to issue shares of differing face value
clearly connects to the second objective while at the same time increas-
ing the means they can use to attract new investors. However, since
the number of voting rights depends on the size of the stake held, the
proportional equality of shareholders would remain protected.12 Funds
could also be raised thanks to the new powers to issue separate subscrip-
tion rights and shares of less than the fractional value of old shares.13
Looking to Belgian law, the Bill would also allow sociétés anonymes to
give priority rights at capital increases for which pre-emptive rights have
been cancelled or reduced.14 Replacing pre-emptive rights with prior-
ity rights should enable third parties to subscribe new shares in public
issues at the market price or near market price of the issuer’s old shares.
The introduction of shares carrying double voting rights, which
already exists under French law, would encourage greater loyalty by
rewarding shareholders who retain their shares for at least two years.

12
Bill: art. II, 22) and 43) amendments to arts. 37 and 67 of the 10 August 1915 Act.
13
Bill: art. II, 17) and 21) amendments to arts. 32 and 32–4 of the 10 August 1915 Act.
14
New art. 32–3 to the 1915 Act proposed by the Bill.
308 Perspectiv es in compa n y l aw

The Bill would not however adopt the French approach of restricting this
option to European shareholders only.15
Since the original reason for banning the sale of future shares or
bonds has disappeared,16 the Bill, following in the footsteps of changes in
Belgian law in this area, proposes that the restriction should be lifted.17
Future shares and bonds would therefore be regulated only by ordinary
law on the sale of future items as the sale is defined in article 1130 of the
Civil Code.

2. Freedom to organize and operate

management structures
The Luxembourg legislator has taken advantage of the arrival of the SE
to allow all sociétés anonymes to opt for a two-tier management system
with both a management board and a supervisory board. Few compa-
nies appear to have taken up the option so far but a large number have
set up management committees with powers far beyond those needed to
carry out day-to-day management. In banking the committee is almost
unavoidable if there is to be compliance with the ‘four eyes criterion’
(Vieraugenprinzip). At present, under the 1915 Act the board of directors
of a société anonyme can permanently delegate day-to-day management
only.
The Bill proposes that management committees should be officially
recognized and be subject to rules close to those adopted in Belgium in
2002, which allow the articles of association to permit boards of direc-
tors to delegate their management powers to a management committee
without this impinging on the company’s general policies or on any of
those areas that are by law reserved to the board of directors.18 Where
such delegation occurs, the board of directors is required to supervise
the management committee. To prevent objections to a potential con-
flict of powers, which Belgian law has not prevented, the Bill is careful to
point out that powers delegated to a management committee would be
exercised by that committee alone. In other words, the board of direc-
tors would not be able to reserve any residual authority in those areas.
For the protection of third parties, the Bill also states that any restric-
tions placed on the management powers delegated to a management

15
Proposed new art. 67 para. 4 bis to the 1915 Act.
16
To prevent agiotage.
17
By the abrogation of article 43, para. 1 and of article 79 of the 1915 Act.
18
Proposed new art. 60–1 of the 1915 Act.
 Lu x embou rg compa n y law – a tota l over hau l 309

committee and any distribution of duties among management commit-

tee members could not be enforced against third parties. The conflict
of interests regime that applies to members of boards of directors and
management boards would be transposed to apply also to members of
management committees.19
Other sections of the Bill aim to facilitate the running of manage-
ment bodies and their decision-making processes. For example, it is
suggested that circular resolutions by boards of directors, which are
already common practice, should be formally recognized. Directors,
like the members of the supervisory boards of sociétés anonymes, but
unlike the members of management committees, would as a result be
able without fear to take unanimous decisions in writing so long as this
is allowed in the articles of association.20 There would be no need to
justify the procedure on the grounds of emergency, as is required under
Belgian law.
Preceding the recent EU directive on shareholder rights,21 the Bill
would enable shareholders outside the Grand Duchy to take part in the
general meetings of Luxembourg companies by videoconference or any
other remote method that ensures effective participation. An original
presumption is that general meetings of shareholders held using these
techniques would be deemed to be held at the company’s registered
office. The Bill simply requires that at least one shareholder or his proxy
is physically present in Luxembourg.22

C. New freedom to choose finance methods

The most remarkable innovation of the Bill in this area is without any
doubt the right of any company with a legal personality of its own to
raise finance by issuing ordinary bonds,23 i.e. by issuing bonds that are
not convertible into shares and carry no warrants. To ensure maximum
flexibility, the bonds could be registered or bearer and the issue could be
private or public. The ability to issue bonds would give companies that
are not sociétés anonymes new financing options that they will certainly
leap at.

19
Proposed new art. 60–2 of the 1915 Act.
20
Amendment of art. 64 (1) proposed under the Bill.
21
Directive of the European Parliament and of the Council of 11 July 2007 on the exercise
of certain rights of shareholders in listed companies 2007/36/EC [2007] OJ L184.
22
Bill: art. II, 43) and 49) amending arts. 67 and 70 of the 10 August 1915 Act.
23
Bill: art. 11ter of the 10 August 1915 Act.
310 Perspectiv es in compa n y l aw

The important position Luxembourg accords to the société à respon-

sabilité limitée (private limited company) has led the government to
make an additional suggestion that would allow this type of company,
like sociétés anonymes, to issue convertible bonds and bonds carrying
subscription rights, both of which are particularly appreciated when it
comes to financing. The change would not be possible however were it
not for the closed nature of sociétés à responsabilité limitée that allow
new partners only if approved by a reinforced majority of existing part-
ners. The new proposal is that anyone wishing to subscribe or acquire
a convertible bond or bond carrying a subscription right should be put
up immediately for approval. This would give him prior permission to
become a partner in the company, after which he could exercise his right
of conversion or subscription without hindrance. At the same time, the
issue of these bonds would not short-circuit the agreement process.
Another proposal to help sociétés à responsabilité limitée is that in
future sweat equity contributions would be allowed. While these of
course do not create capital and therefore are not a source of financing,
they do provide resources of a different kind that can be particularly
valuable if the company is micro or medium sized. Following the French
model, the government therefore wants to give sociétés à responsabilité
limitée the right to accept sweat equity so long as this is allowed under
their articles of association, which must also set out the acceptance
method.

D. Assessment
We expect economic operators will know exactly how to exploit these
new freedoms to the full: the increase in the number of available com-
pany formats that will follow the introduction of the société par actions
simplifiée, the new ways of transforming companies and economic inter-
est groups, the resources provided for the fi ner tuning of shareholder
powers, the tighter organization of management committees and the
ability of any company with its own legal personality to obtain fi nance
by issuing bonds which, in the case of sociétés à responsabilité limité, can
even be convertible bonds.
Yet modern company law cannot focus only on contractual freedom,
it must also seek to ensure that companies operate properly and to give
balanced protection to the various interests involved. It is in this area
that Luxembourg company law appears to hang back, paralysed by the
fear that too much regulation could prevent business expansion. Indeed
 Lu x embou rg compa n y law – a tota l over hau l 311

before the recent reforms, the only changes undertaken were the almost
verbatim transposal of Community directives, strictly limited to the
mandatory provisions only, although every option to increase share-
holder freedom was carefully picked up. At the same time, Luxembourg
legislation did not follow the consecutive reforms introduced in Belgium
and France, firstly to prevent dilution of the original liberal spirit of the
1915 Act and secondly because Luxembourg remained largely immune
to the economic incidents that were often the trigger for change in other
countries. Despite the applause this attitude has usually drawn from eco-
nomic operators, it does present problems. The 1915 Act is now a dated
law that is no longer entirely in step with modern economic reality. Its
remoteness from the changes in Belgian law and to a lesser extent from
French law also prevent it from using the case law and doctrine of these
two systems that are so valuable to interpretation.
The Bill in some way seeks to reduce these weaknesses by increasing
the intrinsic protection afforded by Luxembourg company law as well as
that which it must provide to company members and third parties.

III. Greater protection

The Bill deals with protection in two ways: firstly, by making the effect of
company law (i.e. legal protection) clear and transparent; and secondly,
by ensuring a proper balance among the interests at stake. The first way
removes a number of muddy areas and the second produces the most
interesting of the innovations.
Apart from steps to protect creditors, particularly during restructur-
ings, Luxembourg company law has until now been little interested in
the ‘agency’ problems of majority rule or in the relationship between
shareholders and management. Today, the position of minorities and
the relative independence of management bodies from partners/own-
ers create problems to which, particularly for listed sociétés anonymes,
the 1915 Act offers no answers. Recent disputes have highlighted these
shortcomings. By proposing new rights for shareholders and increasing
management duties and responsibilities, the Bill is aiming to counter
the potentially negative effects of excessive liberalism. In order better to
protect third parties it also suggests that sociétés à responsabilité limitée
should be subject to some of the capital protection rules that already
apply to sociétés anonymes. In future, decisions on which of these two
company formats to choose should no longer be based on the loopholes
in the société à responsabilité limitée format.
312 Perspectiv es in compa n y l aw

A. New rights and responsibilities

The biggest problem with the 1915 Act is probably its treatment of
minorities and in particular of société anonyme minority shareholders.24
Under the Bill, they would be far better protected. In addition, the con-
cern of shareholders in general that their ownership interests should be
properly protected by management acting in a transparent and respon-
sible manner is no longer overlooked, even though the adjustments to
the 1915 Act in this respect would be more modest. The Bill proposes
to bring sociétés à responsabilité limitée in line with sociétés anonymes
as regards certain provisions on capital protection; this would be in
addition to the recommended increase in the protection company law
provides to third parties.

1. Majority–minority relations
Under the law as it stands at present, the complex relationship between
controlling and non-controlling shareholders is subject to the double
democratic principle that each share carries one single vote and that
decisions passed by majority vote are binding on all the shareholders.
Of course, parts bénéficiaires that carry voting rights and non-voting
shares can have a (considerable) impact on these rules. Yet the 1915
Act offers little help to minorities seeking to protect themselves against
majority shareholders acting primarily in their own sole interests. The
theory of ‘essential items’ or ‘accrued entitlement’ has had limited suc-
cess in Luxembourg law.25 Only decisions that do not increase members’
commitments or that change the company’s nationality are exempt from
the majority rule. Now, in order to facilitate trans-European mobil-
ity for companies, the Bill proposes abandoning even the unanimous
rule for nationality changes. Minorities who believe they have been
treated unfairly by majority shareholders are thus generally forced to rely
on abuse of rights as a defence. But in this area actions come up against
not only the difficult task of proving that disputed decisions go against
the company’s interests and have been taken solely in order to benefit the

24
See as an example the recent decision by the Luxembourg Supreme Court, on 21 February
2008 in Audiolux et al. v. Groupe Bruxelles Lambert, RTL Group, Bertelsmann et al. (case
no. 2456).
25
I. Corbisier and A. Prum, ‘Le droit luxembougeois des sociétés, une conception contrac-
tuelle et une personnalité morale non obligatoire’, in J.P. Buyle, W. Derijcke, J. Embrechts
and I. Verougstraete (eds.), Bicentenaire du code de commerce, (Brussels: Larcier, 2007),
139 and 183.
 Lu x embou rg compa n y law – a tota l over hau l 313

majority shareholders to the detriment of the minority shareholders, but

also against the sensitivity of the Luxembourg courts on the matter.26
The Bill offers a real remedy here by expanding the scope of the exper-
tise de gestion (the expert report minority shareholders can demand in
the event of disputes with majority shareholders) and introducing the
action sociale minoritaire (derivative action). But in some circumstances,
differences between the huge majority and small minority of sharehold-
ers will have to be resolved: either in the interest of one of the two parties
or by liquidating the minority shareholding. New exclusion, sell-out and
squeeze-out procedures meet this need.

a. Action sociale minoritaire and expertise de gestion To date the

1915 Act does not allow shareholders acting individually to sue company
officers for negligence. This right is reserved to the company alone and
is subject to approval by the board of directors and the general meeting
of shareholders.27 The rule is the result of the view that the relationship
between directors and the company is similar to a mandate and binds
directors to the company alone, not to each shareholder. While logical,
the view creates a problem in that liability actions against negligent offic-
ers cannot be brought without the agreement of the majority sharehold-
ers, who may be reluctant to proceed against people they have themselves
appointed. This is probably the reason for the rarity of such actions.
The problem has been overcome in many countries, notably in
Belgium and France, by allowing minority shareholders that individu-
ally or collectively hold a minimum shareholding to sue officers on the
company’s behalf if the company itself fails to take such action.
The Bill proposes adopting the same approach by introducing the
action sociale minoritaire (derivative action).28 Based primarily on the
provisions added to the Belgian companies code in this area, it would
allow shareholders and part bénéficiaire holders who own at least 1% of
the company’s voting rights to bring an action sociale minoritaire. The
holders of non-voting shares could take the same action so long as the neg-
ligence imputed to the officer(s) concerned relates to a decision in which
they do hold exceptional voting rights, i.e. a decision that might alter the
privileges given to compensate for the normal loss of voting rights or one

26
A. Steichen, Précis de droit des sociétés, (Luxembourg: Saint-Paul, 2006), n. 335 and
quoted case law.
27
Corbisier and Prum, ‘Le droit luxembougeois’, (note 25, above), n. 46.
28
Bill: art. II, 41 introducing arts. 63bis to 63septies to the 10 August 1915 Act.
314 Perspectiv es in compa n y l aw

affecting the substance or survival of the company. As in French law, an

action sociale minoritaire could be brought not only against directors but
also, if the company has a two-tier board structure, against members of
the management and/or supervisory board. The procedure would be to
appoint a special agent to take charge of the case. To prevent frivolous
proceedings, if their action failed, the applicants could be ordered to pay
all costs personally plus, if appropriate, compensation to the defendants.
However, if they won, all costs reasonably claimed by the applicants and
not included in the defendants’ costs, would be refunded by the company.
These rules should ensure that the action sociale minoritaire is as popular
as in the countries that have already adopted the system.
Under the present law, the right of shareholders to have management
documents examined is very strictly limited: fi rstly, to shareholders who
individually or collectively represent at least one-fi ft h of the company’s
capital; secondly, it covers only inspections of the company’s books and
accounts by auditors appointed by the court; and fi nally, applications
for investigations will be rejected unless there is proof of exceptional
circumstances.
This contrasts with the regime that applies in European countries that
have already modernized their company law. Based this time on French
law, the Bill proposes a total overhaul of the system. The number of
people who could request an expertise de gestion would be significantly
raised to include any member or group of members representing at least
10% of the share capital or 10% of all voting rights. In addition to drop-
ping the threshold by 50%, the Bill also recommends extending the right
to all forms of commercial company. Although the proposed threshold
is higher than that set under French law, it is the same as that applying
to the rights to convene meetings of shareholders, request an item to be
placed on the agenda of a meeting of shareholders or, as a result of the
Bill, to request an adjournment.
There would be a two-stage procedure when exercising the right.
Entitled shareholders could firstly ask the management body for details
of one or more transactions or operations by the company or a consoli-
dated subsidiary. If a satisfactory answer is not forthcoming within one
month they could then ask the courts to appoint one or more experts
to produce a report on the operations in question. The urgent applica-
tions judge ordering the report could also order the company to pay the
expense and require publication in the manner he decides.29

29
Art. II(76) of the Bill reforming art. 154 of the 10 August 1915 Act.
 Lu x embou rg compa n y law – a tota l over hau l 315

By making it easier to obtain expertises de gestion and extending their

scope, the reports themselves become significantly more useful and
should encourage the members of commercial companies to make use of
a so far very underused facility.
The Bill gives minority shareholders authority by allowing them to
sue negligent officers and to demand expertises de gestion, thus strength-
ening their position vis-à-vis the majority shareholders. But these rights
will be meaningless unless the minority shareholders, who feel over-
powered, can impact on company decisions at least in the medium term.
In some cases the dominant position of the majority shareholders will
be so all-encompassing that the only solution will be to fi nd some way of
enabling the minority shareholder to leave the company.

b. Exclusion, sell-out and squeeze-out Sell-outs and squeeze-outs

first appeared in Luxembourg law at the same time as mandatory general
offers (MGOs) – in the 19 May 2006 Act transposing directive 2004/25/
EC of the European Parliament and of the Council of 21 April 2004 on
takeover bids. But under this Act such operations can be undertaken only
if the shares in a company listed on a regulated market in one or more
Member States of the European Union are, as a result of an MGO, highly
concentrated in the hands of one or more persons acting together.
The Bill relies on the introduction into Luxembourg of sell-outs and
squeeze-outs but proposes firstly to expand their scope and secondly
to introduce a parallel general exclusion and sell-out procedure to be
applied when there is just cause.
In its opinion on the Bill and MGOs, the Conseil d’État said it hoped
that sell-outs and squeeze-outs would not be used only when the con-
centration of power was the result of an MGO. Their hope will become a
reality if the Bill is passed, since minority shareholders will then be able
to demand sell-out of their holdings and majority shareholders will be
able to force minority shareholders to sell them their shares (squeeze-
out) as soon as 95% of the voting capital and 95% of the voting rights
are directly or indirectly in the hands of a single shareholder. The result
will be that minorities will have the right to sell their shares if any sin-
gle shareholder acquires such a dominant position within the company
that their own shares almost cease to be liquid. The only condition for
sell-outs of this kind is a threshold that is higher than that for sell-outs
following an MGO, when the offeror need have obtained only 90% of
the company’s capital. At the same time, any shareholder who, without
any takeover bid, has obtained a hyper majority may buy out the hyper
316 Perspectiv es in compa n y l aw

minority shareholders. In both sell-outs and squeeze-outs the right to

buy or sell applies not only to voting shares but also to non-voting shares
and parts bénéficiaires. The Bill refers precise procedures and price-
setting methods to a future Grand Ducal regulation.
These proposals apply not only to sociétés anonymes all or some of
whose securities are traded on regulated markets, but also to those whose
securities have been delisted. They do not apply however to securities
that have never been listed.
For the latter, the Bill suggests an alternative path by introducing a
general exclusion and sell-out with just cause system for all SAs.30 The
idea comes directly from Belgium, where the system appears to have been
highly successful ever since its introduction. The aim is to ensure that in
the event of disputes between shareholders that have a serious impact
on their affectio societatis there is an alternative to the extreme solution
of winding up with just cause that is allowed under article 1871 of the
Civil Code. By bringing an exclusion action, the shareholders who hold
a substantial part of the powers within the société anonyme (in principle
at least 30% of the voting rights) can remove a shareholder with whom
disagreements are so great that they compromise the proper running of
the company. If the court can be convinced that the just cause they allege
in support of their application is relevant, it will order the respondent
to transfer his securities to the applicant at a price set by the court. The
pendant to this solution is the shareholder’s right to demand in law that
another shareholder be ordered to buy his securities. There would be no
threshold on the number of shares or voting rights held but the applicant
would have to prove not only that there is just cause for the action (e.g.
by demonstrating serious disagreement) but also that this is imputable
to the respondent. As in exclusion, the court would set the transfer price
and order the respondent to sell his securities.
It is hard to predict how the Luxembourg courts would react to exclu-
sion and sell-out proceedings since the position of the judge in such
actions is the complete opposite of the extremely cautious attitude judges
normally adopt in disputes between shareholders, particularly where
majority interests are concerned. The duty of setting share or other
risk security price that would now be imposed on the judge is likely,

30
Unlike Belgian law, this would also apply to companies with listed securities. See art.
II(58) of the Bill which introduces arts. 98bis to 98quinquies to the 10 August 1915 Act.
The system would also apply to sociétés à responsabilité limitée under art. II(101) of the
Bill which introduces arts. 201bis and 201ter to the 10 August 1915 Act.
 Lu x embou rg compa n y law – a tota l over hau l 317

particularly where unlisted securities are concerned, to cause quite a

few palpitations. To make the bringing of such actions easier, articles of
association could provide price-setting methods that the court would
have to use. They would not be able to rule out either system.

2. Shareholder/management relations
a. Increased liability of directors and members of the management
board The new right given in the Bill to minority shareholders under
certain circumstances to bring liability actions against negligent com-
pany officers on behalf of the company does expose officers to greater
risk of such action.
The Bill not only increases the scope of the right of action, but it also
increases the liability of directors and members of management boards
if as a result of major loss the company’s net assets fall below half its share
capital. Officers would then have to convene a general meeting of share-
holders to be held within two months to decide whether the company is
still a going concern or whether it should be wound up. If it is decided to
remain in business, the report presented by management would have to
set out the steps recommended for putting the company back on a firm
financial footing.
Under the law as it stands at present, failure to convene a shareholder
meeting in due time means directors and members of management
boards can be sued for serious negligence. In theory, company officers
could be ordered to pay all or part of the loss incurred as a result of the
failure to call the shareholder meeting but in practice it is hard to prove
sufficient causal link between the loss and the alleged negligence of the
company officers.
Referring to the Belgian solution, the Bill would remove the problem
by creating a simple presumption of sufficient causation between the loss
suffered by the company and the failure to call a shareholder meeting.31
Serious liability actions could also be brought against directors and
members of management committees for violation of the new account-
ing standards.

b. Better regulation of conflicts of interest The 1915 Act uses stand-

ard prevention methods to regulate situations in which a company
officer might put personal interest before that of the company: direc-
tors must disclose confl icts of interest to colleagues, they are excluded

31
Bill: Art. II, 60) reforming art. 100 of the 10 August 1915 Act.
318 Perspectiv es in compa n y l aw

from deliberations on operations and transactions in which the conflict

occurs, and they must report the conflict to the meeting of shareholders
with a view to ex-post approval.
The key change by the Bill in this field is the expansion of the scope of
the rule to cover day-to-day management, members of management and
supervisory boards and also liquidators.
But the Bill also seeks to make the rules on conflicts of interest more
effective.32 This is achieved by making the rules apply specifically to the
direct and indirect interests of the company officer but not to non-
pecuniary interests. Other exclusions are current operations entered into
under ordinary conditions. The person or body before whom the matter
is put will now have to prepare a report on the cause of the conflict, the
decision taken and the reason for that decision, along with its impact
on company assets. The consequences will also have to be assessed in a
report to the shareholders prepared either by the statutory or the inter-
nal auditor, depending on circumstances.
If the shareholders do not approve the decision taken by the board of
directors on a conflict of interests, they can dismiss the board or bring
a liability action against it. Th is will however not affect the action actu-
ally authorized by the board. Under current law, in the event of violation
of a required procedure the ability of the company to cancel decisions
taken and actions undertaken by the board of directors is unclear.33 The
Bill removes all uncertainty by giving the company the specific right
to demand cancellation by the courts if the third party involved in the
operation, transaction or decision knew, or ought to have known, that
the rules governing conflicts of interests had been violated.
In addition to making confl icts of interest more transparent and
introducing more direct procedural sanctions to protect the company,
the amendments introduced by the Bill would clarify the scope and
operation of this area of law, generally tightening up the 1915 Act.

3. Protection of third parties

The current focus is on the third parties – particularly the creditors – of
sociétés à responsabilité limitée since although this company format was
originally devised as an alternative to the société anonyme, it is not cov-
ered by the capital protection rules that company law applies to sociétés
anonymes by virtue of the 2nd Directive.

32
Bill: New art. 57 of the 1915 Act.
33
A. Steichen, Précis de droit des sociétés, (note 26, above), n. 816.
 Lu x embou rg compa n y law – a tota l over hau l 319

The limitations of the société à responsabilité limitée include no duty

to have independent appraisals of contributions in kind, no regulation of
its subscription of its own shares or of any third-party financing of own
share buy-ins.
The Bill would stop these loopholes.
Contributions in kind to sociétés à responsabilité limitée would have
to be independently appraised along with the valuation method used,
to certify that their value is at least equal to the shares issued as consid-
eration. The exceptions currently applying to sociétés anonymes would
apply to sociétés à responsabilité limitée too.
The rules on sociétés anonymes are also the model for the terms under
which a société à responsabilité limitée could buy in its own shares or
finance their purchase through third parties.34 The aim in both cases
would be to prevent buy-ins being used by companies materially to
reduce unavailable equity without creditors’ knowledge. Not all the
same rules would apply to sociétés à responsabilité limitée however – e.g.
the 10% ceiling, the maximum holding period and the duty to obtain the
approval of the general meeting of shareholders.
The legal profession is unlikely to be happy about the extension to
sociétés à responsabilité limitée of the third-party protection until now
afforded only by sociétés anonymes. But is it reasonable to allow a choice
to be made between two company formats on the basis of the weaknesses
in the société à responsabilité limitée system? In our view, the need to pro-
vide reasonable protection to creditors, who must be able to place at least
some trust in the declared capital of a company, justifies the restrictions
the Bill would place on shareholder freedom.

B. New certainties
The absence of regulation is not necessarily conducive to private initia-
tives or to contract innovation since the lack of any framework can give
rise to considerable uncertainty, particularly in an area as technical as
company law, where the ordinary law of obligations does not always pro-
vide the reassurances economic operators need as to the legality of the
mechanisms they have developed. The lack of a reliable framework can
therefore limit contractual freedom.35

34
Bill: new articles 190bis to 190octies of the 10 August 1915 Act.
35
Bill: grounds, 37.
320 Perspectiv es in compa n y l aw

The legislative intent here is clear: ordinary law and contractual free-
dom in particular are not always able to provide economic operators
with the legal security they require.
Doubts remain about the validity of voting agreements, the legality of
contract restrictions on the sale of shares or parts bénéficiaires in sociétés
anonymes, the scope of the ban on the use of leonine clauses and the
rights of remaindermen and usufructuaries where stripped rights are
concerned, to take only the most significant examples.
The Bill would remove these uncertainties.
Voting agreements between shareholders in a société anonyme and
partners in a société à responsabilité limitée would be valid in principle
and invalid only if in breach of the company’s interests or of the 1915
Act, or if they rendered the person concerned subject to the decisions of
the company’s officers and bodies. As a precaution, squeeze-out for just
cause is also introduced.
The free negotiation of shares and other securities carrying an enti-
tlement to shares could be limited through the articles of association
or by agreement, so long as the limitation is restricted in time and is in
the company’s interests. Any transfer made in violation of such a clause
would be invalid.
The ban on leonine clauses imposed under article 1855 of the Civil
Code is now too radical because it undermines schemes set up to enable
banks and other contributors of funds temporarily to acquire shares or
units so that they can support the restructuring of the issuer. Indeed,
both the French and the Belgian courts of cassation have relaxed their
positions here and have recognized the legality of these carry methods.
The Bill would codify the changes in case law by recognizing the legality
of the sale or acquisition of company rights ‘that do not aim to harm par-
ticipation in the profits, or contribution to the losses, of the company ’.36
The stripping of ownership rights from company rights with attri-
bution to a remainderman and a usufructuary raises many questions
about, in particular: who is the partner and who has the right to vote?
who owns the right to dividends and to attributed reserves? who has the
right to information? What are the rights of the remainderman and the
usufructuary in the event of capital increase or sell-out by the company
of its shares, capital depreciation etc? The Bill presents a bold, original
general solution for the allocation of the rights of the remainderman and
the usufructuary of the company rights, based on the assumption that

36
New paragraph 3 of article 1855 of the Civil Code as proposed by the Bill.
 Lu x embou rg compa n y law – a tota l over hau l 321

in principle the remainderman is the partner. Yet it does not ignore the
rights of the usufructuary, particularly where quasi usufruct is involved,
or the spirit of fair collaboration with which both must exercise their
rights.
To illustrate the government’s intention of ensuring company law
provides more legal protection, we must add to the above some reference
to: the abolition of the invalidity of meetings of partners or bond hold-
ers; the amendment of the bans on companies subscribing or buying in
their own shares or financing the subscription or buy-in of their own
shares through third parties; and the differentiation between sociétés
coopératives à responsabilité limitée (limited cooperative companies)
and sociétés coopératives à responsabilité illimitée (unlimited cooperative
companies). This article does not unfortunately allow us to go beyond a
brief description of the general orientations of the Bill.
The additions with which the Bill fi lls some of the loopholes in the
1915 Act are not the only corrections it would make to clarify the Act
and increase the legal protection it affords. The thirty-eight amend-
ments the Act has undergone since it was brought into law have allowed
some inconsistencies in wording to slip in and its architecture in general
is not particularly harmonious. By looking at the Act as a whole, the Bill
deals with these two weaknesses. If only at a marginal level, it does sug-
gest some adjustment to the terminology used.
More ambitiously, the Bill paves the way for the merger of the 1915 Act
with the relevant sections of the Civil Code to produce a new Companies
Code to remove ‘pointless repetitions, inconsistencies and contradictions’
that would delete ‘words, expressions and concepts that are no longer used
or are old-fashioned ’.37 It would also reorganize the whole into a more
comprehensive and logical body of work, simplifying the process of
access and understanding of its rules.
The modernized substance would thus be reflected also in the form.

37
Bill: grounds, 42.
 18

Role of corporate governance reform and

enforcement in the Netherlands
Joseph A. McCahery and Er ik P. M. Ver meulen *

I. Introduction
As the recent wave of governance scandals and reforms has focused the
public debate on how publicly held corporations should be structured
and organized, it is hardly surprising that corporate governance of listed
companies has captured the legal imagination. Books, articles and reports
on the corporate governance of listed companies abound. Corporate
governance reforms in developed countries as well as emerging markets
are high on the policy agendas. Proposals have arisen to change, among
other things, the role of non-executive directors, executive pay, disclo-
sure, the internal and external audit process, and sanctions on director’s
misconduct. Suggestions have also been advanced to create new stand-
ards of integrity for auditors, analysts and rating agencies. Policymakers
and lawmakers are prompted to design measures to protect sharehold-
ers from fraud, poor board performance and auditor failure. These most
notably include CEO and CFO certification of accounts,1 imposition of
internal controls, the prohibition of company loans to managers and the
requiring of firms to establish an independent audit committee.
While the question of the economic effect of the corporate governance
regulation on the performance of listed companies has become a lead-
ing concern for both lawmakers and investors, the evidence, however,
is mixed. On the one hand, it is widely acknowledged that corporate
governance rules and standards promote efficiency, transparency and
accountability within firms, thereby improving a sustainable economic


*
We would like to thank William Bratton, Stijn Claessens, Florencio Lopez-de-Silanes,
and Jaap Winter for their comments. Th is is an updated and revised version of a working
paper on the competitiveness of the Dutch corporate governance regime that was pre-
pared for the Netherlands Ministry of Finance.
1
CEO: Chief Executive Officer; CFO: Chief Financial Officer.

322
 Cor por ate gov er na nce r efor m & en forcement 323

development and financial stability. On the other hand, some scholars

argue that the corporate governance movement has gone too far, entail-
ing nothing more than a box-ticking exercise to ensure compliance with
current corporate fashion trends. In this view, companies do not seem
to benefit from the spillover effect of the application of disproportionate
corporate governance rules and principles that have their origins in the
Sarbanes–Oxley regulation.2
Th is paper focuses on the quality of corporate governance which
varies widely across countries and fi rms. In a series of influential
papers, La Porta et al. 3 have argued that the level of protection afforded
to minority shareholders and creditors is associated with lower con-
centrations of share ownership positively related to valuable growth
opportunities. La Porta et al. found that common law systems tend
to outperform civil law systems by adopting legal rules that offer bet-
ter protection both for expropriation of shareholders by management
and the violation of the rights of minority shareholders by large share-
holders. It appeared that shareholders and creditors received least
protection in French civil law countries, like the Netherlands. The
Scandinavian and German countries came somewhere in between. The
implication of the work of La Porta et al. is that countries should move
toward the more efficient common law system based on transparency
and arm’s length relationships.4 However, the legal systems were gen-
erally insufficient to deter managerial abuses and misconduct within
listed companies at the start of the twenty-fi rst century. Policymakers
2
See Financial Times (by Jeremy Grant), ‘Sarbox changes welcomed but imitators still
abound’, 23 March 2007.
3
R. La Porta, F. Lopez-de-Silanes, A. Shleifer, R.W. Vishny, ‘Legal determinants of exter-
nal fi nance’, Journal of Finance, 52 (1997), 1131–50; R. La Porta, F.Lopez-de-Silanes and
A.Shleifer, ‘Law and fi nance’, Journal of Political Economy, 106 (1998), 1113–1155; R. La
Porta, F. Lopez-de-Silanes, A. Shleifer, R.W. Vishny, ‘Investor protection and corporate
governance’, Journal of Financial Economics, 58 (2000), 3–29.
4
In their study of forty-nine countries, they classified countries according to the origin
of laws, quality of investor protection and quality of law enforcement. Moreover they
investigated the extent to which a country adheres to the one-share-one-vote rule. A
shareholder protection index was constructed which determined whether proxy voting
by mail is allowed, whether minority protection mechanisms are in place and whether
a minimum percentage of share capital entitles a shareholder to call for an extraordi-
nary general meeting. Creditor rights are aggregated into an index that is higher when
the creditor can take possession of the company in the case of fi nancial distress, when
there are no restrictions on workouts and corporate reorganizations and when the abso-
lute priority rule is upheld. Finally, the rule of law index produced by the rating agency,
International Country Risk, indicates the country risk and the degree to which laws are
enforced.
324 Perspectiv es in compa n y l aw

and lawmakers across the board were forced to call for stricter legal
measures that could serve to minimize the managerial agency problem
inherent in corporations. Since then the legal landscape has changed
rapidly. Part II of this chapter examines the recent and current govern-
ance reforms that are designed to lead to the increased accountability,
transparency and enhanced performance within fi rms. We show that
substantial progress has been made in corporate governance, bringing
improvements from country to country to the legal, regulatory and
commercial environments.
Recent empirical work by La Porta et al.5 found that firms operat-
ing in jurisdictions with strong minority shareholder protections tend
to have a higher Tobin’s Q. The work of Lombardo and Pagano6 sup-
ports the findings of La Porta et al., showing that better legal institutions
influence equity rate of returns and the demand for equity finance by
companies. They offer two reasons: (1) good laws and efficient courts
curtail the private benefits of managers; (2) better law and more efficient
courts facilitate the contractibility of corporate relations with customers
and suppliers and the enforceability of such contractual relations. As a
result, companies are more profitable which hence raise their rates of
return and the amount of external financing. In their model, Lombardo
and Pagano reduce managerial benefits by introducing legal limits to
transactions with other companies that may dilute the income rights
of minority shareholders. They also reduce the legal and auditing costs
that shareholders must bear to prevent managerial opportunism. Such
cost reduction may, for example, result from the introduction of class
action suits or voting by mail. They conclude that the size of these effects
on the equilibrium rate of return is increasing in the degree of inter-
national segmentation of equity markets.7 This paper seeks to explore
which specific corporate governance mechanisms are positively related
to firm performance in the Netherlands. The wealth of recent empirical
evidence supports the hypothesis of La Porta et al. that good corporate
governance is among the most important factors responsible for good
corporate performance.8

5
R. La Porta, F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, ‘Investor Protection and
Corporate Valuation’, Journal of Finance, 57 (2002), 1147–1170.
6
D. Lombardo and M. Pagano, ‘Legal Determinants of the Return on Equity’, in J.A.
McCahery et al. (eds), Convergence and Diversity, (Oxford University Press, 2002).
7
Lombardo and Pagano use the dividend yield as measure of the cost of capital.
8
P.A. Gompers, J. Ishii and A. Metrick, ‘Extreme Governance: An Analysis of Dual Class
Firms in the United States’, Working Paper, Harvard, Stanford and Wharton (2006);
 Cor por ate gov er na nce r efor m & en forcement 325

This chapter is organized as follows. Section II takes a brief look at

corporate governance in the Netherlands. Special attention is given to the
channels through which corporate governance impacts valuation and firm
performance in the case of the Netherlands. We focus on how the changes
introduced by the Dutch Code are likely to improve the performance of
publicly listed firms in the Netherlands. Section III supplies an account of
the ex post enforcement regime in the Netherlands. Section IV concludes.

II. The Dutch Corporate Governance Regime

In this section, we investigate the quality of the Dutch corporate gov-
ernance regime, and consider how well the strategy of relying on
principles-based measures can encourage transparency, an independ-
ent boardroom that monitors management, and a structure through
which the company’s objectives are met. The approach taken here is to
focus on the consequence of the widespread adoption of the best prac-
tice code and which ex ante corporate governance practices are being
implemented and enforced. In this part, our focus is on how effective
the current round of ex ante measures are in substantially improving
the general institutional environment of Dutch firms. Special attention
is given to the channels through which corporate governance impacts
valuation and firm performance. Our aim is to give directions to inter-
vention to country policy makers and company shareholders. We first
give a concise picture of the current status of corporate governance in
the Netherlands and argue that recent developments and reforms have
altered the rules of the corporate governance game (thereby improving
the rights and protection of minority shareholders).

A. Investor protection and corporate governance in

the Netherlands
The Netherlands regime lies between the Anglo-American system of dif-
fuse stockholders and the concentrated ownership regime characteristic
of many continental European countries.9 In the Netherlands, share
ownership is widely dispersed and the quoted sector is a significant part

L.A. Bebchuk and A. Cohen, ‘Firm’s Decision Where to Incorporate’, Journal of Law and
Economics, 46 (2003), 383; L.A. Bebchuk, A. Cohen, and A. Ferrell, ‘Does the Evidence
Favor State Competition in Corporate Law?’ California Law Review, 90 (2002), 1775.
9
W.W. Bratton and J.A. McCahery, ‘Restructuring the Relationship between Shareholders
and Managers’, in H. Schenk (ed), Preadviezen van de Koninklijke Vereniging voor de
326 Perspectiv es in compa n y l aw

of the economy. The percentage of closely held shares for the average
Dutch listed company (7.30%), is much lower than the average European
company (19.72%), but is still higher than the average UK (3.29%) or US
(1.45%) company (LLSV 2000). However, about 22% of Dutch fi rms have
a dual class structure which is relatively large compared to the European
average (17.01%) and the average US (5.00%) and British (less than
1.00%) company. Similarly, research on the direct and indirect owner-
ship of Dutch companies reveals a concentrated ownership structure to
the extent that large blockholders (14.30%), pension funds (10.08%) and
banks (7.75%) enjoy large stakes.10 To be sure, whilst there is some evi-
dence that concentrated control has a negative relationship for outside
equity, there is some evidence for no effects11 and positive effects12.
Historically, the weaknesses in Dutch corporate governance most
observers point out centred on limited influence of shareholders on
management and extensive takeover defences. A large portion of Dutch
listed companies are virtually immune to hostile takeovers. Many Dutch
companies adopt one or more anti-takeover provisions, for instance
through the use of preference shares. Other firms employ a depository
receipt scheme, through which a listed company places its shares with
a foundation. The foundation office then issues non-voting depository
receipts, thus retaining control with ‘insiders’, and providing impedi-
ments to (hostile) takeovers. For large Dutch companies, shareholders
had limited influence on corporate management as compared to the
Anglo-Saxon countries. Companies that meet certain requirements for
a period of three years are governed by the so-called ‘structure regime’,
which means that a supervisory board is mandatory and able to veto
important changes in the identity or structure of the company as well
as to appoint the management board. Enactment of the legislation was
largely a response to demands for increasing management’s accounta-
bility to a broader set of stakeholders, and to ensure closer monitoring of
managers. The structure regime has three variations: the Full Structure
Model, the Mitigated Structure Model and the Common Model. The

Staathuishoudkunde, Herpositionering van Ondernemingen (Utrecht: Lemma, 2001),

63–85.
10
D. De Jong, G. Mertens and P. Roosenboom, ‘Shareholders’ Voting at General Meetings:
Evidence from the Netherlands’, EMIM Report Series, Reference No. ERS-2004–039-
F&A (2004).
11
P.A. Gompers, J. Ishii and A. Metrick, ‘Extreme Governance: An Analysis of Dual Class
Firms in the United States’, Working Paper, Harvard, Stanford and Wharton (2006).
12
R.B. Adams and J.A.C. Santos, ‘Identifying the Effect of Managerial Control on Firm
Performance’, Journal of Accounting and Economics, 41 (2006), 55–85.
 Cor por ate gov er na nce r efor m & en forcement 327

Full Structure Model is the most prevalent. The function of the super-
visory board, which typically holds all voting rights and is granted con-
siderable power, is to evaluate the performance of the top executives,
ratify management decisions and reward or penalize performance.
Until 1 October 2004, the supervisory board co-opted its own members,
which explains historically the predominant position of the supervisory
board at the expense of shareholders. In contrast, under new legislation
the power to appoint the members of the supervisory board is given to
the shareholders. However, the supervisory board retains the power to
nominate its own members with the exception that the works council
has a right to recommend one-third of the members of the supervisory
board. Nevertheless, the general shareholders’ meeting is empowered to
discharge the entire supervisory board which requires the interference
of the Enterprise Chamber in the process of appointing new members.
Even though there is little evidence on the effect of supervisory board
control on management performance, there is evidence that contrasts
firm performance between shareholder-controlled firms and compa-
nies organized under the structure regime. A study by the Netherlands
Ministry of Finance13 evaluated the supervisory board performance of
Dutch listed, non-financial fi rms in terms of market returns, account-
ing returns and Tobin’s Q. The study revealed that for the period of
1993–1997, the sampled fi rm’s market returns were affected by owner-
ship concentration (positive), the size of the supervisory board (nega-
tive), depository receipts for shares (negative) and the structure regime
(negative). Further, the study showed that companies which voluntarily
adopted the structure regime underperformed shareholder-controlled
companies. The results in De Jong et al. support the magnitude of these
effects of the structure regime on firm performance. Interestingly, they
find that the effect is less for Dutch multinational firms that voluntarily
adopt the structure regime. We believe that this result is consistent with
international competition being an important reason why these firms are
better governed and therefore explains why the structure regime has no
significant effect on profitability. Our discussion of the structure regime
shows that the regime imposes a significant cost on shareholders.
While some groups benefited from the traditional Dutch corpo-
rate governance norms, at the same time the increasing focus on

13
Netherlands Ministry of Finance, Zeggenschapsverhoudingen en Financiële van
Beursvennootschappen, Report prepared by Center for Applied Research (Tilburg
University, 2000.
328 Perspectiv es in compa n y l aw

management accountability to shareholders led to the design and

implementation of legal measures perceived to increase the rights of
shareholders and holders of depository receipts. The actual govern-
ance arrangements adopted by Dutch legislators, effective 1 October
2004, include:
• increased powers for shareholders to ratify certain management
board resolutions that effect the identity or character of the NV or its
businesses;
• a new regulation that gives shareholders a right to vote on the adop-
tion of the company’s remuneration policy and an entitlement to vote
on a yearly basis to approve the directors’ option plans;
• a right to add resolutions to the agenda of a listed company’s general
meeting for members holding at least 1% of share capital or a stake
with a market value of €50 million;
• a measure that gives depository receipt holders in a public company
the right to use proxies to exercise their voting rights (except in the
context of a hostile takeover);
• an obligation that the board of directors disclose yearly to the supervi-
sory board the main elements of its strategy, business risks and man-
agement and control systems; and
• regulation that requires that quoted companies comply with
the corporate governance code or explain the reasons for non-
compliance.
The common thread running through the reforms is that they increase
scrutiny and accountability of directors while providing shareholders
with the institutional arrangements that give them the means to exercise
their basic rights of voting and economic participation.
So far it is not possible to say what the effect of these reforms have
been on the fi nancial performance of Dutch fi rms. Nevertheless the
Dutch government’s reliance on disclosure and associated mechanisms
appear to have improved shareholder participation in the affairs of
quoted companies and induced management to improve performance.
The Electronic Means of Communication (Promotion) Act, which came
into force on 1 January 2007, enhances shareholder protection by allow-
ing electronic participation in the general shareholders meeting as well
as simplifying the issuance of proxies and voting instructions. Under
this Act, firms could allow shareholders to cast their votes even before
the actual shareholders meeting.
 Cor por ate gov er na nce r efor m & en forcement 329

B. The Dutch Corporate Governance Code

While there are differences in patterns of ownership and control in
Europe and the US, the recent corporate scandals have occurred more in
the US than Europe.14 The Netherlands, however, has not been immune
from corporate governance scandals, which attracted the media and
regulator attention and highlighted some aspects and weaknesses of the
Dutch system. Consistent with Coffee’s observations, the Ahold scan-
dal emerged in February 2003, when the company announced that a
series of accounting irregularities in its US Food Services subsidiary had
led it to overstate more than $500 million in profit booked in the pre-
vious two years. Subsequent disclosures revealed that Ahold’s reported
earnings had been overstated by more than $1 billion and that prior rev-
enues had been overstated by $24 billion. This event focused observers
on the state of Dutch corporate governance and prompted the promul-
gation of a new principles-based code of conduct (the Dutch Corporate
Governance Code or Code Tabaksblat, hereinafter ‘Code’) based on a
comply-or-explain standard.15
The Code contains general principles and detailed best practice pro-
visions related to: the management board (role, remuneration, confl icts
of interest); the supervisory board (role, independence, composition, the
role of the chairman, remuneration, confl icts of interest); the general
meeting of shareholders (powers, depositary receipts, provision of infor-
mation, responsibility); and financial reporting (internal and external
auditors, disclosure). In particular, the Code recommends the appoint-
ment of an audit, remuneration and nomination committee, which
roles are to prepare the decision making of the supervisory board and
supervise the management board. The members of such committees are
appointed from among the members of the supervisory board. In case
of a one-tier management structure, it advocates the separation between

14
J.C. Coffee Jr., ‘A Theory of Corporate Scandals: Why the USA and Europe Differ’, Oxford
Review of Economic Policy, 21 (2005), 198–211.
15
In order to improve the quality of corporate governance practice of firms, the first Dutch
Corporate Governance Committee (‘Peters Committee’) handed down a report in 1997
that introduced several recommendations designed to strengthen the monitoring role of
the supervisory board including that there should be: 1) greater independence of supervi-
sory board members, 2) greater independence of stakeholders associated with the company,
3) more selective procedures for the appointment of supervisory board members, and 4)
shareholders should have a more active role in the annual general meeting (Bratton and
McCahery, ‘Restructuring the Relationship between Shareholders and Managers’, 2001).
330 Perspectiv es in compa n y l aw

the Chairman and the CEO and the presence of a majority of independ-
ent non-executive directors on the board. On the matter of depositary
receipts for shares, the Code states that they should not be used as an
anti-takeover measure, but instead depositary receipt holders should
have the possibility to exercise their voting rights.
Whilst compliance is not mandated legally, Dutch lawmakers since
2004 require an explanation for non-compliance pursuant to article 391
of Book 2 of the Dutch Civil Code. The Dutch Monitoring Committee’s
investigations show that there has been widespread adoption of the Code
standards by a large majority of Dutch listed companies. However, a sig-
nificant minority of companies do not explain the reasons for departing
from best practice. This percentage is particularly high for the provi-
sion related to the anti-takeover devices. Indeed, a quarter of the com-
panies in the survey provide no information about their anti-takeover
measures, against the Code requirements. The report of the Monitoring
Committee does not explicitly deal with the quality of the explanations
provided by non-compliant companies, but it indicates some commonly
given explanations, which appear to be standard, general and unin-
formative. Importantly, a study on the effectiveness of the comply-or-
explain system in the UK16 shows that shareholders should pay attention
to the quality of the explanation. UK companies that do not provide
any explanation for their non-compliance underperform all others.
Conversely, companies which give detailed and narrative explanation
in the matters of non-compliance are the best performers, even outper-
forming the companies that are fully compliant with the UK code of best
practice. This could be explained by the fact that such companies, which
have carefully considered their governance needs and eventually opted-
out from best practice, are able to provide a justification to shareholders,
and are well governed to deliver high returns to shareholders.

C. Benchmarking the Dutch corporate governance regime

In this section, we will review the empirical studies assessing the
Dutch corporate governance regime. We can look initially to the most
well-known indicator of investor protection, the La Porta et al.17 LLSV
16
S.R. Arcot and V.G. Bruno, ‘One Size Does Not Fit All, After All: Evidence from Corporate
Governance’, Working Paper (2006), http://ssrn.com/abstract=887947.
17
R. La Porta, F. Lopez-de-Silanes, A. Shleifer, R.W. Vishny, ‘Legal determinants of exter-
nal fi nance’, Journal of Finance, 52 (1997), 1131–50; R. La Porta, F. Lopez-de-Silanes and
A. Shleifer, ‘Law and Finance’, Journal of Political Economy, 106 (1998), 1113–55.
 Cor por ate gov er na nce r efor m & en forcement 331

anti-director rights index, which summarizes the level of protection of

minority shareholders in the corporate decision-making process.18 The
Netherlands differs from the other countries in terms of the LLSV anti-
director index. The index of investor protection in the Netherlands (3)
is in line with the US (3) and Europe (3.1 on average), but it is well below
the UK (5). In particular, minority shareholders in the Netherlands
seem to have strong powers in challenging resolutions that they fear to
be against the company’s interests, but have impediments in the exercise
of their voting rights.
According to the LLSV index, the law in the Netherlands does not
explicitly allow vote by mail or proxy form, allowing shareholders to
vote on the items on the agenda in absence.19 Further, the law requires
shareholders to deposit any of their shares prior to a general shareholder
meeting. This requirement imposes a cost on shareholders. In addition,
the law does not set a default rule specifying the possibility for sharehold-
ers to cast all their votes for one candidate for the board or supervisory
board (cumulative voting), thus limiting shareholders’ monitoring and
decisional powers. The LLSV index reveals that the Netherlands shows
a mixed corporate governance framework and practices. Compared to
companies in other countries, Dutch companies have highly independ-
ent boards, but on average have an entrenched board and fewer board
committees. In terms of legal regime, the Netherlands ranks relatively
low in investor protection index too. Therefore, the corporate govern-
ance picture offered by Dutch companies is less favourable due to the
presence of entrenched boards, few board committees and low protec-
tion of shareholders rights; investors are more cautious about the gov-
ernance of companies. This gets reflected into lower valuation.
It is important to recall that the LLSV index on the value of investor
protection is based exclusively on hard law. Fortunately the recent stud-
ies by the Monitoring Committee of the Corporate Governance Code
(‘Monitoring Committee’) on the implementation of the Code allows
us to have an idea on the role of the code in promoting best practices
in the constitution of board committees, compensation and disclosure.
Thus, in terms of actual corporate governance practices prompted by
Code changes, the new results of the Monitoring Committee offer a
18
The index has been updated since 1998 and the more recent data are used (see discussion
below).
19
As discussed above, the Electronic Means of Communication (Promotion) Act intro-
duces (1) the electronic convening of a general meeting of shareholders, (2) electronic
participation in the meeting, and (3) electronic voting prior to the meeting.
332 Perspectiv es in compa n y l aw

benchmark against which Dutch companies can be compared. The

Monitoring Committee established on 6 December 2004 commissioned
surveys in order to obtain information on how the Code is complied
with in practice. The first report on compliance with the Code was
released in December 2005. It shows Dutch companies to have embraced
the regulation: the average non-compliance rate per code provision is
12%. This is quite high, although it does not provide comparison with
how compliance was prior to the adoption of the Code. The second
report was released in December 2006 showing the average application
rate and compliance increasing to respectively 92% and 96%. Despite the
improvement in compliance overall, the recommendations on internal
risk management and remuneration are less than average.
Using the data from the Monitoring Committee Reports, we can
begin to assess the impact of the code. While the period of compliance
is very short, we can nevertheless assess the role of the Code in promot-
ing best practice. For Part II of the Code, the Management Board, there
is an average compliance rate of approximately 80%.20 Importantly, all
compliance percentages are higher than those of the 2004 financial year.
Despite the improvements since last year, compliance with two impor-
tant parts of this chapter of the Code is less than average. These are the
provisions on internal risk management and control systems (II.1.3 and
II.1.4) and on directors’ pay (particularly II.2.9 and II.2.10). The rates of
compliance in respect of all these parts are high, namely between 95%
(role and procedure and independence) and 100% (one-tier structure).
The application rates are on average 4% lower than 2004. The average
compliance rates (89% and 91% respectively) are lower than the total
average compliance rate of 96%. This lower average figure is caused in
particular by the local companies, whose compliance rates are 84% for
the powers of shareholders (Part IV.1) and 75% for information and
logistics regarding the general meeting (Part IV.3).
In sum, two patterns emerge. First, corporate governance practices
are improving dramatically in the short term. Not only is there a high
overall compliance and application rate, but key characteristics of the
Code have high compliance rates. It may be argued that when companies
adopt good governance practices the probability of misconduct decreases
and the returns on the stock are better than those with worse corporate
governance. Second, some corporate governance practices still deviate
in some respects from international best practices. The percentage of

20
See Monitoring Committee (www.corpgov.nl).
 Cor por ate gov er na nce r efor m & en forcement 333

companies with a committee dealing with corporate governance issues,

for example, only slightly increases over years, from 16.3% in 2004 to
21.2% in 2005. The pattern suggests that companies follow only what the
Code recommends, and not other best practices in corporate govern-
ance. Moreover, the persistence of control-enhancing mechanisms, such
as dual class shares and opaque capital structures, are also likely to affect
the governance ratings for Dutch firms.21
Finally, there is recent evidence22 that the degree of investor protection
against self-dealing is quite low viewed from a comparative corporate
governance perspective. If this is the case, Dutch corporate governance
needs to be corrected if the business environment for entrepreneurs is
to improve. In the next section, we discuss the anti-self-dealing index
of Djankov et al. and we interpret the Netherlands regulations in terms
of the protection of investors against self-dealing.

D. Protecting investors against self-dealing

This section looks at the legal rules and their enforcement which have
been developed to regulate self-dealing transactions, with particular ref-
erence to the Netherlands. Here we look at evidence from other countries
when discussing the developments in the Netherlands, which has more
in common with other European countries than the UK or the US in this
area.
There is widespread agreement about the important role that related
party transactions can play in an economy. Concretely, a related party
transaction is a situation where there is one man (Mr James) who con-
trolled 60% of company A and proposes that the company buy fi ft y used
vehicles from a company in which he owns 90% of the company. In this
context, the price is likely to be higher and Mr James will clearly benefit
from the transaction. Such transactions are authorized in many juris-
dictions to permit flexibility and to make room for private contractual
arrangements that are consistent with the furtherance of corporate
objectives and are subject to appropriate checks and balances. In some
of these cases, the company’s financial situation might preclude it from
negotiating arm’s length arrangements with third parties.

21
Deminor-rating (2005), Application of the One Share-One Vote Principle in Europe, A
study commissioned by the Association of British Insurers, available at www.abi.org.uk.
22
S. Djankov, R. La Porta, F. Lopez-de-Silanes and A. Shleifer, ‘The Law and Economics of
Self Dealing’, NBER Working Paper 11883 (2006).
334 Perspectiv es in compa n y l aw

A key concern about related party transactions is that they can be

influenced by the relationship between two sides of a transaction and
not undertaken according to market prices. For both controlling share-
holders and insiders such as management, related party transactions can
be the mechanism for extracting private benefits at the expense of other
shareholders. The limited ability of investors to protect themselves against
opportunism by insiders and the high cost of regulating such transactions
have influenced regulators’ strategies. Moreover, the nature of the poten-
tial problem varies: in companies with controlling shareholders and with
corporate groups the transactions and the measures needed to deal with
them differ from those companies where ownership is dispersed and where
the board and management are effectively entrenched. Corporate law in
many countries allows related party transactions, but also includes a vari-
ety of techniques and measures to control the danger of opportunism.
As Djankov, La Porta, Lopez-de-Silanes and Shleifer have showed with
their comparative work on protections against self-dealing, common
law and civil law countries use similar legal strategies to control related
party transactions, namely mandatory disclosure, board approval, the
specification of fiduciary duties for the board and shareholder approval.
For example, studies show that countries with very different corpo-
rate governance systems can achieve similar results in mitigating abu-
sive transactions with different combinations of corporate governance
mechanisms.23 The most common and effective response is disclosure
of potentially conflicted transactions. In fact, public disclosure is the
predominate pattern around the world. In the US, for instance, publicly
listed companies are required not only to publicly disclose all major
transactions, but also certain relationships and material transactions
between the company and its officers and/or their families and their
enterprises. Most jurisdictions rely on board approval to screen con-
flicted transactions and evaluate whether a related party transaction is at
arms length or whether it is detrimental to the company. Authorization
for most self-dealing transactions can usually only be given by non-in-
terested directors. Even though lawmakers in common law countries do
not typically require mandatory board approval, it functions, neverthe-
less, to encourage interested managers to obtain approval of confl icted
transactions.

23
G. Hertig and H. Kanda, ‘Related Party Transactions’, in R. Kraakman, P. Davies,
H. Hansmann, G. Hertig, K.J. Hopt, H. Kanda and E. Rock, The Anatomy of Corporate
Law, A Comparative and Functional Approach, (Oxford University Press, 2005), 101–30.
 Cor por ate gov er na nce r efor m & en forcement 335

Judging from Djankov’s data, countries have made significant progress

in establishing measures to protect investors from the wrongdoing of
directors. The Netherlands approach of curtailing private benefits and
other mismanagement (0.21) is, however, half as low as the average
European country (0.40), three times lower than the US (0.65) and almost
four times as low as the UK (0.93). Th is Dutch approach to the enforce-
ment of investor protection from management and large blockholder
fraud is based on board disclosure and approval of any confl ict of inter-
est or potential conflict of interest that may be of material significance
to the company. Shareholders are also required to approve the interested
transactions that have obtained board approval and ratification.
In fact, Book 2 of the Dutch Civil Code states in Section 146 (for pub-
licly held corporations) and Section 256 (for closely held corporations)
that if directors have a conflict of interest, the corporation shall be repre-
sented by the members of the supervisory board. The shareholders’ meet-
ing is authorized to appoint another person to represent the company.
The Dutch Enterprise Chamber, a division of the Amsterdam Court of
Appeals, and Supreme Court have clarified these statutory provisions
and decided that the corporation is not bound to a conflicted transaction
if the third party did not act in good faith. This ‘external effect’ is con-
sidered to be particularly cumbersome for banks that enter into credit
facility agreements with a group of companies as banks run the risk that
transactions and payments under the facility will be nullified by subsidi-
aries in a financially distressed group. Still, even though the legal litera-
ture does not approve the ex post clarification of the conflict of interest
rule, the court’s decisions seem to evince the court’s intention to enhance
shareholder rights by requiring the explicit and immediate approval of
conflicted transactions. The following part will highlight the importance
of specialized courts in resolving corporate governance related disputes.

III. Ex post enforcement in Dutch corporate law

A. Role of gatekeepers
An assessment of the corporate governance movement in the Netherlands
would be incomplete if it neglected the role of institutions – corporate
governance monitoring committees, supervisory authorities, securities
regulators, investors’ associations, stock exchanges, the judiciary, insti-
tutional investors, equity analysts, accountants and a probing media – in
safeguarding and promoting the Dutch corporate governance principles.
336 Perspectiv es in compa n y l aw

Arguably these gatekeepers are responsible for interpreting, preserv-

ing and developing good governance. At first sight, the interaction of
different institutions appears to be conducive to an efficient evolution
of the corporate governance framework. Gatekeepers are complemen-
tary to each other, and so are more responsive to economic and social
change. To see this, let us again look at the Dutch Corporate Governance
Code and assess the effect of the code two years after its promulgation. It
seems that the enabling (‘comply-or-explain’) nature of the code could
not totally prevent firms from engaging in merely box-ticking, thereby
adopting opportunistic strategies to subvert the norm.24
Nevertheless, it might be argued that the structure of the game
between policymakers and lawmakers on the one side and gatekeep-
ers on the other eventually tends towards a regulatory equilibrium. As
noted, policymakers and lawmakers, having promulgated the Code to
restore the public confidence in stock markets and to protect the share-
holders from managerial opportunism and malfeasance, are compelled
to revise, in the next round, their regulatory strategies to induce firm
compliance to the stated norms. In response, we can expect gatekeep-
ers to continue to develop innovative interpretations of the principles
and give recommendation on how firms should implement the norms in
order to be most effective for their own needs. Because the gatekeepers
must anticipate being overruled by the necessary update of the policy-
makers and lawmakers, their explanations and interruptions appear to
be consistent with the dictates of efficiency.
In practice, though, the ideal interplay may not prevail. For instance,
the corporate governance movement in the Netherlands is more akin
to a battleground – in which gatekeepers, preoccupied with their own
interests, such as increasing their powers and prestige, strive for market
share – than a system of checks and balances. This is evidenced by the

24
EFFECT (VEB-magazine – ‘Journal of the Dutch investors’ association’ – 24 December
2005) mentions ten tricks that firms use to circumvent the code. For instance, (1) fi rms
create their own defi nitions of ‘being independent’; (2) fi rms state that there are no indi-
cations that their internal control systems are not effective (fi rms do not show explicitly
that the internal control systems are optimal); and (3) fi rms tend to use very general and
brief statements, instead of giving the detailed explanations and descriptions as required
by the Code. Naturally if all firms were mere box tickers this would lead to a pooling
equilibrium. However, since high-quality fi rms will benefit from sending a signal to the
market, fi rms are more likely to profit where the sophistication of the investors is high
and it is more likely that external parties will have the incentives and abilities to bench-
mark the disclosures.
 Cor por ate gov er na nce r efor m & en forcement 337

fact that the corporate governance principles are interpreted broadly by

gatekeeper institutions in favour of the (minority) shareholders.
The gatekeepers seem to agree on one thing: so far the Code has
resulted in a modest improvement of the diligence in doing business
and reporting accurate information. In general, gatekeepers are of the
opinion that more must be done to achieve good corporate governance
practice in firms. They urge shareholders to be increasingly active and
encourage judges and official monitoring agents to contribute to the
strict compliance with the code’s principles. The result is an avalanche
of legal actions for an alleged loss suffered from violations of the corpo-
rate governance code, stemming in particular from the inadequate inde-
pendence of members of the supervisory board in the decision-making
process (Versatel and Begemann), the untransparent group structure of
the firm (Unilever and ASMI), and the unclear business strategy of the
company (Laurus).

B. Reinforcing shareholder rights in the

Dutch Enterprise Chamber
Although there is widespread perception that the Dutch Enterprise
Chamber has played a long-standing role in the enforcement of corpo-
rate governance, the court has only recently made significant progress
as the leading institution establishing its authority over the confl ict of
interest rules, takeovers and the implementation of the code. Under
Dutch law, the Enterprise Chamber has jurisdiction in cases where: 1)
there are doubts about if a company is properly managed, 2) the deci-
sions of management are challenged as being inconsistent with the
code’s principles, 3) shareholders voice dissatisfaction with fi nancial
reporting, 4) complaints are made about the removal of a supervi-
sory board of a company organized under the structure regime, and
5) squeeze-out procedures are initiated by a shareholder that has at
least 95% of the share capital of a company. Judging from the number
of cases, the Enterprise Chamber has properly exerted its influence on
the governance arrangements in disputes over the way companies are
managed.
In Figure 1 we can observe the main steps in an inquiry proceed-
ing. At the first stage, a party can request an inquiry into the affairs
of the corporation to determine whether the company has been mis-
managed. If the Enterprise Chamber shares plaintiff ’s concerns, it will
appoint one or more persons who will conduct an investigation and fi le
338 Perspectiv es in compa n y l aw

The Dutch Inquiry Procedure

The First Stage
Written Request
The Enterprise
Chamber may order
preliminary remedies upon
Is there a substantial reason to question the policy of the corporation? request

NO - request YES - The Enterprise Chamber

rejected appoints one or more
independent investigators

An official report

No Improper Policy Improper Policy

The Second
Stage

Possible Measures
(a) the suspension or nullification of a resolution of the directors, the supervisory board members. the general meeting or of any other
constituent or corporate body of a legal person
(b) the suspension or dismissal of one or more directors or supervisory board members
(c) the temporary appointment of one or more directors or supervisory board members
(d) the temporary derogation from such provisions in the articles of association as shall be specified by the Enterprise Chamber
(e) the temporary transfer of shares to a nominee
(f) the winding up of the legal entity

Figure 1 The Enterprise Chamber’s Enquiry Procedure

a report with the court. At the second stage, the Enterprise Chamber
can, based on the report finding improper conduct, take one or more
measures (including dismissal of board members, nullification of board
resolutions, appointing temporary directors, temporary transfer of
shares) to mitigate the effects of the mismanagement.

1. Takeovers
Increasingly, parties are relying on the Enterprise Chamber to con-
duct inquiry proceedings in the context of a takeover. The shareholder
interest in litigation involving takeovers has peaked recently with share-
holders routinely bringing actions to investigate the target company’s
use of defensive measures. With recent decisions of the court, it is now
becoming clearer that the assumption that Dutch law serve to protect
the interests of large shareholders and incumbent management is no
longer safe.
The Netherlands has a long tradition in defending its domestic com-
panies against foreign acquirers. For instance, Royal Dutch/Shell Group
defended itself already in 1907 by giving a ‘friendly’ foundation enhanced
 Cor por ate gov er na nce r efor m & en forcement 339

voting powers in order to resist potential ‘hostile’ buyers.25 However,

over the past decade the mindset towards takeovers has changed in
the Netherlands. Firstly, the corporate governance principles that were
adopted in 1997 spurred the development of improved shareholder rela-
tions. Secondly, the resistance to international acquirers faded (while
foreign companies that were incorporated in the Netherlands endeav-
oured to protect themselves by employing typical Dutch defensive
mechanisms, such as the issuance of preference shares to a foundation).
The Enterprise Chamber has played an important role in clarifying the
acceptance of anti-takeover defences by deciding in the Gucci case (1997)
and the Rodamco North America case (2002) that defensive measures
should be proportional, reasonable and temporary.
The Enterprise Chamber continues its responsive role in recent
cases involving activist shareholder influence. A recent decision of the
Enterprise Chamber, arising out of a shareholder conflict between Stork,
a European conglomerate, and two hedge funds, Centaurus Capital of
the UK and Paulson & Co of the US, which emerged as its largest inves-
tors holding over 31.4% of the company’s shares, reinforces the pattern of
enhanced shareholder protection in Dutch company law. In 2005, the two
hedge funds took up a high profile campaign against the managers of the
company, who were content to operate an old-style conglomerate struc-
ture consisting of a food systems, technical services and aerospace divi-
sion. Armed with a study of how Stork could realize shareholder value,
the activist funds sought to unbundle Stork’s conglomerate structure by
reducing the number of unrelated divisions and concentrating solely on
the high-value end of its business. Management would reject the hedge
funds’ advice claiming that the fund managers are merely short-term
investors that care more about increasing Stork’s share price through
unbundling than the long-term interest of the company and its stakehold-
ers. Responding to these allegations, the funds increased their pressure
on management by calling a non-binding shareholder resolution that
would ask investors to support their divestiture motion. Shareholders
overwhelming supported the activists’ non-binding resolution, which the
board subsequently ignored on the grounds it was not binding legally.
To further underscore its determination to neutralize the activists’
threat, Stork’s board continued its refusal to discuss strategy with the
fund managers. The funds were ultimately forced to call an extraordinary

25
See The Wall Street Journal (by Adam Cohen), ‘Going Dutch Has New Meaning in
Corporate Takeover Battles’, 30 May 2006.
340 Perspectiv es in compa n y l aw

shareholders meeting on 17 January 2007 to demand the dismissal of the

members of the supervisory board on the grounds of mismanagement.
Surprisingly, this action prompted the Stork Foundation, an unrelated
but closely aligned entity, to trigger a poison pill device that diluted the
hedge funds’ interest in the Stork’s equity, giving the company’s board
and its allies effective control of the company. The hedge funds had
no choice but to challenge the legality of the poison pill device alleg-
ing that the company was guilty of ‘mismanagement’ by attempting to
frustrate shareholders’ rights. The Enterprise Chamber found that the
use of the poison pill was illegal, but barred the shareholders’ planned
vote that called for the dismissal of the supervisory board. Instead, the
Court decided to appoint three additional independent supervisory
board members and to investigate the alleged mismanagement claims
of shareholders. The Stork conflict illustrates the core principle of the
Dutch Code to enhance the rights of shareholders and shows the ever-
increasing important role of the Enterprise Chamber.
Also, another recent case involving a conflict with a majority share-
holder in a tender-offer situation appears to show that the Enterprise
Chamber will no longer rubber stamp a management protective envi-
ronment. In Begemann, there was a tender by Tulip (of which company
Begemann was the controlling shareholder) for the shares of Begemann,
which was supported by the company’s boards. Significantly, the tender
was undertaken without a fairness opinion or other external support
for the tender. Unsurprisingly, the Enterprise Chamber agreed with the
minority shareholders and appointed a temporary director and member
of the supervisory board in Begemann.

2. Conflict of interest
The other significant area of activity for the Enterprise Chamber is con-
flicts of interests. The court has for some time attempted to elaborate a
standard to prevent the adverse consequences of such actions. Recently,
the Enterprise Chamber determined that, in a case involving a struggle
for corporate control, a company would be considered mismanaged not
only if a potential conflict of interest existed, but if it also failed to take
sufficient protections against such a confl ict (see Laurus).
Besides setting a standard measure for remedies, the court has recog-
nized a need to set a norm for complying with the code. An especially
noteworthy example of the intense battleground shaping the contours of
corporate governance in the Netherlands is the recent Versatel case. In
this case, the Enterprise Chamber of the Amsterdam Court of Appeal
 Cor por ate gov er na nce r efor m & en forcement 341

decided in favour of minority shareholders, supported by the Dutch

investors’ association, to forbid the change from compliance to non-
compliance with the corporate governance code between two ordinary
general shareholders meetings. Swedish Tele2 became the controlling
shareholder of Versatel and appointed new ‘Tele2-persons’ as super-
visory board members. According to the Netherlands code, these new
members, due to their conflict of interest, would not be able to take part
in the decision-making process to approve a merger with the aim to buy
out minority shareholders. As a possible solution, Versatel proposed to
amend its corporate governance policy by limiting compliance with the
conflict of interest provisions of the code. Th is argument was rejected by
the Enterprise Chamber on the grounds that Versatel, having agreed to
abide by the Code in their annual accounts of 2004, would respect the
expectations of minority shareholders. The effect of the Versatel decision
is to dramatically strengthen the rule-based character of the Code.
The foregoing discussions together show that the Enterprise Chamber
has reinvented itself, moving from a body engaged in specialized inves-
tigations into disputes arising in the context of bankruptcy proceedings
to addressing the major governance claims of parties, particularly in
the area of takeovers and conflicts of interest. By choosing to intervene
in disputes to determine whether misconduct took place, and resolve
quickly these actions in a decisive and definitive manner, the court has
gradually increased its ability to improve the corporate governance
environment in which companies operate. It follows that the Enterprise
Chamber has become a leader in the ongoing discussion about the Code
and best practices and as a result, has been transformed into the main
body responsible for balancing the demands between management and
shareholders in the Netherlands.

IV. Conclusion
In this chapter, we discussed the effect of the corporate governance
regulation on the performance of listed companies. We reviewed recent
analyses that focus on the role of corporate governance rules that tend to
promote efficiency, transparency and accountability within firms. With
respect to the Netherlands, we identified the various legislative and soft-
law measures that have emerged recently and attempted to benchmark
the effect of the Dutch reforms. Having explained how corporate govern-
ance measures and reform are valued, we then considered if Dutch com-
panies are undervalued relative to their international counterparts in
342 Perspectiv es in compa n y l aw

similar industries having similar corporate governance practices. While

Dutch firms continue to be undervalued, there are indications that the
recent changes introduced by the Dutch Code are likely to improve the
performance of publicly listed firms in the Netherlands. Finally, we
reviewed the Dutch ex post enforcement regime, pointing to a number of
key decisions of the Enterprise Chamber that are likely to make minor-
ity shareholder protection more effective.
SEC T ION 3

Takeover law
 19

Adoption of the European Directive on takeover

bids: an on-again, off-again story
Joëlle Simon 

The on-again, off-again progress of the takeover Directive began in the

1980s at a time when major economic restructurings were being carried
out. The debate on the Directive became less active in 2004 and was there-
after resumed at the beginning of 2005 and came to fruition in March
2006.2
This progress corresponds to a series in five episodes:
1st episode (from 1985 to 1999): the rise. Why a takeover directive? What
provisions should this directive contain?
2nd episode (from 2000 to 2001): the downfall. Many accidents marred
the progress of the directive and led to its rejection by the European
Parliament in 2001.
3rd episode (from the end of 2001 to 2003): the reprieve. Mr. Bolkestein
did not accept this setback and sought to give a new momentum to
these efforts by entrusting a group of experts with the task of finding
a way to break the deadlock.
4th episode (in 2004): smoke and mirrors. Adoption in 2004 of a non-
directive.
5th episode (starting from 2004): implementation in the domestic laws
of the Member States.

1
The author states her personal views in this chapter.
2
See also, L. Lambert and S. Bedrossian, ‘La réglementation des OPA dans l’Union
européenne, un chantier plein de surprises’, HEC dissertation, May 2002; D. Muffat-
Jeandet, ‘OPA: l’histoire d’une directive européenne. Le rejet de la proposition de 1989 et
de ses versions revises’, Revue du Marché commun et de l’Union européenne, 475 (2004),
111; J. Simon, ‘OPA: divine surprise ou faux semblant?’, Revue européenne de droit ban-
caire et financier, 3 (2003), 329.
345
346 Perspectiv es in compa n y l aw

I. 1st episode: Why a takeover directive? What provisions

should this directive contain?
In 1985, the Commission published its White Paper (Completing the
Internal Market) and announced its intent to propose a directive in
order to approximate Member States’ legislations on takeover bids. The
Commission then launched a four-year works programme.
Upon completion of these works, in 1989, the Commission submitted
a proposal for a 13th company law directive concerning takeover bids.
This proposal was amended on 10 September 1990 in order to take into
account the opinions issued by the ESC and the European Parliament.
This ambitious proposal had been drafted in a context in which inter-
national takeover bids were becoming more numerous. This proposal
was also prepared under the pressure of several Member States that
deemed it advisable to create fair-play rules in order to protect all parties
concerned by a takeover bid.
The Commission intended to be neutral vis-à-vis takeover bids and
saw these bids as a way of contributing to the growth and development of
European companies in order to cope with international competition.3
With the recession that led to a slowdown in M&A activity, the demand
from Member States for a takeover directive became less strong, and
criticism was levelled against the initial proposal.
In December 1992, during the Edinburgh European Council, the
Commission announced that it would revise its text. After lengthy con-
sultations with Member States, the Commission submitted in 1996 a
second proposal that was less ambitious and set a number of objectives
to be reached by Member States.
After the ESC issued its opinion in July 1996 and after a review by
the European Parliament in June 1997, the Commission submitted to
the Council a third, amended proposal that integrated a large part of the
proposed amendments.
In July 1998, negotiations resumed within the Council.
On 21 June 1999, the Chairmanship brokered a political agreement
among the E-15 despite the reluctance of the United Kingdom and the
Netherlands.

3
G. Ferrarini, ‘Take Over Defences and New Proposal for a European Directive’, Second
European Conference on Corporate Governance, Brussels, 28–29 November 2002;
Lambert and Bedrossian, ‘La réglementation des OPA dans l’Union européenne, (note 1,
above).
 the Eu ropea n Dir ective on tak eover bids 347

The terms of the agreement were then as follows:

• a framework directive allowing for certain specific local features
provided that the same are not incompatible with the principles laid
down in the directive,
• a directive aimed at fostering takeovers within the European Union,
• a directive aimed at protecting minority shareholders and provid-
ing a measure of information and publicity during the time of the
offer,
• a directive asking each Member State to appoint a supervisory author-
ity and enforcing the principles and obligations imposed by the
directive.

II. 2nd episode: The downfall. Many accidents marred the

progress of the directive and led to its rejection by the
European Parliament in 2001
Several incidents hindered the progress of this initiative: the Gibraltar
issue and the German opposition.

A. The Gibraltar issue

The long-standing dispute between Spain and the United Kingdom con-
cerning the status of Gibraltar blocked the passing of a number of EU pro-
visions. Spain exercised pressure in order to oblige the United Kingdom
to reach a general agreement concerning the status of this autonomous
territory. Finally, Spain and the United Kingdom reached an agreement
in April 2002, and Spain withdrew its reservation concerning the pro-
posal for a directive.

B. The German opposition

The German opposition was triggered by the Vodafone/Mannesmann
deal: in Germany, the takeover bid launched by Vodafone for
Mannesmann seemed like a bolt of lightning out of the blue. Until then,
the German industrial community had never voiced any specific oppo-
sition to the harmonization of the rules concerning takeover bids. Even
though Mannesmann was already controlled by foreign shareholders,
this bid came as a shock.
348 Perspectiv es in compa n y l aw

This takeover bid triggered an immediate reaction from the German

government. The takeover bill that was being prepared was amended in
order to re-introduce anti-takeover bid defences with the Voratbeschluss,
i.e. the possibility for officers of a company to approve any defence
against a takeover bid if shareholders have granted an approval to that
end during the eighteen preceding months.
The proposal for a directive then became the focus of attacks by
German commentators. The reporter of the Parliament’s Legal Affairs
Commission, Mr. Klaus Lehne, launched the offensive by targeting
mainly Article 9, which laid down the principle according to which
general meetings had the fi nal say. Such a provision deprived German
companies of any defence, while companies from other Member States
and third countries could adopt defensive measures that were hence-
forth prohibited in Germany, such as multiple voting rights. Mr. Lehne
then emphasized the need for a level playing field.
On 13 December 2000, Parliament approved the Council’s joint
position with fi fteen amendments (control threshold, definition of fair
price, etc.), one of which aimed at introducing a German-style excep-
tion. However, these amendments were eventually dismissed by the
Council after receiving the Commission’s opinion.
A conciliation procedure then started.
Finally, the German opposition agreed with the German Government,
which took a position unfavourable to Article 9 which asserts the gen-
eral meeting’s power as regards takeover bids. Despite Germany’s oppo-
sition, other Member States decided to maintain their initial position
during the negotiation with Parliament and reached a compromise on
5 June 2001.
The EDF case: EDF, which was at the time a public-sector agency and
was therefore not subject to the takeover regulations, started buying
companies in Spain and Italy, thus triggering an anti-EDF, and thus an
anti-takeover, campaign in Italy. The Italian members of the majority
then joined all those opposing the directive.
A surprising turn: the directive was rejected by the European
Parliament.
On 4 July 2001, the European Parliament surprised everyone by
dismissing the compromise by 273 votes in favour and 273 votes against
the proposal, the equality of votes resulting in the rejection of the
proposal. All German MPs voted against the proposal. It seems that
such was also the case for certain French MPs.
 the Eu ropea n Dir ective on tak eover bids 349

III. 3rd episode: The reprieve. A new momentum

Mr Bolkestein, who was at the time Commissioner in charge of the
Internal Market, refused to concede defeat. After being encouraged by
certain Member States and enterprises from certain countries (MEDEF
had supported this directive), he decided to table a new proposal for a
directive.
Then, an expert group came into play, comprising seven individuals:
Jaap Winter (Netherlands), Jonathan Rickford (United Kingdom), Guido
Rossi (Italy), Jose Garrido Garcia (Spain), Jan Christensen (Denmark),
Klaus Hopt (Germany) and Joëlle Simon (France).
Already in spring 2001, Mr. Bolkestein had decided to set up an expert
group in order to examine the future of European company law in the
next few years. Indeed, it is necessary to point out that European institu-
tions had not been very active as regards company law, aside from the
last-minute agreement reached at the end of thirty years of efforts in
relation to the European company.
Mr Bolkestein took this failure personally and asked the group to
deliver to him, on a priority basis, a report by January 2002 concerning
the three following issues, which are of unequal importance, but were
defined by the European Parliament:
• How is the fair price to be defined in case of a mandatory offer?
• Is it necessary to provide for a mandatory expulsion procedure
(squeeze-out and sell-out)?
• Is it possible to create a level playing field and, if so, how?
While the first two issues did not lead to overly heated debates, things
went differently for the third question4.
Fair price: the various existing systems were reviewed, including the
French multi-criteria approach, taking into account in particular tangi-
ble assets and the affi liation with a group. The group finally approved the
definition used in the United Kingdom, i.e. the highest price paid by the
offeror during a period preceding the offer, such period being determined
by each Member State and ranging between six and twelve months, with
possible exceptions. While it is true that this definition has the merit of
facilitating the calculation of the fair price and being more favourable
to minority shareholders, the application of this test nevertheless leads
4
European Commission, Report on Issues Related to Takeover Bids, Report of the High
Level Group of Company Law Experts, (2002).
350 Perspectiv es in compa n y l aw

to an increase in the price of takeovers and is not necessarily fair for the
offeror in particular at times of sharp and swift share price fluctuations.
Thus, by making takeovers more expensive, this test may, in certain
cases, be an anti-takeover defence, and this is paradoxical.
Squeeze out and sell out: there is already, in a number of Member
States, including France, a procedure for the expulsion of minority
shareholders by majority shareholders holding between 90% and 95% of
the capital (mandatory withdrawal if the offeror holds 95% of the voting
rights). As this procedure restricts minority shareholders’ rights, it may
seem logical to have it set off by a withdrawal right offered to minority
shareholders who may procure the redemption of their shares (under
French law, such right exists when the majority shareholder holds 95%
of the voting rights, and the minority shareholder does not belong to
the majority group; a decision made by the AMF is indispensable), even
though the parallelism of these procedures is challenged by certain
commentators.
The level playing field: do we need a level playing field? The search for
a level playing field, which is a little bit like the quest for the Holy Grail,
relies on the following postulate.
Theoretically, when a company taps the market in order to finance
its operations, and all or part of its shares are admitted to trading on
a regulated market, an offeror should be able to acquire control of the
company, without having to face any anti-takeover defences.
However, it is interesting to note that on the two most important
financial markets (the US and the UK), the response given is totally
different, while the capital structure is similar in both countries, with
scattered capital.
US law never barred takeover defences, whether they consisted of
poison pills or takeover-proof companies. In contrast, UK law does not
allow anti-takeover measures. Thus anti-takeover barriers can survive
market laws.
Nevertheless, this does not mean that this issue is not debated in the
United States, and certain commentators recommend barring anti-takeover
measures. Also, the impact of these measures is assessed in diverging man-
ners. Certain observers consider that they have only a limited impact on
the outcome of the bids and only have a marginal impact,5 while others

5
See, in that sense: J. McCahery and G. Hertig, ‘An Agenda for Reform: Company and
Takeover Law in the EU’, in G. Ferrarini, K. Hopt, J. Winter and E. Wymeersch (eds.),
Modern Company and Takeover Law in Europe (Oxford University Press, 2004).
 the Eu ropea n Dir ective on tak eover bids 351

conclude that the most frequently used poison pills caused the number of
hostile takeover bids to drop by 75% in ten years in the United States.6
This raises the very issue of challengeability of control that largely
depends on the structure of capital.7 While it seems that this issue has
not been widely debated in Europe, it has been covered by in-depth
analyses conducted by US academics.8
According to certain US authors, control does not necessarily have
negative effects on shareholders, and may even benefit minority share-
holders. On the other hand, the European Round Table considers
that it has not been demonstrated that the challengeability of control
increases the target’s value, by questioning management. According to
those defending this approach, a directive concerning takeover bids in
Europe should not be used as an instrument for restructuring European
economies: the market alone should decide on where it invests and
therefore on the structure of capital. However, because Parliament and
the Commission settled this debate by choosing the opposite direction,
the Commission entrusted the group of experts with the task of defi ning
the best ways of reaching this goal.
How could this be done? Th is issue gave rise to arduous and complex
discussions, at the end of which the group proposed a relatively complex
scheme:
• the general meeting must have the final say, without any possible
delegation;
• the risk taking should be commensurate with the control exercised
after the launch of the bid: this is the risk-bearing share capital rule
according to which shareholders may only vote according to the share
of capital that they hold: one share, one vote.
• principle of neutralization of the defence mechanisms after the success-
ful completion of the takeover, i.e. when a certain threshold is reached;
• principle of transparency of structures and control.
Discussions within the group showed how difficult it was to cover all
defence mechanisms: thus, do shareholder agreements (which are

6
See: A. Ferrel, ‘Why Continental Takeover Law Matters’, in Ferrarini, Hopt, Winter and
Wymeersch (eds.), Modern Company and Takeover Law in Europe, (note 5, above).
7
For a different opinion, see Guido Ferrarini, ‘The challenge of the 13th directive in the EU’,
debate organized on 4 March 2003 by the Centre of European Policy Studies.
8
See: J. Coates, ‘Ownership, Takeovers and EU Law: How Contestable Should EU
Corporations be’, in Ferrarini, Hopt, Winter and Wymeersch (eds.), Modern Company
and Takeover Law in Europe (note 5, above).
352 Perspectiv es in compa n y l aw

governed by the law of contracts) and pyramid structures avoid the

neutralization principle, as well as Dutch foundations. Therefore, the
double or multiple voting rights constituted an easy target. Such an
approach is not necessarily without guile.
The presentation of the report’s conclusions prompted a strongly neg-
ative response from many Member States.
The sudden emergence of the debate concerning the level playing
field, i.e. on the evenness of the rules of the game applying throughout
the European Union in case of a takeover bid, had a considerable impact
on the very design of the rules that should apply to takeover bids within
the European Union and on the future status of the proposal for a direc-
tive. There is no doubt that this rekindled the opposition to a text that
was nearly adopted by all Member States, but one.
Most Member States reacted quite harshly to this report, as they consid-
ered that the proposals had too much of an impact on company law and
were raising constitutional issues because of the lack of indemnification of
shareholders whose rights would be neutralized. Thus, if the recommenda-
tions contained in this report were to be applied, a voting right would again
be attached to formerly non-voting shares, while financial benefits had been
granted in consideration for the removal of the relevant voting rights.
Therefore, the Commission did not endorse all of the group’s pro-
posals, but asserted very clearly the general meeting’s decision-making
power, by going one step beyond the earlier text, by removing the pos-
sibility of delegating authority to the Board. Also the Commission laid
down the principle of neutralization of certain defence measures.
The debate then focused on the two issues below, possibly to the detri-
ment of other technical issues.

1. Board versus general meeting.

The issue that observers believed to be definitively settled in favour
of the general meeting of shareholders as a result of the 2001 compro-
mise was reopened again, as Parliament considered that the Board could
not be deprived of its powers so long as there was no level playing field
between companies of the various Member States.
Even though the Commission, relying on the groups of experts’ report
and the Member States, confirmed this choice in favour of the general
meeting, the debate was not totally closed between those advocating the
US system in which the Board has all powers and those willing to give
the final say to the general meeting of shareholders. Incidentally, this is
shown by the option selected in the text of the directive.
 the Eu ropea n Dir ective on tak eover bids 353

Those promoting, in Europe, a US-style system argued that the vote

of shareholders in companies having a scattered capital structure was
only an illusion and that it was not certain that the board’s neutrality
rule would have only positive effects: risks of litigation and difficulty for
officers of maximizing shareholders’ investment. Three days after the
launch of a takeover bid, one third of the shares has already changed
hands and is held by arbitrageurs.
In contrast, those opposing a US-style solution considered that such
a system could not be imported into Europe, as the Board’s omnipo-
tence in the United States was legitimately set off by a liability in tort,
on grounds of which shareholders did not hesitate in particular to file
class actions. However, such a debate existed also in the United States
where shareholders recently submitted to general meetings of US
companies draft resolutions under which decisions for the adoption
of poison pills were to be submitted for approval to the shareholders.
It is worthy of note that those advocating the Board’s decision-making
powers include representatives of employees who thus consider that the
Board is better placed than the general meeting of shareholders (who
represent the capital) to take into account the interests of employees. The
idea of freedom of choice between the general meeting and the Board was
even brought forward, assuming the creation of an adequate dispute set-
tlement mechanism. However, because of the small likelihood of finding
adequate means of effecting such a settlement in Europe, those favour-
ing this idea recommended giving the final say to the general meeting.
The future of this provision is indubitably linked to that concerning the
neutralization of defence measures.

2. Up to what point is it necessary to neutralize defence measures?

The group of experts proposed to apply the neutralization prin-
ciple immediately from the launch of the bid as regards the measures
departing from the proportionality principle, after the offeror reached
a threshold defined according to the threshold required in the Member
State concerned, in order to amend the company’s articles of association
as regards all of the relevant measures.
While the neutralization principle did not per se raise many objec-
tions in Europe, such is not the case for the list of measures to which
such neutralization may apply. On the contrary, US authors challenge
the very usefulness of neutralization measures, in that they doubt their
effectiveness in order to create a level playing field and even consider
that neutralization measures might create additional costs.
354 Perspectiv es in compa n y l aw

In any event, the neutralization of certain measures, such as the

measures preventing free trading in shares (incidentally such measures
are often barred as regards companies whose shares are admitted to trad-
ing on a regulated market) may not be subject to a serious challenge.
In contrast, and although the scope of the Commission’s proposal
and the fi nal text of the directive did not fi nally include double voting
rights, we may regret that such double voting rights eventually became
the focus of the debate, while other mechanisms were not discussed.
Those willing to give double voting rights a bad name had political
afterthoughts and knew very well that any attempt to challenge these
mechanisms would unavoidably prompt certain Member States to
oppose the proposal.
Regardless of our opinion concerning mechanisms departing from
the ‘one share, one vote’ principle, we may deplore that this debate largely
contributed to blocking, for months, any significant progress towards
the adoption of a directive.
In addition, even if the proportionality principle were to be applied,
US authors consider that the neutralization principle would not have any
effect on most listed European companies which they see as immune to
takeover bids. This principle would then lead to the application of the
measures to less transparent systems, such as pyramids.
Finally, US structures show that there is no evidence that structures
with double or multiple voting rights have a lower performance and are
used in order to support a poor management team.9 The use of these
structures and that of the non-voting shares forms part of enterprises’
right to freely choose their organization and management mode in order
to gain readier access to capital markets. For the market, the controlling
factor is the transparency of the structures and control, proper corporate
governance and a high-quality audit process.

IV. 4th episode: Breaking the deadlock through a conjuring

trick – the obscuring of the level playing field
Those many years of debate on the harmonization of European takeover
bid law were not completely futile, as they are likely to have contributed
9
See in particular Ferrel, ‘Why Continental Takeover Law Matters’, (note 3, above) and
McCahery and Hertig, ‘An Agenda for Reform’, (note 5, above). It is also necessary to
note the change in Mr. Klaus-Heiner Lehne’s position in this respect in Revised draft of
the report concerning the proposal for a directive of the European Parliament and the
Council concerning takeover bids.
 the Eu ropea n Dir ective on tak eover bids 355

to a change in domestic laws: virtually all Member States now have

takeover regulations. The last Member State not to have had such reg-
ulation, i.e. Luxembourg, adopted takeover rules in connection with
Mittal’s bid for Arcelor. Therefore was a directive still necessary, as the
United States does not have any uniform legislation in this area? It is
necessary to answer this question in the affi rmative, and not only for
symbolic reasons: such was the unanimous decision of the Member
States (Spain abstained) and the European Parliament.

A. If so, what should the directive’s contents consist of?

Past debates have been marked by the rejection of an overly detailed and
technical directive and the adoption of a text that is half political and half
technical. Curiously, the final outcome is a directive affording a double
option to Member States and, where applicable, to enterprises: nobody
would have bet on the chances for success of the so-called Portuguese
proposal, i.e. a directive containing an option for Member States and for
enterprises. After a few amendments, this proposal was endorsed by the
Italian Presidency and was eventually approved.
Finally, the Directive lays down the principle according to which the
general meeting of shareholders has the final say (Article 9) and that
certain defence measures must be neutralized (Article 11), but offers
Member States and enterprises, as the case may be, the possibility of not
applying either or both of these Articles (Article 12–3).

B. A first outline of the level playing field

As regards the decision-making body, the text no longer makes it possi-
ble, contrary to the draft that was rejected in 2001, for the general meet-
ing to grant, from the outset, authority to the Board. Concerning the
neutralization rule, the directive sets forth that its provisions shall apply
to restrictions on the free trading of shares, set forth in articles of asso-
ciation or in contractual arrangements, and to provisions of the articles
of association or contracts limiting voting rights and governing shares
with multiple voting rights.
In addition, the directive sets forth that where, following a bid, the
offeror holds 75% or more of the capital carrying voting rights, no such
restrictions nor any extraordinary rights of shareholders concerning the
appointment or removal of board members provided for in the articles of
association of the offeree company or multiple voting rights shall apply
356 Perspectiv es in compa n y l aw

during the first general meeting following the bid as convened by the
offeree company in order to enable it to amend the company’s articles of
association or remove or appoint the members of the board. The holders
of the said rights must then be entitled to fair indemnification making
whole any loss possibly sustained.
However, while the highly complicated text of this compromise
eventually ruled for the neutralization of securities with multiple vot-
ing rights, the compromise excludes, from the scope of this regulation,
securities having a double voting right, because of the definition given to
multiple voting securities. Indeed, these securities are defined as securi-
ties included in a distinct and separate class and carrying more than one
vote each, which is not the case in French law for shares having a double
voting right.
Indeed, double voting rights are not vested unless certain objective
requirements are satisfied: the shares must be registered and held for no
less than two years and no more than four years as regards companies
whose securities are admitted to trading on a regulated market. Such
double voting right is forfeited in the event of a share sale.

C. . . . with the possibility for Member States, and possibly for

enterprises, to provide for exceptions
Member States may reserve the right not to require companies regis-
tered on their territory to apply Article 9 (2 and 3) (neutrality of the
Board) and Article 11 (neutralization of defence measures). However, in
such event, the said Member States may nevertheless authorize the said
companies to apply either or both of the said Articles on a voluntary
basis.
The decision will then be made by the general meeting of sharehold-
ers (this is consistent with Article 9) subject to the quorum and majority
rules imposed by the company’s articles of association. Notice of this
decision shall be given to the supervisory authority of the Member State
in which the company has its registered office and to all supervisory
authorities of the Member State in which the company’s securities are
admitted to trading on a regulated market or where such admission has
been requested.
Finally, Member States may, under the conditions determined by
national law, exempt companies which apply Article 9 (2 and 3) and/or
Article 11 from the application of the said Articles, if they become the
subject of an offer launched by a company which does not apply the same
 the Eu ropea n Dir ective on tak eover bids 357

Articles as they do or by a company controlled, directly or indirectly, by

such a company (Article 12–3).
In the current draft ing of this text, it seems that this possibility is
granted to all Member States, and therefore even to those Member States
that require their domestic companies to apply Articles 9 and 11. In such
event, an authorization will have to be granted by the general meeting of
the offeree company. Such authorization may not be granted more than
eighteen months in advance of the time when the bid is made public. The
general meeting may, at any time, withdraw such an authority.
It is interesting to note that the proposal does not provide for the irre-
versibility of the options, whether as regards Member States or companies,
while such irreversibility was a feature of the Portuguese proposal – which
is rather fortunate.
Indeed, it is likely that such irreversibility might have created constitu-
tional issues in certain States. Moreover, the irreversibility of the choice
made by a company for the application of Articles 9 and 11 is consistent with
the spirit of the proposal, i.e. over time to turn such application into a gen-
eral rule, but is contrary to the company law principle according to which a
corporate body must be able to undo any decision that it has made.
Those advocating this system consider that it corresponds to a lib-
eral solution, in that the market should prompt companies to adopt the
board’s neutrality principle and remove defence measures. Articles 9 and
11 would then constitute the benchmark, even though certain observers
characterize these provisions as a half-way benchmark in that they tar-
get only certain defence measures.
Although this mechanism is ingenious, it also raises a number of
questions, while leaving other questions unanswered.
Certain observers have feared that the system would not reach the
assigned objective, in that it might prompt Member States, under pres-
sure from their enterprises, and possibly thereafter these enterprises, to
choose the most protective system. This might thus lead to a regression
within the Member States currently applying the principles set forth in
Articles 9 and 11. This did in fact happen, as we shall see.
This system runs counter to a minimum harmonization of rules
applicable to takeover bids. This system is complex to apply, in particu-
lar because the option made available to Member States and enterprises
may cover either or both of these two Articles.
Even though reciprocity requires a decision of the Member State and
the approval of the general meeting of the offeree company, this sys-
tem lacks consistency and may prove difficult to manage for supervisory
358 Perspectiv es in compa n y l aw

authorities and may lack clarity for investors. Th is reciprocity principle

is totally new in EU company law and even seems contrary to the funda-
mental principles of EU company law: i.e. freedom of establishment and
free movement of capital. This may be an unwelcome precedent in EU
company law, with a view to the preparation of the action plan prepared
by the European Commission.

D. We may therefore question the merits of a

‘cherry-picking’ directive
Wouldn’t it have been preferable to adopt an admittedly less ambitious and
more pragmatic solution, i.e. a Directive without Articles 9 and 11? This
would have made it possible to dispense with this needlessly complex mecha-
nism that is contrary to EU company law principles. Incidentally, this result
will be reached by this complex mechanism whenever the reciprocity rule
shall apply on a case-by-case basis. Indeed, a Directive not containing Article
9 or Article 11 would not have been completely without merit, as it would
have created a common foundation consisting in the following principles:
• mandatory bid
• protection and information of employees and minority shareholders
• squeeze-out and sell-out procedures
• transparency of structures and control.
Contrary to the opinion of certain commentators, abandoning Articles 9
and 11 would not have been seen as a setback. It is true that the proposal,
rejected in 2001 by Parliament, included an Article 9. However, if we
take the example of France, it was very unlikely that the country would
call into question the affirmed principle of neutrality of the board and
the decision-making power of the general meeting or the neutralization
of voting right restrictions in the event of a successful bid. This was con-
firmed by the Act of 31 March 2006. However, it is true that the political
process may be driven by reasons that are foreign to law making.

E. Non-optional provisions of the directive:

1. Scope (Articles 1 and 2)
The directive applies to:
• companies governed by the laws of Member States whose securities are
admitted to trading on a regulated market in one or more Member States;
 the Eu ropea n Dir ective on tak eover bids 359

• voluntary or mandatory takeover bids leading to the acquisition of

control of the offeree company.

2. General principles (Article 3)

Pursuant to the subsidiarity principle, the directive merely sets forth a
number of general principles:
• Equality: all holders of the securities of an offeree company of the
same class must be afforded equivalent treatment.
• The intended recipients of the offer must have a right to be informed
in due time in order to be able to make a decision with full knowledge
of the facts.
• The board or management board of the offeree company must act in
the interest of the company as a whole and must not deny the hold-
ers of securities the opportunity to decide on the merits of the bid.
• An offeror must announce a bid only after ensuring that he/she can
fulfi l the promises made.
• An offeree company must not be hindered in the conduct of its affairs
for longer than is reasonable.
In all cases, Member States may impose more restrictive rules.

3. Supervisory authority and applicable law

(Article 4)
Member States shall designate the authority or authorities competent to
supervise bids and enforce the rules set forth in the directive:
• public or private authority (AMF),
• requirements: impartiality and independence of all parties to the
offer,
• close cooperation among supervisory authorities for cross-border
transactions.

4. Rules of conflict for the determination of the supervisory

authority and applicable law
The Directive sets forth conflict rules for the determination of the super-
visory authority and applicable law in the case of a takeover bid involving
one or more Member States. The principle is as follows: the supervisory
authority and the applicable law are those of the Member State in which
it has its registered office, when the securities are admitted for trading
on a regulated market of such Member State.
360 Perspectiv es in compa n y l aw

If the registered office is different from the place of listing, the solu-
tion is different depending on the issues raised:
• company law: in particular as regards the control threshold, the infor-
mation provided to employees: the supervisory authority and the
applicable law are those of the country in which the company has its
registered office;
• offer procedure and offered consideration: the rules applied are those of
the country in which the securities are listed and, if there are several
listing places, the rules of the country in which the shares have been
first listed.
In the first case, shareholders are anticipating complying with the rules
of the offeree company’s home country. In the second case, it is advisable
that the offer procedure be governed by the laws of the market on which
the bid is launched.

5. Protection of minority shareholders (Article 5)

The best way to protect minority shareholders consists in offering them
the possibility of selling their shares at a fair price. This is the objective
of the mandatory bid sent to all holders of securities for the purchase of
all of their securities at a fair price. We may regret that the Directive no
longer defines the percentage of voting rights giving control or the mode
of calculation of such percentage.

6. Information (Article 6)
The decision to launch a bid must be disclosed forthwith. The supervi-
sory authority must be informed in order to be able to check whether the
information that shall be published meets all applicable requirements.
The board of directors or the management board must also inform the
employees as soon as the bid has been made public. The Directive lists the
minimum information that must be contained in the offer document.

7. Time allowed for acceptance (Article 7)

• such time may not be less than two weeks or more than ten weeks
from the date of publication of the offer document;
• such time may not hinder corporate operations for too long a
period;
• such time must where applicable enable the offeree company to organ-
ize a general meeting concerning the offer.
 the Eu ropea n Dir ective on tak eover bids 361

8. Disclosure (Article 8)
Any information likely to influence the market for the relevant securi-
ties must be disclosed, in order to ensure the transparency and integrity
of the market for the securities and avoid the publication or circulation
of false or deceptive information.

V. 5th episode: Implementation in the laws of

the Member States
The implementation of the Directive gave rise to heated discussions in
certain Member States and in particular in France where the debate,
which was somehow stimulated by Mittal’s offer for Arcelor, primarily
covered the way in which the options were to be exercised, as most of
the provisions of French law were already in line with the Directive. Act
No. 2006–387 of 31 March 2006 on takeover bids eventually confi rmed
the principle of neutrality of general meetings (Article 9), provided for
the neutralization of certain control mechanisms (partial application of
Article 11), and the implementation of the reciprocity clause (Article 12).
In February 2007, the European Commission published a report on
the implementation of the directive in the Member States10.
Upon publication of the report, seventeen Member States had imple-
mented the Directive.11
Board neutrality principle: eighteen Member States have imposed or
shall impose the neutrality rule, thus confirming, except for five Member
States, a rule already contained in their substantive law. Five Member
States, including France, chose to apply the reciprocity exception.
The possibility introduced in French law to issue securities similar to
those existing under the US right plans is presented as a negative measure.
Rule for the neutralization of anti-takeover restrictions: the large
majority of Member States did not impose or shall not impose such

10
Commission Staff Working Document-report on the Implementation of the Directive
on Takeover Bids, Commission of the European Communities, Brussels, 21 February
2007.
11
The Directive was implemented in French law by Act No. 2006–387 of 31 March 2006
concerning takeover bids. The said Act confi rmed the decision-making powers of the
general meeting of shareholders during an offer period and chose to partly apply Article
11 consisting in the confi rmation of the neutralization of voting right restrictions by the
general meeting if the offer is successful and the prohibition of approval clauses in the
articles of association of listed companies. The Act also approved the reciprocity clause.
362 Perspectiv es in compa n y l aw

neutralization, which is a mere option available to enterprises. Only

Baltic countries, which account for only 1% of EU listed companies,
shall impose such neutralization. However, certain Member States have
already eliminated the multiple voting rights and/or the other defence
measures. Other Member States have already done so for certain meas-
ures, such as France and Italy.
Reciprocity: a majority of Member States introduced the reciprocity
rule as regards the implementation of (i) the board neutrality rule and/or
(ii) the rule for the neutralization of defence mechanisms. Th is was seen
by the Commission as the expression of a certain form of protection-
ism. Incidentally, the European Commission illustrated its demonstra-
tion by citing excerpts from French parliamentary debates. However,
the Commission also cites the argument stated in the Lepetit report,
according to which the reciprocity rule prompts companies to apply on
a voluntary basis the provisions of the directive, if they do not want to
have the reciprocity rule used against them in case of an acquisition on
foreign markets.

VI. Conclusion
In conclusion, although the Commission does not discount the positive
effects of the directive (mandatory takeover bid, information given to
shareholders and employees, etc.), it criticizes Member States’ reluctance
to remove anti-takeover obstacles.
The Commission will closely monitor the implementation of the
directive and hold public hearings in 2008, while waiting for 2011 which
is the scheduled time for a possible review.
Let us stay tuned . . . while waiting for the next episode.
 20

Application of the Dutch investigation procedure

on two listed companies: the Gucci and
ABN AMRO cases
Levin us Timmer m an

In recent years some decisions of the Dutch Enterprise Chamber of the

Amsterdam Court of Appeal (and the Dutch Supreme Court) attracted
attention in the international financial press. These judgments refer to
takeovers of internationally well-known companies which were estab-
lished according to Dutch company law. All these decisions were issued
within the framework of the Dutch investigation procedure. Below I
will explain some features of this investigation procedure (which has
no equivalent in foreign jurisdictions, as far as I know), and clarify the
position of the Enterprise Chamber in Dutch company law. Thereupon I
will discuss the Gucci and the ABN AMRO cases which aroused world-
wide interest from the financial world.
The investigation procedure was introduced in Dutch law in 1928.1
Originally, it was a very simple provision. Minority shareholders were
conferred the power to request a court to order an investigation into the
matters of the company. The purpose of such an inquiry was to bring to
light some facts that could otherwise be difficult for the shareholders to
establish. It was up to the parties that asked for the inquiry to seek rem-
edies in accordance with general civil and company law. Th is provision
was not a great success. Only two inquiries in a period of forty years were
requested. The unpopularity of the inquiry proceedings may have been
caused by the fact that, even when the court ruled that there had been
a case of misconduct, it was not capable of attaching any measures to its

1
An excellent overview of the investigation procedure in English has been written by Marius
Josephus Jitta, ‘The procedural aspect of the right of inquiry’ in The Companies and Business
Court from a Comparative Perspective (Kluwer, 2004), 1–42. I used some of his formula-
tions in this essay. See also L. Timmerman and A. Doorman, ‘Rights of minority sharehold-
ers’, in E. Perakis (ed.), Rights of Minority Shareholders: XVIth Congress of the International
Academy of Comparative Law (Brisbane), (Brussels: Bruylant, 2004), 484–609.
363
364 Perspectiv es in compa n y l aw

decision. In 1971 the investigation procedure was renewed and became

an instrument which was extensively elaborated in the Dutch legisla-
tion. As from 1971, an investigation procedure consists of two phases.
The purpose of the first phase is to get an order for an inquiry into the
conduct and policies of the company. An investigation will be ordered if
there appear to be well-founded reasons to doubt the correctness of the
policies or the conduct of a company. The law grants the right to request
an inquiry to inter alia shareholders who own 10% of the issued share
capital or hold shares with a nominal value of €225,000. It is important to
notice that this second threshold is very low, especially when it is applied
to a listed company with millions of shareholders. The consequence of
this low threshold is that listed companies are often the target of inquiry
proceedings if there are problems within the company.2 The second phase
of the procedure aims at establishing whether there has been miscon-
duct and, if so, whether definitive remedies should be ordered in order
to correct the misconduct. These questions are discussed on the basis
of the report of the investigators. Examples of remedies to be deployed
are the dismissal of one or more directors and the temporary nomina-
tion of a director. When choosing a measure, the Enterprise Chamber is
limited to a list which is to be found in the relevant legislation. In 1994,
the Dutch legislator added an interim injunction procedure to the inves-
tigation procedure. This new provision enables the competent court to
order provisional, immediate measures once an investigation procedure
has been initiated before it. In recent years this interim injunction pro-
cedure has turned out to be of extreme importance. The reason hereof
is inter alia that in company law a provisional measure is often de facto
definitive because of the high speed at which businesses operate.
In 1971, the Enterprise Chamber of the Amsterdam Court of Appeals
has been introduced in the Dutch judiciary as a specialized court for
matters of company law for which the Chamber was designated by the
legislator as competent court. One of these matters is the investigation
procedure. In Dutch company law the Chamber plays a pivotal role.
Since its establishment, its competence has been gradually increased by
the legislator. It is interesting to note that the chamber is not entirely
made up of lawyers. Two of the five judges are layman, usually account-
ants or former entrepreneurs. Since 1971 the enterprise Chamber
has turned to be a court with the traits we normally associate with a

2
Worldwide known companies such as Unilever, Ahold, Heineken, HBG, Rodamco,
Corus and DSM were the subject of the investigation procedure.
 Dutch in v estigation procedu r e 365

specialized court.3 One may expect that specialized courts are activist
and not reluctant judges and tend to adopt a rather informal approach
to procedural matters. These traits fully apply to the Dutch Enterprise
Chamber. The Chamber is a very activist and very informal court and
it has for a specialized court the natural tendency to interpret its tasks
broadly with all the connected pros and cons. It tends to let substance
override form. The Chamber is further helped with the active and infor-
mal performance of its tasks by the open structure of the way in which
the right of inquiry has been legislated for. For instance, the Chamber
can grant provisional immediate measures when these are required in
connection with the condition of the company or in the interest of the
inquiry. The Chamber is not limited to any specific set of measures, but
it can order any provisional measure it deems appropriate. An example
of a provisional measure is a prohibition on the directors to act on behalf
of the company or to carry out a resolution. It should be noted that the
Supreme Court has limited the competence of the Chamber to issue pro-
visional measures to matters of great urgency.4 Another example of the
activist and informal approach is that the Chamber has the power to
order an inquiry into broader subjects than that demanded by the plain-
tiffs. The consequence of all this is that the Chamber has considerable
freedom of action. In addition to this, the possibilities of review of deci-
sions taken by the Chamber are limited. The only possibility is to fi le an
appeal in cassation with the Dutch Supreme Court. The Supreme Court
only reviews decisions of the Chamber on limited grounds, i.e. whether
the law has been correctly applied and whether the decision has been
properly reasoned. The Supreme Court is not authorized to review the
facts of the case. The Chamber is the only instance which deals with the
establishment of the facts.
If one takes the number of decisions under the investigation procedure
by the Chamber into consideration, the investigation procedure is a great
hit. Since 1971, the Chamber has issued more than 1500 decisions con-
nected with the investigation procedure in approximately 500 cases. The
Supreme Court rendered about 100 decisions. A very attractive aspect
of the way the Chamber operates is its speed. For instance, the Chamber
is prepared to hear the request for an immediate measure within a week
and can rule immediately after hearing the case. The popularity of the

3
See on the traits of specialized courts: M. Kroeze, ‘The companies and business court as
a specialized court’, Ondernemingsrecht (2007), 86–91.
4
HR 14 December 2007, Nederlandse Jurisprudentie (2008), 105.
366 Perspectiv es in compa n y l aw

investigation proceedings is also caused by the fact that the proceed-

ings contain a cost allocation rule that is beneficial for the plaintiff: the
company has to pay the costs of the investigation, ordered by the Court
which are sometimes high (a sum of €500,000 is not exceptional). For a
plaintiff, the request for an investigation is a good gamble: it costs little
and has a high nuisance value for the company that is the subject of the
investigation. Another reason for the success of the investigation proce-
dure is that the Chamber has the power to order a provisional measure
before it takes a decision on the request for an investigation. The power
to order a provisional measure within the framework of the investiga-
tion procedure has developed into more or less independent summary
proceedings for corporate matters. These summary proceedings are of
high importance, as the investigation procedure sometimes ends with a
temporary measure, for instance because parties resign with the interim
measures. Sometimes, the interim measures and suggestions of the
Chamber stimulate the parties to reach a compromise.
A consequence of the practice of the investigation procedure is that
judges of the Chamber sometimes interfere in the affairs of a company
in an unprecedented manner. The Supreme Court quashed some deci-
sions of the Chamber because these decisions left too little room for
the management to pursue policies under its own responsibilities.5 It
is very difficult to assess the contribution the Chamber has delivered
to the sound functioning of Dutch corporate life. Without any doubt,
the Chamber has contributed to many settlements between the inter-
ested parties. Another important fact is that provisional and definitive
remedies have often led to a dispute being solved in a certain direction.
However, the question remains to what extent judicial interference can
really terminate conflicts within companies. This question is legitimate,
because the Dutch legislator had certainly an optimistic view on the
abilities of the judge in this respect. It was the intention of the Dutch
legislator to get a company back on track by restoring sound relations
within a company through the investigation procedure. The legislator
had in mind confl icts in a company which resulted in a deadlock of the
management of the company. However, we know that the resources for
all kinds of conflicts within a company are infinite. The investigation
procedure has the intention to look forward, i.e. to look into the future

5
HR 21 February 2003, Nederlandse Jurisprudentie (2003), 182 (HBG). See on this subject
Vino Timmerman, ‘Review of management decisions by the courts’ in The Companies
and Business Court from a comparative law perspective (Kluwer, 2004), 43–57.
 Dutch in v estigation procedu r e 367

of the company. I wonder whether this is not a somewhat idealistic trait

of the investigation procedure taking into consideration that the busi-
ness world tends to become more and more antagonistic. Sometimes,
the investigation procedure is used by aggressive investors for tactical
litigation and not for saving a company. The investigation procedure is
in such a case used as one of the instruments to conquer the company.
One thing is certain: the investigation procedure offers an interesting
tool to Dutch corporate lawyers to further develop Dutch company law.
It is a real lawyer’s paradise. In the framework of the investigation proce-
dure, litigation over nearly every aspect of company law and procedural
aspects thereof has taken place. Against this background, I would like to
make some comments on the Gucci and ABN AMRO cases.
Gucci is a world-famous group of companies specialized in the pro-
duction and sale of Italian-designed luxury goods. For tax reasons,
the listed top holding of the Gucci Group was situated in Amsterdam
and established according to Dutch company law and had subsidiar-
ies in Italy, France and several other countries. Gucci Group NV was a
Dutch company to which the investigation procedure was applicable. In
1999 LVMH – a French competitor of Gucci, the V in LVMH stands for
Vuiton – notified in a public statement that it had acquired an interest
of 34.4% in the Gucci Group and that it did not intend to issue a public
offer on the shares of the Gucci Group. The management of Gucci Group
was not amused. It took countermeasures. Gucci Group issued shares to
a newly established foundation ‘Employees interests’ under an employee
stock option plan. The number of shares issued to the foundation was
equal to the number which were held by LVMH. Gucci Group lent the
foundation the sum it needed to pay up the shares. Some time later, the
management of the Gucci Group made public that it had reached an
agreement with the white knight PPR – another competitor of Gucci –
on a strategic cooperation. Within the framework of this cooperation,
Gucci Group issued shares to PPR equal to 40% of its capital without
requesting the general meeting of shareholders’ approval. Hereafter,
LVMH announced a public offer. With the benefit of hindsight, we can
conclude that this gentle gesture was too late.
When the management of a Dutch company gets into this kind of
mischief, the Pavlov reaction of a shareholder who does not agree with
the course of action by the management is to request an investigation
into the affairs of the company and ask for immediate, provisional
measures. LVMH did not resist this common urge. Immediately after
the installation of the stock option plan, it requested an investigation
368 Perspectiv es in compa n y l aw

and several provisional measures. The Chamber issued a number of

interim decisions. In one of its decrees, the Chamber ordered by way of
a provisional measure that LVMH and the foundation were not allowed
to vote on their shares. Some weeks later, the Chamber lifted the ban
to cast a vote with regard to the shares held by LVMH, because in the
meantime, PPR had acquired more than 40% of the capital of Gucci
with the willing cooperation of the management of Gucci Group. The
Chamber refused to nullify the issuance of shares to PPR because it
would be too burdensome to reverse all the consequences of the trans-
action. On 27 April 1999, the Chamber published its fi nal decision. In
this decision, the Chamber denied the request to launch an inquiry
into the policies of Gucci Group, it further declared that there was mis-
management on the part of Gucci Group, it quashed the decision by
Gucci Group to establish the stock option by way of defi nitive measure
and it ruled that the foundation could not exercise any rights in its
capacity of shareholder in the Gucci Group. Th is decision seems on
the face of it obvious. The foundation was a strange corporate crea-
ture, as all of its shares had been paid up with the fi nancial help of the
Gucci Group. However, this decision belongs to the most audacious
decisions the Chamber took since its foundation in 1971. The statu-
tory text clearly states that the Chamber is only authorized to conclude
that there is a case of mismanagement and to issue defi nitive meas-
ures on the basis of a report prepared by the designated investigators.
In its fi nal Gucci decision, the Chamber determined mismanagement
without a report, thereby skipping the inquiry part of the investigation
procedure and ruled that a report could not bring to light any further
relevant information and that a more detailed investigation would be
superfluous and of no use. In this decision, the Chamber set aside a
clear legislative text. An appeal in cassation was lodged. The Supreme
Court is crystal-clear as well:
The judgment of the Enterprise Chamber…bears witness to an incorrect
interpretation of the law. First, the phrasing and the system of the law bear
out that the Enterprise Chamber is not authorized to provide for relief …
until ‘misconduct has been borne out by the report’. Second it follows
from the way in which the stipulations at hand have historically formed…
that it was always the legislator’s intention that the aforementioned relief
could only be provided for once the first proceeding had been concluded
with the report on the investigation, in so far as it had been borne out
by the report that there had been question of misconduct on the part of
the company. Third, it must furthermore be assumed on the basis of the
 Dutch in v estigation procedu r e 369

purport of the law that the Enterprise Chamber has not been authorized
independently to judge on the basis of such facts as it has established that
it had been borne out that there had been a question of misconduct and
provide for relief on the exclusive basis of its own judgment…In so far as
there is no reason for launching an investigation…and there is a need for
relief, the regular procedure before the civil court with the full comple-
ment of related guarantees is always available for this purpose.6

In this decision, the Supreme Court underlines the pivotal role of the
investigation report in the investigation procedure and quashes the rul-
ing of the Chamber in the Gucci case. The effect of the Supreme Court’s
decision is that the freedom of action of the Chamber has been some-
what diminished. However, I have the impression that the Chamber uti-
lizes to a larger scale the instrument of the provisional measures since
the Gucci decision of the Supreme Court. The requirement of a previous
report does not apply to a provisional measure. By ordering provisional
measures, the Chamber can sometimes achieve the same effect as with
a definitive measure. The Gucci affair ended with a settlement under
which PPR acquired all the shares in Gucci.
For Dutch corporate lawyers, the ABN AMRO affair is among the
most painful that has ever happened. The roots of ABN AMRO go back
to a bank that was founded in the beginning of the nineteenth century
by our King William I. In the Netherlands, ABN AMRO was considered
to be one of the most important companies. The end of the affair is that
ABN AMRO has been cut into four pieces, some parts of which have
been resold and that ABN AMRO de facto has ceased to exist. The reason
for this dramatic course of affairs is that, for several years, ABN AMRO
did not meet the expectations it had raised. Among shareholders, there
was widespread dissatisfaction about the level of the profits ABN AMRO
had generated during the last years. Early in 2007, ABN AMRO made
public its intention to enter into a share-merger with Barclays Bank in
response to this dissatisfaction. Immediately after the announcement,
a consortium of three other banks (Fortis, Banco Santander and Royal
Bank of Scotland), announced its intention to launch a public offer to
ABN AMRO in cash. After several months, the offer of the consortium
turned out to be successful, which led to the split-up of ABN AMRO.
The ABN AMRO case landed with the Enterprise Chamber, because
ABN AMRO announced that it had sold its US subsidiary, which repre-
sented approximately 25% of the value of ABN AMRO, to an American

6
HR 27 September 2000, Nederlandse Jurisprudentie (2000), 653.
370 Perspectiv es in compa n y l aw

bank, while the bid of the consortium was imminent. A Dutch investors’
association and some ABN AMRO shareholders requested an investiga-
tion by the Chamber and a provisional order to forbid ABN AMRO to
sell its American activities. Hereupon, the Chamber deferred its deci-
sion on the investigation, but prohibited ABN AMRO bank to sell its
American activities without the approval of the shareholders meeting
for the duration of the proceedings. It should be noted that ABN AMRO
had obtained legal advice that such an approval was not necessary under
Dutch company law.
The question of the approval of the shareholders meeting for impor-
tant transactions is regulated in section 107a of Book 2 of the Civil Code.
Section 107a provides as follows:
Resolutions of the management require approval of the general meeting
when these relate to an important change in the identity or character of
the company or the undertaking, including in any case…
the acquisition or divestment by it or a subsidiary of a participating
interest in the capital of a company having a value of at least one-third of
its assets according to its balance sheet and explanatory notes or, if the
company prepares a consolidated balance sheet, according to its con-
solidated balance sheet and explanatory notes in the last adopted annual
accounts of the company.
The absence of approval by the general meeting of a resolution …shall
not affect the representative authority of the management or the directors.

One may conclude from this text that it is not evident that the approval
of the general meeting is required for the sale of American ABN AMRO
activities. The Chamber agrees with this conclusion, but solves this prob-
lem by interpreting the provision broadly:

Taking matters into account the Chamber also considers that, in view of
the particularities of the case at hand, it cannot be ignored that, even if
it cannot directly be brought under the scope of application of section
2:107a Civil Code, it at least represents an occasion which touches on the
cases foreseen by this provision (either generically or specifically) to such
a degree that it can be virtually equivocated with it, and that the board and
supervisory board of ABN AMRO Holding should have felt compelled to
put the decision making concerning the sale of LaSalle (i.e. its American
subsidiary, LT) before the general meeting. The Chamber points to the
following circumstances in this, which should be considered in conjunc-
tion: 1. ABN AMRO Holding confirmed at 17 April 2007 to be talking
to Barclays on a form of combination of activities; 2. previously – on
 Dutch in v estigation procedu r e 371

13 April 2007 – ABN AMRO Holding announced it would be carefully

dealing with a letter from the Consortium, entailing an invitation to hold
explanatory talks; 3. LaSalle represents a considerable part of the value
of ABN AMRO…; 4. actors such as TCI (author’s note: The Children’s
Investment Fund Management, i.e. an investment fund), VEB (author’s
note: Vereniging van Effectenbezitters, i.e. a Dutch investors’ association)
and the Consortium had let their wishes and plans concerning a possible
merger or acquisition of ABN AMRO Holding and the associated sale of
LaSalle be known in the period of time concerned; 5. Barclays made the
sale of LaSalle …a condition for its intended offer to go ahead. Th is all
means that the sale of LaSalle had become (or had been made) such an
issue that the board and the supervisory board of ABN AMRO Holding
was no longer at liberty to withhold this, in the circumstances, major
and (as talks on the merger and the acquisition of ABN AMRO Holding
revealed) critical transaction, from the consultation and the approval of
the shareholders meeting.

This consideration is typical for the Chamber. It focuses on the circum-

stances of the case and does not regard the wording of a statutory pro-
vision as decisive. ABN AMRO did not acquiesce in the judgment and
lodged an appeal in cassation.
The Supreme Court sings a different tune:7
The circumstances cannot, unless the law or the articles of association
so provide, result in a right of approval of the general meeting of share-
holders of ABN AMRO holding with regard to the sale of LaSalle by ABN
AMRO Bank…The Enterprise Chamber rightly assumed that the present
case does not fall within the scope of this provision (i.e. section 107a, LT)…
The first paragraph of Section 107a cannot, at variance with the findings
of the Enterprise Chamber, be applied by analogy…now that the legal his-
tory – as set out in… Advocate General’s advisory opinion…shows that
the legislature, precisely for the sake of legal certainty, wished to deprive
this provision from such a broad scope.

The language of the Supreme Court is again crystal-clear and does not
need further comments. The Supreme Court quashes the judgment of
the Enterprise Chamber. Some months later, the Chamber denied the
requested investigation.
What can be learned from the Gucci and ABN AMRO sagas? I have
tried to think deeply on this question, as I was involved in my capacity as
Attorney-General to the Dutch Supreme Court. Foreign lawyers could

7
HR 13 July 2007, Nederlandse Jurisprudentie (2007), 434.
372 Perspectiv es in compa n y l aw

conclude that the Dutch Supreme Court and the Enterprise Chamber
disagree about fundamental questions of Dutch corporate law.8 However,
I have concluded something different. I think this is an example of a
more general phenomenon of interaction between two courts of justice.
If a certain legal court is deciding in an activist and informal way – and,
as we have seen, this is the case of the Enterprise Chamber – the higher
judicial body that has to review the lower court of justice will take a
more distant and formal approach. I am of the opinion that this is an
example of a natural interaction between two judicial bodies which
will finally lead to a certain state of balance. I am convinced that if the
Enterprise Chamber had taken a more distant and formal approach, this
would have challenged the Supreme Court to a more active and informal
attitude.

8
See on the jurisprudence of the Dutch Supreme Court in matters of company law:
L. Timmerman, ‘Company law and the Dutch Supreme Court, some remarks on contex-
tualism and traditionalism in company law’, Ondernemingsrecht (2007), 91–5.
 21

Obstacles to corporate restructuring:

observations from a European and
German perspective
Klaus J. Hopt *

In Europe there are still many obstacles to corporate restructuring, even

beyond the takeover context. The experience with the implementation
of the 13th Directive on Takeovers is sobering indeed. The number of
Member States implementing the directive in a seemingly protectionist
way is unexpectedly large. This is in line with a growing popular fear of
globalization and definite trends toward political protectionism regard-
ing foreign investments in various Member States. Germany is not an
exception, as the Risk Limitation Act of July 2008 and the ongoing discus-
sion on further restrictions illustrate. The declaration by Commissioner
McCreevy of 3 October 2007 that there will be no European action on the
issue of one-share/one-vote should not mean the end of the discussion. The
report of the European Corporate Governance Forum Working Group
on Proportionality of June 2007 is right in pleading for an enhanced dis-
closure regime concerning control-enhancing mechanisms. In any case,
there is a definite need for more data and further analysis.

I. Introduction
The topic of this chapter is ‘Obstacles to Corporate Restructuring’, with
an emphasis on takeover rules and the market of corporate control. There
are two underlying implications to this choice: fi rst, that takeovers play
or can play an important role in corporate restructuring; and second,
that there are other important parameters for corporate restructuring
beyond takeovers. Let me make two1 preliminary remarks on this.

* Th is essay is dedicated to Eddy Wymeersch, colleague and friend since the 1970s, with
whom I had such a longstanding and fruitful cooperation that we pass for academic twin
brothers.

373
374 Perspectiv es in compa n y l aw

As to the role of takeovers in corporate restructuring, one should keep

in mind that this is twofold. Takeovers may have synergistic grounds as
well as disciplinary reasons. Empirical evidence suggests that there is a
certain disciplinary effect on the management of badly performing com-
panies, insofar as functioning markets of corporate control are indeed
a means of external corporate governance, as it is sometimes called.
But on the whole, takeover targets are not noticeably badly performing
companies. This implies that the synergistic reasons for takeovers are
more frequent and more important. More details can be found in the ISS
report and related studies of the ECGI for the European Commission.1
As to the second implication, two other parameters beyond takeo-
vers and takeover law are of key importance for corporate restructur-
ing: the possibility for companies of merging beyond national borders,2
and the availability of sound rescue procedures before and after formal
insolvency. The possibility of merging beyond national borders has been
considerably improved by the European directive of 26 October 2005
on cross-border mergers of limited liability companies, 3 which is in the
process of being transformed by the Member States. The Sevic decision
of the European Court of Justice of 13 December 20054 has gone even
further in opening this door. Company practice in the various Member
States is working hard on using both of these new ways of restructuring
companies: the way via the directive is narrower but its requirements are
more spelled out, therefore making it safer; the way via the ECJ decision
is more far-reaching, but it lacks the details of how to go about it and is
therefore rather insecure. When things become tighter for companies,
the availability of sound rescue procedures becomes paramount. I will
just mention in passing that in many of the Member States, both pre-
and post-insolvency rescue law reforms have been enacted in the last

1
Institutional Shareholder Services (ISS) in collaboration with Shearman & Sterling LLP
and the European Corporate Governance Institute (ECGI), Report on the Proportionality
Principle in the European Union (18 May 2007); Deutsche Bank AG London, ‘Corporate
Governance, The control of corporate Europe’, Report (16 March 2007); see also infra II A.
2
ECFR Symposium ‘Cross-border Company Transactions’, Milan, 13 October 2006,
European Company and Financial Law Review, 4 (2007), 1–172.
3
European Parliament and Council Directive 2005/56/EC [2005] OJ L310/1.
4
Case C-411/03, Landgericht Koblenz v. Sevic Systems AG, [2005] ECR-I-10805, also in
Neue Juristische Wochenschrift (2006), 425 with many comments in various law reviews,
e.g., W. Bayer and J. Schmidt, ‘Der Schutz der grenzüberschreitenden Verschmelzung
durch die Niederlassungsfreiheit’, Zeitschrift für Wirtschaftsrecht (ZIP) (2006), 210; C.
Teichmann, ‘Binnenmarktmobilität von Gesellschaften nach “Sevic’’’, Zeitschrift für
Wirtschaftsrecht (2006), 355.
 Obstacles to cor por ate r estructu r ing 375

years or are being discussed – for example, in the UK in 2002, in France

in 2005, in Germany in 2007, as well as in Italy and elsewhere.5
From these two preliminary remarks, it would appear that identi-
fying and overcoming obstacles to corporate restructuring in the take-
over context is important, but only as part of a much greater task. If the
outcome of our discussion is that not very much can be done on the
European takeover front at the moment, then there might be other fields
in which the conditions for corporate restructuring in Europe are better,
can be used, and should and could be further improved.
Having said this, I shall turn to the obstacles to corporate restructuring
in the takeover context. I shall first have a quick look at the implementation
of the 13th Directive on Takeover Bids,6 using the report of the European
Commission of 21 February 2007.7 As we shall see, the findings of the
European Commission are not very encouraging, though the overall pessi-
mistic undertone of the report may be exaggerated. Furthermore, the most
recent discussions and reform plans in a number of Member States suggest
that there is a popular fear of globalization and open markets combined
with a new wave of protectionism. I shall illustrate the danger of such a
development, even in a traditionally European-minded Member State like
Germany, in the second part of my article by taking a short look at the law
on limitation of risks of July 2008 and the pending reform of the foreign
investment law. In the last part I shall present the findings of the European
Corporate Governance Forum Working Group on Proportionality as of
June 2007.8 While there is scepticism about a European one-share/one-vote
rule, this group has made some policy recommendations on how to pro-
ceed further with deviations from the proportionality principle.

II. The sobering experience with the implementation of

the 13th Directive
A. Basic principles of the European 13th Directive on Takeovers
a) The history of the origins, aims, and content of the 13th Directive
of 21 April 2004 on takeovers cannot be repeated here. The coming

5
The contributions of a symposium of the ECFR in 2007 in Paris can be found in European
Company and Financial Law Review, 5 (2008), 135 et seq.
6
Directive 2004/25/EC [2004] OJ L 142/12.
7
European Commission Staff Working Document, Report on the Implementation of the
Directive on Takeover Bids (21 February 2007), SEC(2007) 268.
8
Infra IV.
376 Perspectiv es in compa n y l aw

about of the directive took decades: it was full of regulatory and

political ups and downs, and it was made possible at the end only
by a complicated political compromise. The regulatory idea underly-
ing the directive9 is that in an internal market, takeovers may not be
blocked nationally, and that takeovers – including hostile ones – are in
general economically useful. This is because a well-functioning mar-
ket for corporate control strengthens the competitiveness of enter-
prises and is an important means of external corporate governance.
The threat of takeovers tends to discipline managers and encourages
them to strive for good share prices. These lie in the interest of both
shareholders and management and are the best defence against hos-
tile takeovers. The regulation of takeovers faces three serious princi-
pal-agent problems: the first exist between the shareholders and the
managers (the board, one-tier or two-tier); the second between the
majority shareholders or the parent and the minority shareholders
of the target; and the third between the acquirer and the non-share-
holder constituencies, in particular labour and other creditors. The
first principal-agent problem is particularly relevant in those coun-
tries where public companies and dispersed shareholders are the
rule, such as the United States and the United Kingdom. The second
is prominent in countries with block holders, family enterprises and
companies controlled by the state or other public entities; examples
are Germany, France and other continental European countries. The
regulatory problems for takeover law vary according to these share-
holders structures.10
b) The 13th Directive tries to solve the first problem apart from disclo-
sure rules through the anti-frustration rule for the board, or, in the case

9
European Commission, High Level Group of Company Law Experts, Report on Issues
Related to Takeover Bids (10 January 2002), reprinted in G. Ferrarini, K. J. Hopt,
J. Winter, E. Wymeersch (eds.), Reforming Company and Takeover Law in Europe
(Oxford University Press, 2004), Annex 2, 825–924.
A law and economics study on the regulation of takeovers in various countries can
be found in: P. Davies and K. J. Hopt, ‘Chapter on Control Transactions’, in R. R.
Kraakman, P. Davies, H. Hansmann, G. Hertig, K. J. Hopt, H. Kanda, E. Rock (eds.),
Th e Anatomy of Corporate Law, A Comparative and Functional Approach (Oxford
University Press, 2004); the revised and enlarged 2nd edition is to appear in winter
2008/09.
10
See in more detail Davies and Hopt, ‘Chapter on Control Transactions’, (note 9, above);
Cf. also J. Armour and D. A. Skeel, ‘Who Writes the Rules for Hostile Takeovers and
Why? – The Peculiar Divergence of U.S. and U.K. Takeover Regulation’, Georgetown Law
Journal, 95 (2007), 1728–94.
 Obstacles to cor por ate r estructu r ing 377

of a two-tier board, for the managing board as well as for the super-
visory board (Art. 9 on obligations of the board of the offeree com-
pany). This rule means that the board of the target company may not
engage in defensive actions which may frustrate the bid. Defensive
actions are strictly reserved for the shareholders in the general
assembly. The reason for this rule is that the directors are tempted
to act in their self-interest of keeping their job. The anti-frustration
rule is modelled after the example of the English Code on Takeovers
and Mergers and is sometimes also called the neutrality principle,
though this is not precise since the board is not meant to be strictly
inactive, but must give an advisory opinion of its own to the share-
holders and may look for a white knight. The anti-frustration rule
is supplemented by the breakthrough of certain restrictions in the
target, for example on the transfer of securities and on voting rights
provided for in the articles of association or in contractual agree-
ments between the target and holders of its securities (Art. 11; in
the German version this is wrongly translated as ‘Durchgriff ’, which
means ‘piercing the corporate veil’).
The second principal-agent problem is mitigated by the mandatory
bid, which must be made to all shareholders at an equitable price (Art.
5). By such a bid the minority shareholders are enabled to exit at an
early stage of acquisition of control or change of controller. Th is is one
of the few European group law rules, i.e., a rule which already takes
effect upon entry into the group (group entry control). In contrast, in
some countries (like Germany) there is an established group law only
during the operation of the group, leading to problems of interpreta-
tion, proof and enforcement.11 Of course, the drawback of the manda-
tory bid is that it makes the bidder’s decision to make a bid more costly,
thereby discouraging bids. On the other hand, the successful bidder has
the right to squeeze out a small minority left after the bid (from 90% of
the voting rights on, Art. 15). Th is squeeze-out right of the controlling
shareholders is balanced by a parallel sell-out right of the small minor-
ity (Art. 16).
The third principal-agent problem is dealt with by mere disclosure, as
well as the general principle that the board of the target must act in the
interests of the company as a whole (Art. 3 (1) (c)).

11
K. J. Hopt, ‘Konzernrecht: Die Europäische Perspektive’, Zeitschrift für das gesamte
Handelsrecht und Wirtschaftsrecht, 171 (2007), 199–240.
378 Perspectiv es in compa n y l aw

The above-mentioned compromise that made the directive accept-

able in the end consists of a double option of the Member States and an
option of the companies concerned. The Member States may opt out of
the anti-frustration and breakthrough rules (Art. 9 (2) and (3) and/or
Art. 11). But if they do, they must allow the companies with seats in
their territory to voluntarily opt in to these rules by a decision of the
general meeting (Art. 12 (1) and (2)). In this regard, the Member States
may enact a reciprocity rule for companies that have opted in (Art. 12
(3)). Reciprocity means that if such a company becomes the target of a
takeover bid by a bidder that is not itself subject to the same restrictions
as the target company, the target company is not bound by its option
decision, but can defend itself against the bid like any other company in
this state.

B. Implementation of the 13th Directive in the

Member States
a) The implementation of the 13th Directive by the Member States went
rather slowly. A Commission Staff Working Document of 21 February
2007 delivered an interim report on the implementation. The key find-
ings of the report are rather sobering. The two major pieces of the 13th
Directive on which the document reports are the anti-frustration and
breakthrough rules, and the minority shareholder protection by a man-
datory bid and a sell-out right that balances the squeeze-out right of the
acquirer.
According to the report, the anti-frustration rule has been imposed
or is expected to be imposed by eighteen Member States. But what is
relevant in this context is that an anti-frustration rule of this or a similar
kind already existed previously in all of these Member States, with the
exception of only one, namely Malta. Furthermore, five of these Member
States have introduced or intend to introduce the reciprocity exception
under Article 12 (3).
As to the breakthrough rule, the report says that it is expected to be
imposed (or indeed may have been imposed already) only by the Baltic
States, and that no other country will obligate its companies to apply
this provision in full. Instead, according to the report, all the other
countries have made the breakthrough optional for companies under
Article 12 (1). Hungary has gone even further and eliminated the partial
breakthrough rule it had before. Yet since the publication of the report,
Italy has transformed the 13th Directive and now has a breakthrough
 Obstacles to cor por ate r estructu r ing 379

rule which fully corresponds to Article 11.12 The report’s statement

that just 1% of listed companies in the EU will apply the breakthrough
rule on a mandatory basis must therefore be corrected. In any case, the
majority of Member States have adopted or will adopt the reciprocity
rule here as well.
As to minority shareholder protection, most Member States already
had the mandatory bid rule previously, but they have used the flexibility
granted by the directive to maintain their national exceptions from the
mandatory bid rule. These exceptions and far-reaching discretionary
powers of the supervisory agencies, for example in the UK,13 can under-
mine the effectiveness provided by this rule.
Only as far as the sell-out rule is concerned can clear progress be
reported. This rule has been or will be introduced in a large number of
Member States for the first time as a consequence of Article 16 of the
directive.
b) How should we evaluate these findings? The report concludes on
a pessimistic note: ‘The number of Member States implementing the
Directive in a seemingly protectionist way is unexpectedly large.’ The
Commission even fears that the new takeover rules of the 13th Directive
will have potentially negative effects on the European market. While
this is not based on evidence, it is certainly incontestable that there is
a strong reluctance among Member States to lift takeover barriers, and
particularly to do so in the international context. This is in line with a
popular fear of globalization and a general trend in the Member States
toward political protectionism.14
On the other hand, the facts found by the report should not be
evaluated too negatively either. The implementation corresponds to
the instructions of the directive, which expressly concedes options
and room for discretion. It is quite understandable that the Member
States made use of them, in particular if the underlying rules of the
directive departed from their national takeover law. Therefore, such

12
Decreto Legislativo 19 novembre 2007, n. 229, Gazzetta Ufficiale n. 289 del 13 dicembre
2007, Art.104-bis del decreto legislativo n. 58 del 1998: ‘Regola di neutralizzazione.’ Cf.
M. Lamandini, ‘Takeover Bids and ‘Italian’ Law Reciprocity, European Company Law 5
(April 2008) issue 2, 56–7.
13
It is interesting to confront these far-reaching discretionary powers of the Takeover
Panel with the much more legalistic approach taken by the German legislators, which is
to be explained by German history and a strict supervision of the German BaFin by the
administrative courts. Th is is a nice example of path dependency.
14
K. J. Hopt, ‘Editorial, Feindliche Übernahmen, Protektionismus, One share one vote?’,
Europäische Zeitschrift für Wirtschaftsrecht, (2007), 257.
380 Perspectiv es in compa n y l aw

implementation is not necessarily only protectionist; depending on

the country, it may simply be the preservation of the existing path
dependency and a reasonable policy of implementation ‘one to one’15
instead of going further and even gold-plating. This is true for the
mandatory bid and the national exceptions from it as well as for the
anti-frustration rule.
But most of all, the European Commission and the discussion on
implementation in the Member States following it seem to miscon-
ceive two important facts. First, the directive represents progress
insofar as it contains uncontested and well-implemented rules on
many issues other than only those contained in Articles 9 and 11, in
particular transparency rules and rules on fair behaviour and proce-
dure in takeovers. Such rules are of key importance for enterprises
and shareholders in the EU that need legal certainty and no conflict-
ing legal requirements in the twenty-seven Member States when they
make their investment or disinvestment decisions. As far as Articles
9 and 11 are concerned, the directive sets a model that is particularly
relevant for those countries and companies with diverse shareholder-
ships. Insofar, the option compromise of the directive in Article 12
is much better than a watered-down version of the anti-frustration
rule or even the omission in toto of the breakthrough rule would have
been.
Second, the reciprocity rule of Article 12 (3) and the fact that the Member
States have made use of it so widely is not to be seen only negatively as an
exception to the basic rules of Articles 9 and 11. Reciprocity may quite
possibly also have positive effects. If a company can be sure not to be taken
over by a bidder who himself is not subject to the anti-frustration and/or
breakthrough rules, the company may be more willing to opt into these
rules itself. As to the latter case, there is no case experience yet, but it is not
expected to remain merely theoretical. Certain companies may consider
an opting in as a positive signal on the capital market, or they may be
under pressure by international, in particular Anglo-American, institu-
tional investors to do so, rather than to fence themselves in by defensive
actions. It follows that while reciprocity is an exception of Articles 9 and
11, it may have the positive effect of promoting companies to voluntarily
opt in to these rules.

15
In Germany the government made this principle of transformation ‘one to one’ part of its
political programme as reflected in the coalition agreement.
 Obstacles to cor por ate r estructu r ing 381

III. Popular fear of globalization and trends toward

political protectionism regarding takeovers and
foreign investments: the German example
A. Discussion in the member states on unwelcome and
potentially dangerous foreign investments
a) As mentioned in the introduction, the globalization movement has led
to strong fears among the population of most European Member States,
a development that is akin to the fear of international terrorism in the
United States. While this fear may be irrational and the challenges and
opportunities of larger European and globalized markets outweigh the
risks by far, the fear is real.16 This is so quite apart from the fact that it is
an illusion that single states may be successful in the long run in fencing
off their markets. In search of popularity and votes, politicians in many
Member States are reacting by making general rules that raise the barriers
to private investments and takeovers, and by state intervention in specific
cases. There are a great many examples for such specific interventions. The
French government massively supported the takeover of Aventis by the
French Sanofi instead of letting the Swiss group Novartis make the deal.
The Spanish government impeded the takeover of the Spanish Endesa by
its German competitor E.ON. The French government forced the merger
of the French Suez and Gaz de France instead of letting the Italian Enel
come in. And the French government started to question the already exist-
ing participation of Siemens in the French Areva.17 Similar cases might be
reported from Italy, Poland and other countries.
b) Some pretend that Germany has a much better record. Yet this is
doubtful in view of a long list of cases in which takeover fears and takeo-
ver defences have influenced the outcome. The 180-degree turnaround
of former Chancellor Schröder is unforgotten. In 2001 Schröder defected
from the unanimously agreed-upon common standpoint of the Council
on the draft 13th Directive of the European Commission that contained
an anti-frustration rule which clearly followed the British model.18 The

16
K. J. Hopt, E. Kantzenbach, T. Straubhaar (eds.), Herausforderungen der Globalisierung
(Göttingen: Vandenhoek & Rupprecht, 2003); C. Linzbach et al. (eds.), Globalisierung
und Europäisches Sozialmodell (Baden-Baden: Nomos, 2007); R. Howse, ‘The End of the
Globalization Debate: A Review Essay’, Harvard Law Review 121 (2008), 1528.
17
For details, see R. von Rosen, ‘Die Umsetzung der EU-Übernahmerichtlinie in Europa, Eine
erste Bilanz’, Management Zeitschrift für Corporate Governance, 6 (2007), 241, 243 et seq.
18
See R. Skog, ‘The Takeover Directive: An Endless Saga?’, European Business Law Review,
13 (2002), 301; K. J. Hopt, ‘La treizième directive sur les OPA-OPE et le droit allemand’,
382 Perspectiv es in compa n y l aw

financial press commented that this was a closing of ranks between

Wolfsburg, the seat of the Volkswagen corporation, and Hannover,
the capital of Lower Saxony, and pointed at the Volkswagen Act19 with
its right for Lower Saxony to be represented in the Volkswagen board.
Indeed, Schröder as Prime Minister of Lower Saxony had been a mem-
ber of the board of Volkswagen and had gotten so close to the automo-
bile industry that he was nicknamed the ‘automobile chancellor’.
In a similar vein, the heated debate on the anti-frustration rule in
the German takeover statute ended with the anti-frustration rule as the
principle, but subject to four exceptions.20 The first three are innocuous,
including the possibility of an anticipated authorization of the board to
engage in defensive actions to be given by the general assembly up to
eighteen months before the takeover bid.21 The Trojan horse is the fourth
exception, i.e., the permissibility of all kinds of defensive actions if the
managing board gets the consent of the supervisory board. Th is waters
down the anti-frustration rule considerably, since notwithstanding the
mandatory separation of the two boards in the German two-tier system,

in Aspects actuels du droit des affaires, Mélanges en l’honneur de Yves Guyon (Paris:
Dalloz, 2003), 529, 537 et seq.
19
In the meantime, see the decision of the Case C-112/05, Commission v. Germany, [2007]
ECR-I-8995, (‘Volkswagen-Gesetz,’) holding parts of this Act in violation of the EC
Treaty. The decision is reprinted and commented e.g., by J. van Bekkum, J. Kloosterman,
J. Winter, ‘Golden Shares and European Company Law: the Implications of Volkswagen’,
European Company Law, 5 (2008) issue 1, 6–12, as well as in many German law reviews,
e.g., Zeitschrift für Wirtschaftsrecht (2007), 2068 and Neue Juristische Wochenschrift
(2007), 3481. The most recent German reaction to this decision proves the point made
in this article. The German government intends to maintain the Act with a few changes
only insofar as the board delegation rights of the Federal Republic of Germany and of
Lower Saxony and the voting cap of 20% combined with a supermajority of 80% for
changes of the company statutes are deleted, but the necessity of a supermajority of 80%
is to be maintained. In addition, a new requirement for the consent of the supervisory
board with a two-thirds majority for important investment decisions is to be introduced.
By this the overwhelming influence of labour via the codetermined board is maintained,
and restructuring involving changes of plants after foreign takeovers is de facto made
impossible. An expert opinion for the blockholder Porsche corporation holds that
this is in violation of European law, ‘Wegen des VW-Gesetzes drohen Zwangsgelder’,
Frankfurter Allgemeine Zeitung, (1 February 2008), No. 27, 14; cf. also F. Möslein,
‘Aufsichtsratsverfassung und Kapitalverkehrsfreiheit’, Der Aufsichtsrat (2008), 72–73; T.
Käseberg and F. Möslein, ‘Auch die Mitbestimmungsregeln im VW-Gesetz sind frag-
würdig’, Frankfurter Allgemeine Zeitung, (12 March 2008), No. 61, 23.
20
Section 33 subsection 1 sentence 1 of the German Takeover Act. For a neutrality require-
ment as to the managing board under company law see Bundesgerichtshof decision of 22
October 2007, Die Aktiengesellschaft, (2008), 164.
21
Section 33 subsection 2.
 Obstacles to cor por ate r estructu r ing 383

the German supervisory board cannot be considered to be independ-

ent. The practical relevance of the fourth exception is even greater if one
considers that in all major German stock corporations, a mandatory
system of quasi-parity labour codetermination is forced upon all major
corporations. As a matter of experience, in cases of hostile takeovers the
best allies for the board of the target are the representatives of labour in
its supervisory board. Both stand to lose if the takeover is successful –
the former their jobs as directors, the latter their employment in case of
restructuring and dismissals.22 It is telling that when the statutes of the
Thyssen Krupp corporation were modified in order to give to the Krupp
Foundation three seats in the supervisory board, it was made clear that
by this move the corporation would be immune from hostile takeovers,
since under such a threat there would always be a thirteen-vote majority
(i.e., the three directors delegated by the foundation and the ten labour
representatives).
The discussion on defending German enterprises from foreign takeo-
vers reached a new peak in 2005 when foreign hedge funds forced the
German Stock Exchange in Frankfurt to change its takeover strategies
concerning a friendly takeover offer to the London Stock Exchange,
to oust its CEO Seifert, and to overhaul the composition of its super-
visory board, including forcing its chairman Breuer to step down.
The German financial markets supervisory agency (Bundesanstalt für
Finanzdienstleistungsaufsicht, BaFin) reacted by starting an inquiry
into whether these hedge funds had acted in concert in trying to acquire
control of the company, and might even have had the obligation under
German law to make a mandatory bid. It is hardly surprising that this
inquiry led to nothing and after a while was silently tabled. Many obser-
vers believe that the conditions for a mandatory bid had in fact been
fulfi lled, but that this just could not be proved. Then came the battle over
ABN AMRO, which ended with a total victory for the team surround-
ing ‘Fred the Shred’ and with the defeat and dismantling of this major
bank.23 In Germany and other Member States, this battle was observed
with mixed feelings and afterthoughts on what this might mean for their
own national bank and industrial champions. Most recently, the grow-

22
Th is is essentially the principal-agent confl ict between the shareholders and the direc-
tors of the target mentioned supra II 1 a. Cf. Davies and Hopt, ‘Chapter on Control
Transactions’, (note 9, above).
23
G. H. White, A. W. Konevsky and B. Anglette, ‘The battle for ABN AMRO and certain
aspects of cross-border takeovers’, Butterworths Journal of International Banking and
Financial Law (April 2008), 171–176.
384 Perspectiv es in compa n y l aw

ing activity of huge foreign state investment funds like the one from
China has created nervousness in the public and among politicians.
These funds have accumulated billions of dollars, and the suspicion is
that once they acquire important stakes in key national industries they
might use their influence not just for shareholder profit as other private
funds, but for political purposes. The consequence of all this was that a
draft Risk Limitation Act was drawn up by the Ministry of Finance and
plans were made to tighten up the foreign investment law.

B. German Risk Limitation Act of July 2008 and the

pending reform of the German Foreign Investment Law
a) The draft Risk Limitation Act was triggered in late summer 2007 by
the fact that private equity investment in Germany was lagging and a
new risk capital investment law and a reform of the law on participations
in enterprises was urgently needed. The draft law on facilitating private
equity investment in Germany by tax and other deregulatory measures
was meant to contribute to the position of Germany in the interna-
tional competition for private equity investment. But the left wing of
the Social Democratic Party as well as influential parts of the Christian
Democratic Party opposed the so-called tax gifts to private equity, and
asked for protective measures against what they called ‘predatory wild
animal capitalism’. At the end, such burden easing for capital was politi-
cally unacceptable without being matched by ‘limitations of the risk’
allegedly presented by this. In order to keep these limitations at a level
which would not endanger the attractiveness of Germany as an invest-
ment place, the German Ministry of Finance asked the Hamburg Max
Planck Institute to compare what other states do in limiting the preda-
tory activities of private equity, hedge funds and state funds. Though
the result of this inquiry was that basically the free internal market
concept still prevailed internationally, the Ministry reacted with the
draft of the so-called Risk Limitation Act in late September 2007. To
begin with, it can be observed that while the expectation of getting real
deregulation and a sensibly better tax environment for the investment
industry was not met, the draft Risk Limitation Act was not eased up
correspondingly.
As of December 2007 the draft law contains a whole set of technical
reforms, among them disclosure rules. An investor with 10% or more
must tell the issuer on demand whether he intends a long-term strate-
gic investment and whether ultimately he even might aim at acquiring
 Obstacles to cor por ate r estructu r ing 385

control of the company. To be sure, this is not a one-shot obligation;

changes of intention must also be disclosed. The investor must also dis-
close to what extent he is fi nancing his acquisition by his own means or
by outside fi nancing. Furthermore, the true owners of the shares will
be more easily identifiable by the company in the future. The banks
are supposed to fi nd out and disclose to the company the true ultimate
owner of a block, thereby piercing through the chain of street name
registrations. The draft does not say how these duties will be enforced
against non-national banks and nominees, but it is intended to with-
hold the voting rights in case of non-compliance. It is quite obvious
that this would create considerable uncertainty on the fi nal outcome of
shareholder voting and would encourage the so-called predatory share-
holders to blackmail the corporations by contesting the votes before
the courts, 24 quite apart from costly and probably fruitless inquisi-
tion efforts of the banking community. Furthermore, the information
rights of the employees of the company against block investors are to be
reinforced.25
Yet the most important and controversial draft reform concerns the
considerably stiffened rules on acting in concert as compared with the
old text.26 Under the proposed rule, acting in concert presupposes an
acting in concert by the owners of shares with a view toward a common
enterprise policy.27 In the future, the concerted acquisition of blocks
of shares will already be relevant. By this, a restrictive decision of the
German Bundesgerichtshof would be set aside which had interpreted the
law in the sense that it covers only acting in concert within the general

24
Th is is a peculiarity of the German corporate reality quite unlike that which exists in
other countries; see T. Baums, A. Keinath and D. Gajek, ‘Fortschritte bei Klagen gegen
Hauptversammlungsbeschlüsse? Eine empirische Studie’, Zeitschrift für Wirtschaftsrecht,
(2007), 1629; T. Baums and F. Drinhausen, ‘Weitere Reform des Rechts der Anfechtung
von Hauptversammlungsbeschlüssen’, Zeitschrift für Wirtschaftsrecht, (2008), 145.
25
Together with presenting the draft Risk Limitation Act, the government announced that
it would examine whether to take legislative action concerning the sale of credit claims,
a controversial consumer protection reform. G. Nobbe, ‘Der Verkauf von Krediten’,
Zeitschrift für Wirtschaftsrecht, (2008), 97.
26
Section 30 subsection 2 sentence 1 of the German Takeover Act says that votes of a third
party are to be counted as votes of the bidder ‘if thereby the bidder or his subsidiary act in
concert as to the target either by agreement or else; agreements on voting in single cases
are excepted’. A. Raloff, Acting in Concert (Gottmadingen: Jenaer Wissenschaft liche
Verlagsgesellschaft, 2007).
27
The formula of the draft act is: ‘There is acting in concert, if the bidder or his subsidiary
and a third party act in concert in a way which is apt to permanently or considerably
influence the entrepreneurial line of the target.’
386 Perspectiv es in compa n y l aw

assembly.28 Furthermore, the exception under the old law that acting in
concert in single cases remains legitimate is meant to be done away with.
In the discussion there is even talk about de facto presumptions of con-
certed action under certain circumstances. Because of the drastic pos-
sible consequence of a mandatory bid, this proposed change is by far the
most controversial reform measure in the public discussion.
The draft Risk Limitation Act met with a criticism that was stron-
ger and more widespread than anything the Ministry of Finance had
experienced before. This criticism was articulated not only in the press,
but in particular in a public hearing of the Committee of Finance of
the German Bundestag in January 2008. The protocols of this hearing
are available29 and need not be taken up here in more detail. It suffices
to mention the critical but moderate comments by the German Share
Institute,30 which had organized a seminar on the draft the day before; by
the commercial law committee of the German Attorneys Association;31
and by the leading German shareholder association, the German
Association for Protection of Securities.32 It is hardly surprising that the
observations made by the institutional investors were most critical, such
as those made by Christian Strenger, a director of the supervisory board
of DWS, the investment arm of the Deutsche Bank, or from abroad by
Hermes, the well-known British pension fund with around €100 billion
in assets. On the other side, the German Trade Union Confederation33
and some academics were in favour of the new law and even asked for
further restrictions for fear of a sell-out of German industry, of losing
jobs, and of nurturing further, as it has been called, ‘neo-liberal market
ideology’.34 Academic critique was made in more detail at the biannual

28
Bundesgerichtshof decision of 18 September 2006, case ‘WMF,’ Entscheidungen des
Bundesgerichtshofes in Zivilsachen 169, 98 et seq., no. 17.
29
German Bundestag, 16th Voting Period, Committee of Finance, 23 January 2008, Berlin,
Protocol No. 16/82.
30
Deutsches Aktieninstitut (DAI) Frankfurt am Main, Comments of 18 January 2008.
31
Handelsrechtsausschuss des Deutschen Anwaltsvereins (DAV), ‘Stellungnahme
zum Regierungsentwurf eines Risikobegrenzungsgesetzes’, Neue Zeitschrift für
Gesellschaftsrecht, (2008), 60.
32
Deutsche Schutzvereinigung für Wertpapierbesitz, Comments of 9 January 2008.
33
Deutscher Gewerkschaft sbund (DGB).
34
Cf. R. Stürner, Markt und Wettbewerb über alles? Gesellschaft und Recht im Fokus neo-
liberaler Marktideologie (Munich: C. H. Beck, 2007). But see, e.g., H. Siebert, Jenseits
des sozialen Marktes, Eine notwendige Neuorientierung der deutschen Politik (Munich:
Deutsche Verlags-Anstalt, 2005); H.-W. Sinn, Ist Deutschland noch zu retten?, 3rd edi-
tion, (Munich: Econ, 2003); S. Empter and R. B. Vehrkamp (eds.), Soziale Gerechtigkeit
– eine Bestandaufnahme (Gütersloh: Bertelsmann, 2007).
 Obstacles to cor por ate r estructu r ing 387

symposium of the leading German company law journal by Holger

Fleischer35 and at the yearly meeting of the working group on econom-
ics and the law by Peter Mülbert.36 These criticisms are well-founded in
several respects:37
(1) Transparency is one thing and – as a general rule – positive, though
details of the proposed disclosure rules are critical. Yet a too harsh
mandatory bid rule frightens off potential bidders, takes away
choices for the shareholders, and weakens the takeover market. It
follows that it would be better to dissolve the parallelism between
the rules on acting in concert in the German Securities Exchange
Act and the Takeover Act.38
(2) More generally, the consequences of the new rule on corporate gov-
ernance must be taken into consideration. Investors must be able
to discuss investments to be made among themselves. Active share-
holders are welcome. Board members are controllers and need to be
able to act together in pursuing this task. A well-functioning take-
over market supplements this internal control from outside and is
an important part of external corporate governance.
(3) For example, shareholders who intend to jointly prevent a too-risky
policy of their corporation (standstill), or want to oust a chairman
whose entrepreneurial policy they do not support, or who are ready
to jointly rescue the corporation in case of financial crisis, must be
able to do this without running the risk of facing a mandatory bid
requirement. These and similar situations should at least be men-
tioned as a safe harbour in the motives of the Act.39
It remains to be seen what the legislators will fi nally decide in the near
future. It might be that the old exception for acting in concert in single
cases will be maintained, or that the proposed alternative of being apt

35
H. Fleischer, ‘Finanzinvestoren im ordnungspolitischen Gesamtgefüge von
Aktien-, Bankaufsichts- und Kapitalmarktrecht’, Zeitschrift für Unternehmens- und
Gesellschaftsrecht, 2–3 (2008), 185.
36
Arbeitskreis Wirtschaft und Recht, 25 January 2008. See also G. Spindler, ‘Acting in
Concert – Begrenzung der Risiken durch Finanzinvestoren?’, Wertpapier-Mitteilungen,
(2007), 2357.
37
See K. J. Hopt, ‘Viel zu defensiv’, Handelsblatt, (30 January 2008), No. 21, 19.
38
The same view has been taken expressly by the statement of DAI (note 30, above), 3.
39
See also the statement of the DAI (note 30, above), suggesting to make clear in the motives
that an exchange of opinion between investors on entrepreneurial topics is safe provided
its result is still open, and that it must remain possible to try to win others over to one’s
own position.
388 Perspectiv es in compa n y l aw

to exercise a ‘permanent or considerable’ influence will be replaced by

‘considerable’ influence only. But it is pretty certain that acting in con-
cert, even outside the general assembly, and also with others than group
members, will be caught by the new provision. On the other hand, if the
text stays as it is now or is not relativized by safe-harbour remarks in the
motives, there will be a serious danger for internal corporate govern-
ance, i.e., active shareholdership, as well as for external corporate gov-
ernance, i.e., an active market for corporate control.40
The latest news is that on 25 June 2008 the Financial Committee of
the German Bundestag reached the following difficult compromise:
‘There is acting in concert, if the bidder or its subsidiary and the third
party come to an agreement with each other as to the exercise of votes
or if they otherwise cooperate with the aim of reaching a permanent
and considerable change of the enterpreneurial direction of the target.’
The German Parliament has accepted this version and enacted the Risk
Limitation Act on 27 June/4 July 2008. The final outcome is a tightening
up with which one can live.
b) The pending reform on the German foreign investment law41 goes
too far as well, at least in its present form which contains only a vague
general clause instead of concrete formulas that could guarantee legal
certainty for the companies of M&A deals or those involved in takeo-
vers. This reform has its origins in two situations: the decision of the
People’s Republic of China to establish a US$200 billion state fund com-
pany which would also seek investment opportunities in foreign corpo-
rations; and the interest of the Russian gas producer Gazprom in looking
for investments in the German transport sector and in the distribution
of natural gas. A list consisting of the more than forty most significant
worldwide state funds shows that the state funds of the Arab Emirates,
Singapore, Norway, Saudi Arabia and Kuwait have still higher assets
than the new Chinese state fund, with the Arab Emirates holding assets
of US$875 billion.42

40
Some even see a violation of European law, cf. R. Schmidtbleicher, ‘Das „neue” acting in
concert – ein Fall für den EuGH?’, Die Aktiengesellschaft, (2008), 73.
41
Federal Ministry of Economics and Technology, Draft 13th Act Modifying the Foreign
Investment Act and the Foreign Investment Ordinance as of 5 November 2007.
42
Abu Dhabi Investment Authority (ADIA) with US$ 875 billion <Milliarden>. A list of the
largest state funds can be found in: State Experts Council for Evaluation of the Economic
Development at Large (Sachverständigenrat zur Begutachtung der gesamtwirtschaft li-
chen Entwicklung), Annual Expert Opinion (2007/08), table 55, 396. According to a more
recent study of the London International Financial Services Institute the total assets
held by the state funds is estimated to increase dramatically by 2015, ‘Neue Macht aus
 Obstacles to cor por ate r estructu r ing 389

Since it is technically difficult to single out hedge funds, and politic-

ally unwise to openly hit state investment funds, the draft foreign invest-
ment law reform plans a rule under which any foreign (now from outside
the EU) investment of 25% or more in a German corporation may be
forbidden if public security is concerned. Originally even the strategic
infrastructure was included in this protection. Th is is very vague indeed,
since specific sectors of industry – such as energy and armament, to name
just two – are not mentioned in the proposal. Even worse, while there is
no requirement of state permission for such investments, the govern-
ment may take up such transactions within three months, ask for full
information and, after having received it, forbid it within another two
months (though not longer). Originally there were even plans to extend
the time frame for state intervention up to three years retroactively, and
the reform would have extended to all foreign investors, i.e. also those
from within the European Union.43 The European Commission and
members of the European Parliament have criticized these reform plans.
While the original version (‘strategic infrastructure’) would certainly
have infringed on the freedoms of establishment and capital of the EC
Treaty, it is still doubtful whether such a general clause is compatible
with European law since such a general clause lacks the clarity needed by
foreign investors and thereby impedes the investment flow.44

dem Osten’, Handelsblatt (1st April 2008), No. 63, 24. See also S. Butt, A. Shivdasani,
C. Stendevad and A. Wyman, ‘Sovereign Wealth Funds: A Growing Global Force in
Corporate Finance’, Journal of Applied Corporate Finance 19 (2007), 73–83.
43
See the draft new section 7 subsection 2 No. 6 of the Foreign Investment Act: ‘Transactions
on the acquisition of enterprises having their seat in Germany as well as of participa-
tions in such enterprises, if the acquisition endangers the public order or security of the
Federal Republic of Germany’. See also the draft new section 53 subsection 1 sentence
1 of the Foreign Investment Ordinance: ‘Acquisition of an enterprise having its seat in
Germany or of a direct or indirect participation in such an enterprise by a foreigner or a
national enterprise in which a foreigner holds at least 25% of the votes…’. In the mean-
time the Minister of Labour demanded to have a say in the decision with the clear aim
of protecting domestic labour. Fortunately this protectionist move was not accepted.
The compromise as of 11 July 2008 is that the decision to take up the affair shall be made
by the Minister of Economics alone, while a decision to prohibit the transaction is up
to the federal government after having heard the various ministries. ‘Federführung bei
Staatsfonds entschieden’, Handelsblatt (14 July 2008), No. 134, 5.
44
‘EU-Kommission lehnt Regeln für Staatsfonds ab’, Frankfurter Allgemeine Zeitung (28
February 2008), No. 50, 12. Unfortunately in the meantime the European Commission
yielded to the political pressures by Germany as transmitted by the German indus-
try Commissioner Verheugen and by other Member States: ‘EU billigt Vorgehen
gegen Staatsfonds’, Handelsblatt (13 March 2008), No. 52, 6. See W. Bayer and C.
Ohler, ‘Staatsfonds ante portas’, Zeitschrift für Gesellschaftsrecht (ZGR), (2008), 12–31
and most recently M. Nettesheim, ‘Unternehmensübernahmen durch Staatsfonds:
390 Perspectiv es in compa n y l aw

The State Experts Council in its yearly report 2007/845 severely crit-
icized the reform plans. According to the Council, other less intru-
sive alternatives are available, in particular antitrust and competition
law measures and the possibility of the state keeping or acquiring a
majority participation in the industries concerned (to be sure, not just
a golden share that gives votes out of proportion to the actual share-
holding of the state).46 The German Council denies, at least at present,
that the state funds present a danger since their aim is to build up a cap-
ital stock for future generations and to help to stabilize prices of natural
resources in case of price fluctuations. It is true that more transparency
is needed, but this would be sufficient. Also the elaboration of a Code
of Conduct for these state funds as planned under the auspices of the
International Monetary Fund is useful. The OECD and the European
Commission declared to be willing to cooperate with the IMF in this
matter, and the European Parliament is preparing a transparency initia-
tive too47. Deliberations on the code are under way with the aim that the
state funds commit themselves to make their investment decisions irre-
spective of any political influence. It is expected that the Code could be
ready by October 2008.48 As a countermove to such a Code the Western
industrial nations should be expected to refrain from their protectionist
moves and to keep their markets open for foreign investments including
those made by state funds.49
The German Council is well aware of the fact that the US has a new
Foreign Investment and National Security Act (FINSA) since October
2007 which gives the basis for a very restrictive and insecure treatment of
foreign investments in the United States.50 Yet the Council is fully right in
stating that this example is leading in the wrong protectionist direction

Europarechtliche Vorgaben und Schranken’, lecture given at the 150 Years Anniversary
Symposion of the Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht on 6
June 2008 in Berlin.
45
State Experts Council, (note 42, above).
46
State Experts Council, (note 42, above), ch. 7, 385–437 with dissenting opinion by
Bofi nger. Similarly J. B. Donges et al. (Kronberger Kreis), Staatsfonds: Muss Deutschland
sich schützen? (Berlin 2008).
47
European Parliament, Committee on Legal Affairs, Klaus-Heiner Lehne, ‘Transparency
of the Institutional Investors’, Working Document (22 January 2008); the fi nal version by
the European Parliament is expected by autumn 2008; cf. also the short report by Fischer
zu Cramburg, ‘Hedgefonds und Private Equity’, Finanzplatz 2 (March 2008), 28.
48
‘Neue Macht aus dem Osten’, Handelsblatt (1 April 2008), No. 63, 24.
49
M. Maisch, ‘Staatsfonds, Die neue Macht’, Handelsblatt (2 April 2008), No. 64, 10.
50
State Experts Council, (note 42, above), 432 et seq. Australia seems to go into the same
direction: ‘Australien rüstet sich gegen Staatsfonds’, Frankfurter Allgemeine Zeitung
 Obstacles to cor por ate r estructu r ing 391

and should not be followed by Germany. Germany is an export-oriented

nation, not only as far as products and services are concerned but also
as to capital. Indeed, if Germany were to protect its own industry from
capital inflows, this would be inconsistent with its own capital export
record and could lead to retaliation. Furthermore, it is probable that
the planned reform would also frighten off those investors and invest-
ments that are clearly useful and welcome. Protection is needed only for
a very few specific sectors, such as armament, the atomic industry, and
the energy sector. Catching all kinds of foreign investment under the
vague general clause of ‘public order and security’ is going too far, since
no M&A deal could be sure any longer whether or not there will be state
intervention.
The general conclusion as to the foreign investment reform plans is that
Germany has an elementary interest in keeping the capital market open.
Germany has a large capital balance surplus51 and cannot afford restric-
tions that would backfire. Foreign investments – also from state funds –
create jobs and may rescue enterprises in difficulties, as illustrated quite
clearly in the current finance crisis of American banks such as Citibank,
Merrill Lynch and even Morgan Stanley. Measures taken specifically
against state funds and/or hedge funds are problematic. As to the latter,
single-handed efforts are bound to fail. International efforts – such as
better transparency for hedge funds52 and possibly further requirements
for banks that finance these funds53 – are more promising alternatives.

(4 March 2008), No. 54, 16. Russia has followed, T. Wiede, ‘Russland verschärft die
Regeln für Investoren’, Handelsblatt (26 March 2008), No. 58, 6.
51
For statistical information see State Experts Council, (note 42, above), at 389 et seq.
52
The fourteen largest European hedge funds under the lead of Andrew Large have agreed
to set up a code of conduct according to which there will be more transparency, control
of the development of the investments by independent experts, and no more voting in
the general assemblies with shares that are only lent and not owned. See Hedge Fund
Working Group (HFWG), Hedge Fund Standards: Final Report (Large Report), London
(January 2008) and, ‘Hedge-Fonds öff nen sich’, Handelsblatt (23 January 2008), No.
16, 22. From the USA see the two private-sector committees reports to the President’s
Working Group on Financial Markets: Asset Managers’ Committee, Best Practices for
the Hedge Fund Industry, and Investors’ Committee, Principles and Best Practices for
Hedge Fund Investors, Washington (April 15, 2008).
53
See the path-breaking study by M. Kahan and E. B. Rock, ‘Hedge Funds in Corporate
Governance and Corporate Control’, University of Pennsylvania Law Review, 155 (2007),
1021–93; see also from Germany: H. Eidenmüller, ‘Regulierung von Finanzinvestoren’,
Deutsches Steuerrecht, (2007), 2116; H. Eidenmüller, ‘Private Equity, Leverage und
die Effi zienz des Gläubigerschutzrechts’, Zeitschrift für das gesamte Handelsrecht und
Wirtschaftsrecht 171 (2007), 644; C. Kumpan, ‘Private Equity und der Schutz deut-
scher Unternehmen’, Die Aktiengesellschaft, (2007), 461; C. Kumpan, DAJV Newsletter
392 Perspectiv es in compa n y l aw

IV. One-share/one-vote discussion and recommendations of

the European Corporate Governance Forum Working
Group on Proportionality of June 2007
A. One-share/one-vote discussion and the reply of
Commissioner McCreevy
In this section, I move to the European discussion on proportional-
ity. The outcome of the one-share/one-vote studies by ISS Europe, the
ECGI and Shearman & Sterling which were published by the European
Commission on 4 June 2007 are well known.54 On 3 October 2007,
Commissioner McCreevy reacted, declaring before the European
Parliament that he had made a deliberately provocative statement when
announcing his plans to bring about a European one-share/one-vote
rule. He acknowledged that there is no economic evidence of a causal
link between deviations from the proportionality principle and the eco-
nomic performance of companies, and concluded that there is no need
for action at the EU level on this issue. Unfortunately, he also declared
that he does not intend to propose any action in this context, not even
concerning more transparency.
I belong to those experts and investors who, even in light of the
economic evidence brought forward in the aforementioned studies,
plead for more transparency in the need for and use of control-enhancing
mechanisms. Th is is what the recommendations of the European
Corporate Governance Forum Working Group on Proportionality of
June 2007 say.55

(2007), 166, concerning the US; G. Spindler, ‘Die Regulierung von Hedge-Fonds im
Kapitalmarkt- und Gesellschaftsrecht’, Wertpapier-Mitteilungen, (2006), 553 et seq. and
601 et seq.; A. Graef, Aufsicht über Hedgefonds im deutschen und amerikanischen Recht
(Berlin 2008). As to the European initiatives see Athanassiou, ‘Towards Pan-European
Hedge Fund Regulation? State of the Debate’, Legal Issues of Economic Integration, 35
(2008) 1, 1–41.
54
European Commission, Institutional Shareholder Services ISS, Shearman & Sterling,
European Corporate Governance Institute ECGI, Report on the Proportionality Principle
in the European Union (18 May 2007); M. Burkhart, S. Lee, ‘One Share – One Vote: The
Theory’, Review of Finance, 12 (2008), 1–49; R. Adams, D. Ferreira, ‘One Share – One
Vote: The Empirical Evidence’, Review of Finance, 12 (2008), 51–91.
55
IV B-D are closely following the Paper of the European Corporate Governance Forum
Working Group on Proportionality of 12 June 2007. Th is group was headed by Jaap
Winter, the former chairman of the High Level Group of Company Law Experts (note 9,
above) and comprised both members of the High Level Group (among them myself) and
some outside members, including Eddy Wymeersch.
 Obstacles to cor por ate r estructu r ing 393

B. Variety of control-enhancing mechanisms,

the repudiation of a general one-share/one-vote rule and
the need for better understanding
To begin with, the group makes a distinction between four different
disproportionality dimensions: l) corporate institutional arrangements
directly affecting shareholder rights, 2) corporate institutional arrange-
ments indirectly affecting shareholder rights, 3) other corporate insti-
tutional entrenchment mechanisms, and 4) non-corporate institutional
mechanisms. Examples for these four rings are 1) multiple voting rights
and voting ceilings, 2) priority shares conferring an exclusive right
to nominate board members, 3) share transfer restrictions, staggered
board provisions and certain codetermination arrangements, and 4)
pyramids and cross-shareholdings as well as market techniques that
allow for decoupling of voting rights from cash flow rights, resulting,
for example, in votes being exercisable without any economic invest-
ment (so-called ‘empty voting’)56. In light of these wide variations, the
group concluded that an overall European proportionality rule is nei-
ther useful nor feasible. Shareholder democracy is a misleading catch-
word that draws unfounded analogies to politics and democracy of the
people.
On the other hand, the group sees a need for an objective framework
for further analysis of control-enhancing mechanisms, with due con-
sideration of the differences of the instruments used in the four rings
just mentioned – in particular, whether or not they are furthering the
entrenchment of the board and the controlling shareholder, and whether
they might function as obstacles to corporate restructuring. In this con-
text, competing objectives should be examined, such as monitoring by
the controlling shareholder,57 easier access to capital markets, long-term
orientation and stakeholder protection, and last but not least, freedom
of contract and efficient competition. Only under three conditions –
namely, if certain mechanisms are to be judged negatively on balance, if
such mechanisms inhibit the achievement of EU policy objectives and if
regulatory intervention at the EU level seems desirable – should the fol-
lowing possible regulatory tools be discussed and possibly prove useful.

56
See most recently H.T.C. Hu and B. Black, ‘Equity and Debt Decoupling and Empty
Voting II: Importance and Extension’, University of Pennsylvania Law Review, 156
(2008), 625–739.
57
See most recently A. M. Pacces, Featuring Control Power (Rotterdam Institute of Law
and Economics, 2007).
394 Perspectiv es in compa n y l aw

C. Toward an enhanced disclosure regime concerning

control-enhancing mechanisms
In this light and in view of the many open questions found by the two
ECGI studies, the group recommends in the short term an enhanced
disclosure regime.58 This disclosure regime might include the following
four building blocks59 to be discussed:
First, in addition to the disclosure obligations pursuant to Article
10 of the 13th Directive and the disclosures under the Transparency
Directive, companies could be required to provide more detailed trans-
parency on disproportionate mechanisms applied by them.
Second, shareholders who derive a voting position from such mecha-
nisms exceeding, say, 10% of the total votes that can be cast in a meeting,
could be required to provide insight into the size and nature of their
shareholdings and their policy on the exercise of the relevant powers.
Third, companies and shareholders could also be required to provide
more transparency on the actual use of disproportionate mechanisms –
for example, in respect to specific related party transactions not entered
into on an arm’s length basis.
Alternatively, the Commission could ask the Member States to pro-
vide it annually with comparable information regarding application of
disproportionate structures in their jurisdictions to the aforementioned
extent. This would be an extension of the reports due by the Member
States under Article 20 of the 13th Directive.

D. Particularly pressing problem areas and the

need for more data and further analysis
The Forum Working Group further identified a number of particularly
pressing problem areas in the field where it believes that, as a matter of
principle,60 a more substantial approach than mere disclosure is needed.
Among them are:

58
For a survey of the use of disclosure in European law, see S. Grundmann and F. Möslein,
European Company Law, Organization, Finance and Capital Markets (Antwerpen/
Oxford: Intersentia, 2007), § 9. As to the disclosure principle for enterprises in a histori-
cal, economic and legal perspective see H. Merkt, Unternehmenspublizität (Tübingen:
Mohr Siebeck, 2001).
59
For the building block system in European law making, cf. Forum Europaeum Group
Law, ‘Corporate Group Law for Europe’, European Business Organization Law Review, 1
(2000), 165–264.
60
With due respect to the context, see supra IV B last paragraph.
 Obstacles to cor por ate r estructu r ing 395

First, instances where full board entrenchment is achieved. According

to the group, the European Commission should make it clear in a rec-
ommendation that as a matter of principle this is unacceptable from a
corporate governance perspective.
Second, the group is concerned by the decoupling of voting rights and
economic ownership through mechanisms such as securities lending,
contracts for difference, and call/put options whose mechanisms may
affect the effective exercise of proportionate voting rights.61 This point
has also been made forcefully by the ECGI paper on empirical evidence
concerning one-share/one-vote.
In addition to better disclosure, the EU should concentrate on the role
of securities intermediaries in the voting process of their clients. The
role of these intermediaries is crucial.
Overall there is a clear need for more data and further analysis. Part
of this could be brought to light by the enhanced disclosure regime men-
tioned above. In addition, empirical studies are needed on the various
control-enhancing mechanisms, their functions and implications, and
the economic pros and cons. These studies should be supported morally
as well as financially because they are in the public interest.

V. Conclusions
In Europe there are still many obstacles to corporate restructuring in
the takeover context and beyond. According to an Interim Report of the
European Commission, the experience with the implementation of the
13th Directive on Takeovers in the Member States is sobering indeed.
As the Commission Report says, even though too pessimistically, the
number of Member States implementing the directive in a seemingly
protectionist way is unexpectedly large. Th is is in line with a growing
popular fear of globalization and definite trends toward political pro-
tectionism regarding foreign investments in various Member States. In
many, the legislators are tempted to raise the barriers to private invest-
ments and takeovers from abroad, and the governments tend to interfere
when they see their national banking or industry champions threatened
by takeovers from abroad. Germany is not an exception, as the legis-
lative history of the Risk Limitation Act of July 2008 and the ongoing
discussion on further restrictions of the foreign investment law illus-
trate. The far-reaching plans of Commissioner McCreevy of mandating

61
Note 56, above.
396 Perspectiv es in compa n y l aw

a one-share/one-vote rule by European law could not be upheld in the

light of the results of the Commission-mandated studies by ISS Europe,
the ECGI and Shearman & Sterling. Yet the conclusions drawn from
them by the European Commission are too pessimistic, and the declara-
tion by Commissioner McCreevy of 3 October 2007 that there will be
no European action on the issue of one-share/one-vote should not mean
the end of the discussion. While there is a definite need for more data
and further analysis, the report of the European Corporate Governance
Forum Working Group on Proportionality of June 2007 sees a need
for further development of the European internal market and pleads
for an enhanced disclosure regime concerning control-enhancing
mechanisms.
 22

Protection of third-party interests under

German takeover law
Har ald Baum

During the legislative proceedings of the German Takeover Act, the

interests of third parties – i.e. persons only indirectly concerned by but
not actively involved in the takeover process as such, e.g. individual
shareholders of a target company – did not figure prominently. However,
this changed dramatically once the Act came into force. Numerous
court decisions dealt with this question, launching an intensive and still
ongoing discussion.

I. Introduction
The protection of (minority) shareholders confronted with a takeover
of the company they are invested in has been an issue of lasting con-
cern and interest for Eddy Wymeersch. He has long been a high-profi le
promoter as well as a critical commentator of the pertinent European
developments.1 This is especially true with respect to the Takeover

1
See K. J. Hopt and E. Wymeersch (eds.), European Takeovers. Law and Practice (London:
Butterworth, 1992); E. Wymeersch‚ ‘The Mandatory Bid: A Critical View’, in Hopt
and Wymeersch (eds.), European Takeovers, 351–68; E. Wymeersch, ‘Problems of the
Regulation of Takeover Bids in Western Europe: A Comparative Survey’, in Hopt and
Wymeersch (eds.), European Takeovers, 95–131; E. Wymeersch, ‘European Takeovers:
The Mandatory Bid’, Butterworths Journal of International Banking and Financial
Law (1994), 25–33; E. Wymeersch , ‘The Regulation of Takeover Bids in a Comparative
Perspective’ in R. Buxbaum, G. Hertig, A. Hirsch and K. J. Hopt (eds.), European
Economic and Business Law (Berlin: de Gruyter, 1996), 291–323; E. Wymeersch, ‘The
Proposal for a 13th Company Law Directive on Takeovers: A Multi-jurisdiction Survey,
Part 1’, European Financial Services Law (1996), 301–307; ‘Part 2’, European Financial
Services Law (1997), 2–7; E. Wymeersch, ‘Les défenses anti-OPA après la treizième direc-
tive – commentaires sur l’article 8 de la future directive’, Financial Law Institute Working
Paper Series, (Jan. 2000); E. Wymeersch, ‘Übernahme- und Pfl ichtangebote’, Zeitschrift
für Unternehmens- und Gesellschaftsrecht, 31 (2002), 520–45; G. Ferrarini, K. J. Hopt,
J. Winter and E. Wymeersch (eds.), Reforming Company and Takeover Law in Europe
(Oxford University Press, 2004).
397
398 Perspectiv es in compa n y l aw

Directive, whose main goal is the protection of the interests of holders

of securities of companies that are the subject of takeover bids or
of changes of control (Recital 2).2 As a framework directive, the 13th
Directive provides for basic principles to adhere to, but leaves ample
scope for the Member States in other areas. A prominent example of
this is the right of the Member States to determine how the protection
prescribed in the Directive should be enforced, and whether rights for
individual shareholders are to be made available at all. These may be
asserted in administrative or judicial proceedings, either in proceedings
against a supervisory authority or in proceedings between parties of a
bid (Recital 8). Additionally, Article 4 (6) clarifies that the Directive nei-
ther affects the power of Member States to regulate whether and under
which circumstances parties to a bid are entitled to bring administrative
or judicial proceedings, nor does it affect the power of the Member States
to determine the legal position concerning the liability of supervisory
authorities or litigation between the parties to a bid. In sum, it is by and
large left to the national laws of the Member States to determine how
individual shareholders of a target company – the exemplary ‘third par-
ties’ in the takeover proceedings besides the bidder and the target 3 – may
or may not pursue their own interests in the context of a takeover or
change of control situation.
This solution appears somewhat surprising from a regulatory point of
view – though less so from a public choice perspective, given the previ-
ous thirty years of political bargaining about the Directive – because
the question of whether and how individual shareholders may pursue
their own interests in these situations is without doubt an issue of cen-
tral importance for implementing the Directive’s goals. Typical conflicts
arise if a bidder, in spite of getting control of the target and thus being
obliged to make a mandatory bid to acquire all outstanding shares,
refuses to do so, or if the Supervisory Authority mistakenly exempts the
bidder. Also, the target’s shareholders may not be content with the price
offered (and approved by the authority), especially when there are dif-
ferent classes of shares with different price tags attached by the bidder.
These are but a few situations where the shareholders may want to have
the legislative means to pursue their own interests. The German takeover
law, however, at least in principle, does not grant many of these. Instead,

2
Directive of the European Parliament and of the Council of 21 April 2004 on Takeover
Bids 2004/25/EC [2004] OJ L142/2.
3
Other ‘third parties’ are e.g. potential competitive bidders.
 Protection of thir d-party inter est: Ger m a n y 399

it is very restrictive with respect to the enforcement of third-party inter-

ests and offers surprisingly little protection on the procedural level.
However, this outcome is highly disputed as will be discussed hereafter.
The analysis is structured as follows. To frame the discussion, it begins
with an overview of the legislative framework and institutional setting
in Germany (part II). It then deals with the question of whether individ-
ual shareholders may assert their rights against the German supervisory
authority (part III). Thereafter it discusses whether, as an alternative,
civil law remedies are available in judicial proceedings between parties
of a bid (part IV). Part V summarizes the fi ndings.

II. Legislative framework and institutional setting

A. The Takeover Act
The relevant German legislative source is the ‘Securities Acquisition and
Takeover Act’ (Wertpapiererwerbs- und Übernahmegesetz), the WpÜG
of 2001.4 The Act was the end of the German self-regulatory takeover
regime based on the Takeover Codex of 1995.5 The Codex had some
functional shortcomings and mainly failed because it was not accepted
by a sufficient number of listed companies.6 The WpÜG was enacted on
1 January 2002, and thus predates the Takeover Directive. But given
the freedom of choice discussed above that the Directive provides for
national lawmakers, the German legislators rightly did not see a neces-
sity under Community Law to amend the restrictive pertinent provisions
of the WpÜG when implementing the Directive in 2006.7 Therefore, case

4
Gesetz zur Regelung von öff entlichen Angeboten zum Erwerb von Wertpapieren und
von Unternehmensübernahmen (WpÜG), Law of 20 December 2001, Federal Gazette
I (2001) 3822, as amended; the law was accompanied by four ordinances dating from
27 December 2001, Federal Gazette I (2001) 4263 et seq., as amended. English trans-
lations can be found with M. Peltzer and Voight, German Securities Acquisition and
Takeover Act (Cologne: O. Schmidt, 2002); G. Apfelbacher, S. Barthelmess, T. Buhl
and C. von Dryander, German Takeover Law – A Commentary (Munich: C.H. Beck,
2002).
5
Übernahmekodex der Börsensachverständigenkommission beim Bundesministerium der
Finanzen of 14 July 1995, amended 1 January 1998; see S. Schuster and C. Zschocke,
Übernahmerecht / Takeover Law (Frankfurt: F. Knapp, 1996).
6
Cf. C. Kirchner and U. Ehricke, ‘Funktionsdefizite des Übernahmekodex bei der
Börsensachverständigenkommission’, Die Aktiengesellschaft (1998), 105–116.
7
Act for Implementing the Takeover Directive (Gesetz zur Umsetzung der Richtlinie
2004/25/EG des Europäischen Parlaments und des Rates vom 21. April 2004 betreffend
Übernahmeangebote [Übernahmerichtline-Umsetzungsgesetz]), Law of 8 July 2006,
Federal Gazette I (2006) 1426.
400 Perspectiv es in compa n y l aw

law and discussion predating the implementation is still of unchanged

relevance for the question of how third-party interests may be enforced.
The enactment of the WpÜG was triggered by what was – for most
observers – the totally unexpected hostile takeover of Mannesmann
AG, a traditional German manufacturer successfully turned into a
mobile phone operator, by the British Vodafone plc, a foreign bidder,
in 1999/2000. This was the biggest hostile takeover ever, amounting to
more than €150 billion. It sent shock waves down the spine of corporate
Germany, and the German government went into red alert. Accordingly,
the ensuing legislative proceedings attracted wide public attention in
Germany. Academia as well as practitioners were intensely involved in
the discussion on the different drafts of the Takeover Act. However, again
somewhat surprisingly, not much attention was paid to the question of
whether and how individual shareholders and other third parties might
pursue their own interests in the context of a takeover, though obvi-
ously this is an issue of high practical relevance. This situation changed
dramatically once the WpÜG came into force. An unforeseen number
of court decisions were forced to deal with this question, launching an
intensive and still ongoing discussion.8
According to the official legislative texts, in substance – though not in
form and structure – the WpÜG is modelled after the British City Code and
thus has been, in principle, in accordance with the later Takeover Directive
from the beginning. A core element of the WpÜG is the mandatory offer
a bidder has to make if he has gained control of the target company.9 The
relevant threshold is 30% of the voting rights.10 Based on the price regula-
tion of the bid – the average share price or a higher price paid by the bid-
der during the previous six months11 – minority shareholders participate
in a possible control premium. To secure this outcome, the WpÜG – like
the City Code – is necessarily characterized by a high regulatory intensity.
Nevertheless, as in Britain, one of the official goals of the German legislators
was to provide for a legislative framework that allows for speedy takeover
procedures.12 WpÜG § 3 (4) stipulates that the bidder and the target com-
pany must implement the procedure quickly, and the Act includes various
provisions that oblige the parties to act without undue delay.

8
These developments will be addressed below in Section III.
9 10
§ 35 (2) WpÜG. § 29 (2) WpÜG.
11
§ 31 WpÜG, §§ 3–7 of the WpÜG Offer Ordinance (WpÜG-Angebotsverordnung),
Ordinance of 27 December 2001, Federal Gazette I (2001) 4263 as amended.
12
Legislative Materials, BTDrucksache 14/7034, 35.
 Protection of thir d-party inter est: Ger m a n y 401

However, in contrast to the British role model, the WpÜG is not an

act of self-regulation but a body of public law whose actions may be
and already have been challenged rather frequently in the courts, even
though the Act has only been in force for a few years. This outcome dif-
fers markedly from the British experience, where due to the specific
institutional setting takeover-induced litigation is extremely rare.13

B. Supervision in the public interest

Furthermore, the takeover-related supervisory structure in Germany
differs fundamentally from the British. Power to carry out the super-
vision of all segments of the German fi nancial markets lies with
the ‘Federal Financial Supervisory Authority’ (Bundesanstalt für
Finanzdienstleistungsaufsicht), the BaFin, established in its present
form in 2002.14 Since the enactment of WpÜG, its supervision includes
takeovers. The BaFin is a major federal government agency somewhat
similar to the SEC in the USA but different from the British ‘Panel on
Takeovers and Mergers’, which was established in 1968 by the industry
as an independent self-regulatory body and whose main functions are
(only) to issue and administer the ‘City Code on Takeovers and Mergers’
and to supervise and regulate takeovers and other matters to which the
Code applies.
According to § 4 (1) WpÜG, the BaFin shall carry out the supervision
of takeover bids and other public bids for the acquisition of shares in
accordance with the provisions of the Act. Within the scope of the tasks
allocated to it, it has to counter any irregularities that may impair the
orderly execution of bids or that may have materially adverse effects on
the securities market in general. The Federal Authority may issue orders
which are appropriate and necessary to eliminate or prevent such irreg-
ularities. Its exclusive competence to enforce and interpret the WpÜG as
well as its exclusive right to grant exemptions secures a powerful posi-
tion for the BaFin.

13
G. Rosskopf, Selbstregulierung von Übernahmeangeboten in Großbritannien (Berlin:
Duncker & Humblot, 2000), 191 et seq.; in general M. Button (ed.), A Practitioner’s Guide
to the City Code on Takeovers and Mergers (Surrey: Old Woking, 2004); M. A. Weinberg,
M.V. Blank and L. Rabinowitz, Weinberg and Blank on Takeovers and Mergers, 5th edn,
(London: Sweet and Maxwell, 2002).
14
Information about the BaFin is supplied at www.bafi n.de; see also H.-O. Hagemeister,
‘Die neue Bundesanstalt für Finanzdienstleistungsaufsicht’, Wertpapiermitteilungen
(2002), 1773–9.
402 Perspectiv es in compa n y l aw

This quasi-monopolistic position is enhanced by the fact that the

Authority is to perform the tasks and exercise the powers assigned to
it under the Act solely in the interest of the general public, but not of
individual investors (§ 4 (2) WpÜG), who are accordingly regarded by
many as lacking the standing to challenge the Authority’s decisions.15
The BaFin’s supervisory activities are aimed only at maintaining inves-
tor confidence in the processing of public takeovers in general; the legis-
lators regarded this as essential but sufficient for the functioning of the
market.16
This kind of restriction was first introduced in the Banking Act17 after
the German Supreme Court, the Bundesgerichtshof, decided in a shift of
opinion in 1979 that the provisions of that Act describing the tasks of the
former supervisory agency were meant to protect not only the public, but
individual investors as well.18 As a consequence, the government could
be held liable under § 839 of the German Civil Code19 in combination
with Article 34 of the German Constitution to customers of failed banks
if the damages these incurred were caused by faulty banking supervi-
sion. However, to principally exclude any state liability vis-à-vis the in-
dividual customers of banks, insurers, investment funds, or exchanges
active in a financial market supervised by a government agency, all per-
tinent laws now include a provision which expressly stipulates that the
supervision is carried out in the public interest only. Provisions identical
to § 4 (2) WpÜG can be found in § 4 (4) of the Act Concerning the Federal
Financial Supervisory Authority,20 § 3 (3) of the Stock Exchange Act, 21
and § 81 (1) of the Act on the Supervision of Insurance Undertakings.22
Since their introduction, these restrictions have been disputed
on constitutional and public policy grounds.23 However, though the

15
See the discussion hereafter at III.
16
Legislative Materials, BTDrucksache 14/7034, 36.
17
Kreditwesengesetz, Law of 10 July 1961 Federal Gazette I (1961), 881, as amended.
18
BGHZ 74, 144 et seq.; BGHZ 75, 120 et seq.
19
Bürgerliches Gesetzbuch, Law of 18 August 1896, newly publicized 2 January 2002,
Federal Gazette I (2002), 42 and 2909, Federal Gazette I (2003), 738, as amended.
20
Gesetz über die Bundesanstalt für Finanzdienstleistungsaufsicht, Law of 22 April 2002,
Federal Gazette I (2002), 1310, as amended.
21
Börsengesetz, Law of 21 June 2002, Federal Gazette I (2002), 2010, as amended.
22
Gesetz über die Beaufsichtigung der Versicherungsunternehmen, Law of 17 December
1992, Federal Gazette I (1993), 2, as amended.
23
For a detailed discussion, see e.g. B. Rohlfi ng, ‘Wirtschaft saufsicht und amtshaft ung-
srechtlicher Drittschutz’, Wertpapiermitteilungen (2005), 311–19; L. Giesberts in
H. Hirte and T.M.J. Möllers (eds.), Kölner Kommentar zum WpHG (Cologne: Carl
Heymanns Verlag, 2007), § 4, marginal notes 34 et seq.; L. Giesberts in H. Hirte and
 Protection of thir d-party inter est: Ger m a n y 403

German Constitutional Court, the Bundesverfassungsgericht (BVerfG),

has not yet decided on this question, 24 the Supreme Court held in
2005 that the former pertinent provision in the Banking Act – mean-
while replaced without any change in substance by § 4 (4) of the Act
Concerning the Federal Financial Supervisory Authority – did not vio-
late the Constitution.25 Also, the Takeover Senate of the Frankfurt High
Court, the Übernahmesenat des Oberlandesgerichts Frankfurt am Main,
to which § 62 WpÜG assigns a special jurisdiction for takeover-related
administrative proceedings, regarded § 4 (2) WpÜG in two decisions
of 2003 as constitutional.26 With respect to the aforementioned former
provision of the Banking Act (and the accordingly restricted tasks of
the pertinent agency acting as a precursor of the BaFin), the Court of
Justice of the European Communities confirmed in 2004 that a Member
State may assign the supervision over financial institutions to a gov-
ernment agency that acts solely in the public interest without violating
Community law.27
With the various courts squarely backing the German legislators’
attempts to avoid state liability for faulty supervision of their agencies,
an intense discussion has arisen among academia and practitioners
over what consequences this legislative policy has for third parties who
want to assert their rights in the context of a takeover.28 Two different

C. von Bülow (eds.), Kölner Kommentar zum WpÜG (Cologne: Carl Heymanns Verlag,
2003), § 4, marginal notes 24 et seq.
24
In a decision of 2 April 2004 the BVerfG refused to deal with this question as not being
relevant in that specific case; see BVerfG, Wertpapiermitteilungen (2004), 979.
25
Decision of 20 January 2005; see BGHZ 162, 49 et seq.
26
Decisions of 27 May 2003 and 4 July 2003; see Neue Zeitschrift für Gesellschaftsrecht
(2003), 731, 1122 et seq., respectively.
27
Decision of 12 October 2004 – Rs C-222/02; see Zeitschrift für Wirtschaftsrecht (2004),
2039 et seq. (Paul et al. v. the Federal Republic of Germany).
28
See C. Aha, ‘Rechtsschutz der Zielgesellschaft bei mangelhaften Übernahmeangeboten’,
Die Aktiengesellschaft (2002), 160–169; A. Barthel, Die Beschwerde gegen aufsichtsrechtli-
che Verfügungen nach dem WpÜG (Cologne: Carl Heymanns Verlag, 2004); B. Berding,
‘Subjektive öffentliche Rechte Dritter im WpÜG’, Der Konzern (2004), 771–838; A.
Cahn, ‘Verwaltungsbefugnisse der Bundesanstalt für Finanzdienstleistungsaufsicht
im Übernahmerecht und Rechtsschutz Betroffener’, Zeitschrift für das gesamte
Handelsrecht und Wirtschaftsrecht, 167 (2003), 262–300; M. Hecker, ‘Die Beteiligung der
Aktionäre am übernahmerechtlichen Befreiungsverfahren’, Zeitschrift für Bankrecht
und Bankwirtschaft (2004), 41–56; H.-C. Ihrig, ‘Rechtsschutz Drittbetroffener im
Übernahmerecht’, Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht, 167
(2003), 315–50; A. Möller, ‘Das Verwaltungs- und Beschwerdeverfahren nach dem
Wertpapiererwerbs- und Übernahmegesetz unter besonderer Berücksichtigung der
Rechtsstellung Dritter’, Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht,
167 (2003), 301–314; Nietsch, ‘Rechtsschutz der Aktionäre der Zielgesellschaft im
404 Perspectiv es in compa n y l aw

venues are being pondered: enforceable public rights against the German
Supervisory Authority and, alternatively or additionally, civil law rem-
edies against the bidder. As indicated in the text of the Directive cited at
the beginning, both venues are available under Community law, but both
are problematic with respect to the legislative design of the WpÜG.

III. Enforceable public rights against the

German Supervisory Authority?
If a party involved in a takeover is the addressee of an administrative act
by the BaFin, it may, as in any normal administrative procedure, appeal
the decision (§ 48 WpÜG); if the appeal is unsuccessful, it may fi le an ad-
ministrative suit against the Authority with the Frankfurt High Court,
which has a special jurisdiction for these matters (§ 62 WpÜG). There are
at least no major differences in comparison with general administrative
proceedings.29 Also, if a faulty order of the Authority caused damage
for the addressee, it is not disputed that this kind of damage – though
it may be rather rare – has to be compensated by the State in accord-
ance with § 839 of the German Civil Code and Article 34 of the German
Constitution.
But if individual investors who are not the addressees of the specific
administrative Act but are only indirectly affected by the incriminated
decision of the Authority want to challenge a decision of the BaFin, this
central question arises: does the restriction to the public interest to avoid

Übernahmeverfahren, Betriebs-Berater (2003), 2581–2588; P. Pohlmann, ‘Rechtsschutz

der Aktionäre der Zielgesellschaft im Wertpapiererwerbs- und Übernahmeverfahren’,
Zeitschrift für Unternehmens- und Gesellschaftsrecht, 36 (2007), 1–36; von Riegen,
‘Verwaltungsrechtschutz Dritter im WpÜG’, Der Konzern (2003), 583; B. Rohlfi ng,
‘Wirtschaftsaufsicht’, (note 23, above), 311–19; Y. Schnorbus, ‘Rechtsschutz im
Übernahmeverfahren’, Wertpapiermitteilungen (2003), 616–25 (Part I), 657–64
(Part II); Y. Schnorbus, ‘Drittklagen im Übernahmeverfahren – Grundlagen zum
Verwaltungsrechtsschutz im WpÜG’, Zeitschrift für das gesamte Handelsrecht und
Wirtschaftsrecht, 166 (2002), 72–118; C. H. Seibt, ‘Rechtsschutz im Übernahmerecht’,
Zeitschrift für Wirtschaftsrecht (2003), 1865–1877; B. Simon, Rechtsschutz im Hinblick
auf ein Pflichtangebot nach § 35 WpÜG, (Baden-Baden, Nomos, 2005); B. Simon, ‘Zur
Herleitung zivilrechtlicher Ansprüche aus §§ 35 und 38 WpÜG’, Neue Zeitschrift für
Gesellschaftsrecht (2005), 541–544; M. Uechtritz / G. Wirth, ‘Drittschutz im WpÜG –
Erste Entscheidungen des OLG Frankfurt a.M.: Klarstellungen und offene Fragen’,
Wertpapiermitteilungen (2004), 410–417; D. A. Verse, ‘Zum zivilrechtlichen Rechtsschutz
bei Verstößen gegen die Preisbestimmungen des WpÜG’, Zeitschrift für Wirtschaftsrecht
(2004), 199–209.
29
The legislators have expressly stated this in the legislative materials to the WpÜG; see
BTDrucksache 14/7034, 36.
 Protection of thir d-party inter est: Ger m a n y 405

state liability necessarily have the negative effect of denying these any
standing? For example, do individual shareholders of the target company
have the standing to request the BaFin to take action against the bidder
who, in spite of getting control of the target, refuses to make a mandatory
bid? Or do they have the standing to challenge an administrative act by
the Authority that mistakenly exempts the bidder from doing so?
The BaFin and the courts have taken a clear position. The Authority
has consistently decided against a standing of individual shareholders
under these circumstances. In its view, shareholders lack the individual
and direct rights necessary for any action because of the express restric-
tion of its activities to the public interest in § 4 (2) WpÜG. The Frankfurt
High Court has repeatedly confirmed this view and dismissed all per-
tinent suits fi led by shareholders of targets against the BaFin. 30 The High
Court argues that although various provisions of the WpÜG indeed do
have the potential to favour the interests of shareholders, this fact as
such does not imply that the legislators intended to create a regime of
individual enforceable public rights to assert their interests by way of
an active participation in the formal takeover proceedings.31 Nor were
they obliged to do so on constitutional grounds. As the High Court sees
it, the legislators instead had the freedom to design the present regime
restricted to the protection of the public interest only without violat-
ing any constitutional rights of third parties.32 Instead of administra-
tive remedies against the BaFin, the High Court refers shareholders to
potential civil remedies against the bidder.
The High Court quotes legislative history in its argument. In fact, ear-
lier drafts of the Takeover Act did contain a provision that provided for
damages in the case of an abusive use of third-party rights. The existence
of that provision clearly shows that, originally, the legislators must have
planned to grant those rights. That would have made a lot of sense from
the regulatory logic of the WpÜG, which requires that the Act, as well as
the Securities Trading Act and other financial market-related laws, serve
a dual purpose: protection of the functioning of the market in general
as well as protection of individual investors. 33 However, in the course of

30
See the decisions cited supra, note 26, and the decision of 9 October 2003; see Neue
Zeitschrift für Gesellschaftsrecht (2004), 240 et seq.
31
See Decision of 4 July 2003; see Neue Zeitschrift für Gesellschaftsrecht (2003), 1121 et seq.
32
See Decision of 4 July 2003, see Neue Zeitschrift für Gesellschaftsrecht (2003), 1122 et seq.
33
K.J. Hopt, ‘Grundsatz und Praxisprobleme nach dem Wertpapiererwerbs- und
Übernahmegesetz’, Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht, 166
(2002), 386 (‘… Funktionen- und Anlegerschutz’).
406 Perspectiv es in compa n y l aw

the legislative proceedings, actually at its very end, that provision was
scrapped because the Financial Committee of the Parliament in charge
of politically renegotiating the Act did not see any practical necessity for
it; according to the Committee, third parties do not have any individual
rights in this regard that they could possibly abuse.34 In this view, pro-
tection of individual investors is but a mere ‘legislative reflection’ of the
general protection of the market function.
The reasoning of the BaFin and the High Court is disputed on various
grounds. Though the majority of commentators accept the constitution-
ality of § 4 (2) WpÜG – notwithstanding their criticism of the legal solu-
tion on policy grounds – some do so only under the precondition that
the provision is at least interpreted in a constitutional manner which
would exclude a complete denial of third-party rights.35 This approach,
however, is problematic. The legislative order of the provision – to act in
the public interest only – is unequivocal.36 Thus it does not seem permis-
sible to circumvent the clearly expressed legislative intention by way of
constitutional interpretation.37
Others promote a restrictive interpretation of § 4 (2) WpÜG. In
this view the provision aims only at excluding state liability for faulty
administrative acts or a failure to act by the BaFin, but does not say any-
thing about the rights of third parties and their standing vis-à-vis the
Authority.38 However, this interpretation too is problematic. The exclu-
sion of state liability is dependent on the assumption of non-existence
of according individual rights against the Authority. Thus, if § 4 (2)
WpÜG excludes state liability under the provisions of the Act, these
cannot be contradictorily interpreted as simultaneously granting indi-
vidual public rights enforceable against the BaFin with respect to other
matters.39

34
See Legislative Materials, BTDrucksache 14/477, 70; the technical conception of the
WpÜG has been criticized strongly in this regard; see e.g. Y. Schnorbus, ‘Drittklagen’,
(note 28, above), 117.
35
See e.g. L. Giesberts, in H. Hirte and C. von Bülow (eds.), Kölner Kommentar zum WpÜG
(note 23, above), § 4, marginal notes 62 et seq., 75; Aha, ‘Rechtsschutz der Zielgesellschaft’,
(note 28, above), 162 et seq. Others plainly deny the constitutionality; see e.g. B. Berding,
‘Subjektive öffentliche Rechte Dritter im WpÜG’, (note 28, above), 774 et seq.
36
A. Möller, ‘Das Verwaltungs- und Beschwerdeverfahren’, (note 28, above), 306.
37
B. Simon, Rechtsschutz, (note 28, above), 117 et seq.
38
See e.g. A. Cahn, ‘Verwaltungsbefugnisse der Bundesanstalt’, (note 28, above), 284
et seq.
39
P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 20; M. Uechtritz and G.
Wirth, ‘Drittschutzim’, (note 28, above), 414.
 Protection of thir d-party inter est: Ger m a n y 407

Also, it is not permissible, as some have attempted, to disregard the

unequivocal legislative will to exclusively restrict the Act’s regulatory
aim to the protection of the market function by assuming that this does
not actually mean a total exclusion of individual investor protection
because some provisions of the Act expressly refer to their interests.40 An
example of this is § 37 (1) WpÜG. According to this provision, the BaFin
may exempt bidders who have acquired a controlling stake from their
duty to make a full bid for all outstanding shares only if this exemption
would not be contrary to the interests of the other target’s sharehold-
ers.41 However, this reference to the shareholders’ interests cannot be
interpreted as a means to grant them individual and direct public rights.
It is simply a legislative order addressed at the BaFin to balance the inter-
ests of the bidder with those of the other shareholders in general under
specific circumstances.42
The above considerations can be summarized in the – not altogether
happy – finding that the current German takeover legislation does not
make available any direct public rights for third parties involved in a
takeover that might be enforced in an administrative proceeding against
the BaFin. Instead, third parties are forced to rely on the Authority’s zest
to supervise the country’s takeover market. The only alternatives, if any,
are civil law remedies against the bidder that might possibly provide some
direct relief for the shareholders of the target and other third parties.

IV. Civil law remedies against the bidder?

From this perspective, the following questions are of specific practical
interest: does § 35 WpÜG – stipulating the obligation to publish and to
make an offer in the case of an acquisition or change of control – provide
a legal basis for the other shareholders of the company against a share-
holder that has acquired a controlling stake43 to make an offer for all out-
standing shares? If not, or if an offer is made but the consideration offered
is insufficient, may the shareholders sue such a person for damages?
Once more, the issue is highly disputed. In principle, the WpÜG is
conceived as a market surveillance law showing the typical mix of public

40
See e.g. A. Barthel, Die Beschwerde, (note 28, above), 109 et seq.
41
For details, see H. Krause and T. Pötzsch, in H. Assmann, T. Pötzsch, and U. H. Schneider
(eds.), Wertpapiererwerbs- und Übernahmegesetz (Cologne: Otto Schmidt, 2005), § 37,
marginal notes 31 et seq.
42
B. Simon, Rechtsschutz, (note 28, above), 127 et seq.
43
I.e. at least 30% of the target’s voting rights, as defi ned in § 29 WpÜG.
408 Perspectiv es in compa n y l aw

law regulations, administrative powers, quasi-criminal sanctions and

civil law consequences. Within this regulatory framework, the question
of which provisions of the Act can be qualified as civil law in substance
and what legal consequences are attached to this qualification can only
be answered on a case-by-case analysis.44 With respect to the mar-
ket surveillance-oriented character of WpÜG, there is no underlying
assumption that the provisions of the Act are intended to have civil law
consequences in principle; instead, as an exemption this has to be shown
for each individual provision.45
In the decisions cited, the Frankfurt High Court has (expressly) left
open the question as to whether § 35 WpÜG actually provides a legal
basis for shareholders to demand an offer for their shares from a con-
trolling shareholder in accordance with the pertinent provisions of the
Act and the WpÜG Offer Ordinance.46 47 The literature is divided, but a
clear majority of commentators answer the question in the negative.48
There is indeed no room for a different interpretation. The wording of
§ 35 does not mention shareholders at all but (only) stipulates a gen-
eral duty for the controlling shareholder to publish an offer. This general
order matches the market-oriented character of the provision. Any other
understanding would lead to a plethora of difficulties when applying the
rule in a civil law context. Additionally, a broad interpretation would
be problematic on constitutional grounds, as the resulting far-reaching
consequences for the controlling shareholder would have to be based on
a narrowly defined rule.49 Also, allowing for individual claims would be
hard to reconcile with the Act’s overarching aim to provide for a regula-
tory framework that guarantees speedy takeover procedures.50 In other
words, the legislators obviously did not intend to grant shareholders a
direct civil law claim against a controlling shareholder under § 35.51

44
Y. Schnorbus, ‘Rechtsschutz’, (note 28, above), 663.
45
Y. Schnorbus, ‘Rechtsschutz ‘, (note 28, above), 663.
46
§ 31 WpÜG, §§ 3–7 WpÜG-Angebotsverordnung, see supra note 11.
47
See the decisions cited supra, note 26 and note 30.
48
See e.g. H. Krause and T. Pötzsch, in H. Assmann, T. Pötzsch and U.H. Schneider (eds.),
Wertpapiererwerbs- und Übernahmegesetz (Cologne: Otto Schmidt, 2005), § 35, mar-
ginal notes 252 et seq.; P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 11 et
seq.; B. Simon, Rechtsschutz, (note 28, above), 206 et seq.
49
H. Krause and T. Pötzsch, in H. Assmann, T. Pötzsch and U.H. Schneider (eds.),
Wertpapiererwerbs- und Übernahmegesetz (Cologne: Otto Schmidt, 2005), § 35, mar-
ginal note 252.
50
Legislative Materials, BTDrucksache 14/7034, 35.
51
P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 12.
 Protection of thir d-party inter est: Ger m a n y 409

Even if the shareholders do not have a primary claim against the

controlling shareholder, they may nevertheless possibly have a second-
ary claim in the form of damages based on § 823 (2) Civil Code in com-
bination with § 35 WpÜG. § 823 (2) Civil Code provides for a general
liability in damages in combination with specific protective provisions
of other codes. The precondition for this is a violation of a rule that
intends to protect not only the market as such but the individual claim-
ant as well.52 According to a minority view, the denial of direct public
rights of individual shareholders as third parties under the WpÜG auto-
matically implies that none of the provisions of the Act can be regarded
from a civil law perspective as a protective norm in the sense of § 823 (2)
Civil Code in order to prevent a contradictory policy interpretation.53
This view, however, is not convincing. There is no compelling connec-
tion between a public law and a tort law evaluation.54 Rather, the two
questions – whether a person has an administrative claim against a state
agency and/or whether that person, cumulatively or alternatively, has a
tort claim against a controlling shareholder – have to be clearly distin-
guished and, accordingly, different answers to each do not constitute a
contradiction in the evaluation of that norm.
The relevant question is thus whether § 35 as it stands may serve as a
protective norm in the sense of § 823 (2) Civil Code. This again is con-
troversially discussed.55 As has been argued with respect to a possible
primary claim against the controlling shareholder, there is also no indi-
cation in the wording of the provision (nor in the legislative materials)
52
See in general H. Sprau, in Bassenge et al. (eds.), Palandt. Bürgerliches Gesetzbuch, 67th
edn (Munich: C.H. Beck, 2008), § 826, marginal notes 56 et seq.
53
Y. Schnorbus, ‘Rechtsschutz’, (note 28, above), 663; B. Berding, ‘Subjektive öffentliche
Rechte Dritter im WpÜG’, (note 28, above), 777; H. Krause and T. Pötzsch, in H. Assmann,
T. Pötzsch and U. H. Schneider (eds.), Wertpapiererwerbs- und Übernahmegesetz
(Cologne: Otto Schmidt, 2005), § 35, marginal note 253 with respect to § 35 WpÜG.
54
P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 21; D. A. Verse, ‘Zum zivil-
rechtlichen Rechtsschutz’, (note 28, above), 203 et seq.; H.-C. Ihrig, ‘Rechtsschutz’, (note
28, above), 338; C. H. Seibt, ‘Rechtsschutz ‘, (note 28, above), 1868.
55
Pro: e.g. C. von Bülow in H. Hirte and C. von Bülow (eds.), Kölner Kommentar zum WpÜG
(Cologne: Carl Heymanns Verlag, 2003), § 35, marginal note 199; T. Baums and M. Hecker
in T. Baums and G. F. Thoma (eds.), WpÜG – Kommentar zum Wertpapiererwerbs- und
Übernahmegesetz (Cologne: RWS Verlag), § 35, marginal notes 297 et seq.; H.-C. Ihrig,
‘Rechtsschutz’, (note 28, above), 349. Contra: besides those cited supra at note 52, see
e.g. P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 12 et seq.; Hommelhoff
and C.-H. Witt in W. Haarmann and M. Schüppen (eds.), Frankfurter Kommentar zum
Wertpapiererwerbs- und Übernahmegesetz, 2nd edn. (Franfurt am Main: Verlag Recht
und Wirtschaft, 2005), § 35, marginal note 109; B. Simon, ‘Zur Herleitung zivilrechtlicher
Ansprüche’, (note 28, above), 542.
410 Perspectiv es in compa n y l aw

that the legislators intended § 35 to serve as a protective norm for the

individual shareholders as a basis for secondary damages claims. But
such an expressed intent would be necessary. It is a common view that
the mere fact that a norm may (also) have beneficial consequences for a
person involved as such is not sufficient to assume a protective purpose
of that norm. Furthermore, allowing for a secondary claim for the share-
holders would in effect undermine the legislators’ decision not to grant
them a primary claim in the first place: according to § 249 (1) Civil
Code, persons who are liable in damages must restore the position that
would exist if the circumstance obliging them to pay damages had not
occurred. This would mean that the claimants could require the control-
ling shareholder to make an offer to buy their shares as damages.
Instead of allowing for either a primary or a secondary claim in the
form of damages, the legislators have created a unique system of triple
sanctions against the controlling shareholder who failed to make a bid
pursuant to § 35 WpÜG: (i) § 60 WpÜG provides for an administrative
fine, (ii) § 59 WpÜG regulates the loss of rights for controlling share-
holders as long as they do not comply with their duties, and (iii) § 38
WpÜG obliges them to pay the shareholders of the target company, for
the duration of the contravention, interest on the amount of the consid-
eration of five percentage points per year above the relevant base interest
rate pursuant to § 247 Civil Code. Whether shareholders have a direct
claim against the controlling shareholder based on § 38 WpÜG, and how
this provision is to be characterized dogmatically – as a civil law claim
or sanction – is once again controversial.56 But this will no longer come
as a surprise for the patient reader.
Less disputed, however, is the standing of the target’s shareholders
with respect to § 31 WpÜG. Th is provision is of central importance in
the context of a mandatory bid. As already mentioned, it sets out the
standards for an appropriate consideration which the bidder has to offer,
and ensures that all shareholders get the same price.57 To these ends, the
average stock market price and purchases of shares up to six months
prior to the publication of the bid have to be taken into consideration.58

56
See B. Simon, ‘Zur Herleitung zivilrechtlicher Ansprüche’, (note 28, above), 543;
P. Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 18 et seq.; Hommelhoff
and C.-H. Witt in W. Haarmann and M. Schüppen (eds.), Frankfurter Kommentar zum
Wertpapiererwerbs- und Übernahmegesetz, (note 55, above), § 38, marginal notes 1 et
seq., 31 et seq.; Y. Schnorbus, ‘Rechtsschutz’, (note 28, above), 663.
57
Details are regulated in §§ 3–7 WpÜG Offer Ordinance; see supra note 11.
58
§ 31 (I) WpÜG together with § 4 WpÜG Offer Ordinance.
 Protection of thir d-party inter est: Ger m a n y 411

In addition, purchases made during the offer period for a higher price
as well as purchases made within one year after the closing have to be
considered.59 If the price offered by the bidder violates these standards,
the shareholders who have accepted the bid are entitled to fi le a claim
against the bidder demanding the price difference. Though the dogmatic
questions involved are again somewhat controversial, the fact that § 31
WpÜG provides for a direct civil law remedy against the bidder is gener-
ally acknowledged.60 Thus, at least with regard to a consideration offered,
the shareholders might take the initiative to assert their rights.

V. Conclusion
Perhaps the tour d ’ horizon above has unearthed more questions than it
has answered. Indeed, the German takeover regulation shows a surpris-
ing amount of legal uncertainty and unresolved dogmatic questions. This
complexity results partly from the fact that the WpÜG is to a significant
degree a legal transplant whose imported features do not always fit seam-
lessly into the traditional German legal order. However, at least for com-
mentators, this has obviously been a bone of contention. The numerous
commentaries, the multitude of dissertations, and the countless academic
articles on the German takeover regulation have assembled together to
form an incredible amount of literature within a few years that some may
regard as somewhat out of proportion with the actual number of take-
overs in Germany. In this regard as well, the German takeover regime
seems to differ significantly from its British role model.61
Third-party rights are but one example of the intense discussion. These
have also been the cause of an unexpected – and rather ‘un-British’ – spat
of litigation soon after the WpÜG was enacted. However, in most cases
shareholders of target companies have tried to sue in vain. As they have
discovered the hard way, though it is disputed, the current German take-
over legislation does not make available any direct public rights for third
parties involved in a takeover that can be enforced in an administrative
proceeding against the BaFin in its capacity as supervising authority over
the German takeover market.

59
§ 31 (4) (5) WpÜG.
60
See e.g. D. A. Verse, ‘Zum zivilrechtlichen Rechtsschutz’, (note 28, above), 200 et seq.;
Pohlmann, ‘Rechtsschutz der Aktionäre’, (note 28, above), 14 et seq.
61
For a structural comparison, see H. Baum, ‘Funktionale Elemente und
Komplementaritäten des britischen Übernahmerechts’, Recht der Internationalen
Wirtschaft (2003), 421 et seq.
412 Perspectiv es in compa n y l aw

Thus the attention has shifted to civil law remedies as a possible alter-
native. But here, too, the picture is sobering. As a rule, the provisions of
the WpÜG do not provide for directly enforceable rights against a bidder.
This is especially true with respect to the mandatory bid. Shareholders
do not have the means to force a shareholder who gained control to make
a bid for all outstanding shares of the target company as required under
the WpÜG. Some consolidation may come from the fact that, at least
with respect to a consideration offered, shareholders may hold the con-
trolling shareholder accountable.
 23

Takeover defences and the role of law:

a Japanese perspective
Hideki K anda 

I. Introduction
Today, takeovers of publicly held business firms are understood as an
effective and speedy means of resource allocation. Yet the legal frame-
work surrounding takeovers, particularly hostile ones, is not simple.
It appears to vary significantly from country to country.
With regard to takeover defences, the United States is rich both in
its practical experience and academic literature. In contrast, Japan was
poor at least until 2005. While courts in Delaware in the United States
have shaped the law in this area over the past twenty-five years, Japanese
law is not clear despite the existence of several statutory provisions of the
Japanese Company Act and certain well-known cases in recent years.
Although the United States is rich in its practical experience and aca-
demic literature, evidence seems to be inconclusive. Moreover, there is
so much debate among commentators that opinions are quite divided
among reasonable people. As a result, this area has produced (and still
today produces) one of the most difficult issues in US corporate law.2
First, while empirical studies generally show that hostile takeovers are
good for the economy in the sense that they generally enhance the value
of the target firms, it is unclear from the past empirical studies whether
defence measures adopted by target boards, in particular ‘poison pills’,
are good or bad for the target firms (and thus for the economy). Second,
normative arguments in academic literature about what defensive meas-
ures should be legally permitted or prohibited, and to what degree, are
quite split in the United States. In Delaware, however, the standard of

1
Professor of Law, University of Tokyo. An earlier version of this chapter was written for a
project by the Korean Development Institute.
2
The text draws on H. Kanda, ‘Does Corporate Law Really Matter in Hostile Takeovers?:
Commenting on Professor Gilson and Chancellor Chandler’, Columbia Business Law
Review, 67 (2004).

413
414 Perspectiv es in compa n y l aw

judicial review for takeover defences (including poison pills) has already
been established. Delaware courts today apply the ‘enhanced business
judgment rule’ and require ‘proportionality’ in reviewing takeover
defences. Thus, the takeover defences upheld by the courts in Delaware
fall within a certain range, and the law is predictable as to whether a par-
ticular defensive measure (including poison pill attempts) to be taken
would be upheld or denied by Delaware courts.
In contrast, in Japan, until recently, no one could tell what the law
was with respect to takeover defences. However, beginning in 2005,
several well-known hostile takeover attempts took place in Japan, and
a few cases were brought into court rooms. To date, more than three
hundred public firms have introduced the ‘Japanese version’ of the poi-
son pill since 2005. Discussion as to what should be the criteria with
which a particular hostile bid is judged good or bad has been immense.
Correspondingly, a few amendments to the relevant statutes have been
made in 2005 and 2006.
In this chapter, I describe these developments and experiences in
Japan: Section II describes the recent developments; Section III shows
characteristics as found in the recent developments; finally, Section IV
is my preliminary conclusion and offers implications from preceding
sections.3

II. Developments
As Professor Curtis Milhaupt stated, ‘the unthinkable has happened’.4
In 2005, a battle for control over Nippon Broadcasting occurred. In
response to the takeover attempt by Livedoor, the board of Nippon
Broadcasting adopted a defence measure by issuing stock warrants
(shinkabu yoyaku ken) to its de facto parent, Fuji TV in order to dilute
Livedoor’s stake. The Tokyo District Court enjoined the issuance and its
decision was affirmed by the Tokyo High Court.

3
For articles on the Japanese situation in English include S. Kozuka, ‘Recent Developments
in Takeover Law: Changes in Business Practices Meet Decade-Old Rule’, Zeitschrift
für Japanisches Recht, 21 (2006), 5; K. Osugi, ‘What is Converging? Rules on Hostile
Takeovers in Japan and the Convergence Debate’, Asian-Pacific Law and Policy Journal,
9 (2007), 143.
4
C.J. Milhaupt, ‘In the Shadow of Delaware? The Rise of Hostile Takeovers in Japan’,
Columbia Law Review, 105 (2005), 2171. See also J.B. Jacobs, ‘Implementing Japan’s New
Anti-takeover Defense Guidelines, Part II: The Role of Courts as Expositor and Monitor
of the Rules of the Takeover Game’, University of Tokyo Journal of Law and Politics, 3
(2006), 102.
 Tak eov er defences a n d the role of l aw: Japa n 415

Nippon Broadcasting, a radio broadcaster, is part of the Fuji Sankei

media group and was a de facto subsidiary of Fuji Television Network,
Inc. (‘Fuji TV’), Japan’s largest media company. Somewhat anomalously,
however, Nippon broadcasting held 22.5% of the outstanding shares of
Fuji TV while Fuji TV held only 12.4% of Nippon Broadcasting’s shares.
In part to rectify the situation, on 17 January 2005, Fuji TV announced a
cash tender offer for all of the outstanding shares of Nippon Broadcasting.
The bid was approved by the board of Nippon Broadcasting.
In the midst of this tender offer, on 8 February 2005, Livedoor, an
internet service provider, made a sudden announcement that it had just
acquired approximately 29.6% of Nippon Broadcasting’s shares. Livedoor
acquired these shares through market purchase.5 In combination with
the shares previously owned, Livedoor’s stake reached 38% of Nippon
Broadcasting’s shares. On the same day, Livedoor informed Nippon
Broadcasting of its intent to acquire all of its outstanding shares.
In response, on 23 February 2005, Nippon Broadcasting announced
that its board had decided to issue stock warrants to Fuji TV exercis-
able into 47.2 million shares of Nippon Broadcasting stock. If exercised,
the warrants would give Fuji TV majority control and dilute Livedoor’s
stake to less than 20%. Livedoor by that time had acquired approximately
40% of Nippon Broadcasting stock. The board decision was unanimous.
Four outside directors voted for the decision and four directors affi li-
ated with Fuji TV abstained from participation in the decision. The war-
rants were exercisable at 5,950 yen, the price offered in Fuji TV’s tender
offer. Nippon Broadcasting announced that the purpose of the issuance
of warrants was to remain within the Fuji Sankei group, which would
provide long-term benefits to its shareholders.
Livedoor sued to enjoin the issuance of warrants. The Tokyo District
Court enjoined the warrant issuance as ‘significantly unfair’ under the
Commercial Code. The court held that its primary purpose was to main-
tain control of the firm by incumbent management and affi liates by the
Fuji Sankei Group. The Tokyo High Court affirmed.6 Accordingly, Nippon
Broadcasting and Fuji TV abandoned the warrant issuance. Livedoor
eventually obtained a majority of shares of Nippon Broadcasting.

5
The method of purchase deployed by Livedoor, called off the floor, after hour trading,
was permitted during the period when a tender offer was pending. Th is method was
much criticized, and the law was amended in July 2005 so as to make such a trading
method unlawful.
6
Tokyo District Court Decisions on 11 March 2005 and on 16 March 2005. Tokyo High
Court Decision on 23 March 2005, 1899 Hanreijiho 56.
416 Perspectiv es in compa n y l aw

The battle ended in a somewhat peaceful way. On 18 April 2005,

Livedoor agreed to sell its Nippon Broadcasting shares to Fuji TV at 6,300
yen per share, approximately the average price it paid for the shares. In
return, Fuji TV obtained a 12.5% stake in Livedoor for a capital infusion
of approximately $440 million, and the three companies established a
joint committee to explore related ventures.
The rationales in the two decisions of the Tokyo District Court and
the Tokyo High Court are not identical, but they have many common
elements. To cite from the decision of the High Court, the court stated
a basic principle of the ‘power allocation doctrine’. Under this doctrine,
shareholders elect directors. The board of directors has the power to
issue stocks and warrants only for the purpose of funding new capital,
paying incentive-based compensations and others. However, the board
does not have power to take defensive measures against hostile bids. The
decision of who should take control over the company must be delegated
to shareholders. This, however, permits exceptional situations where
the board is permitted to take defence actions as an emergency. Those
situations are found where the bidder attempts to disrupt the firm. The
court did not find such exceptional situation in the battle for control
over Nippon Broadcasting.
This case was enough to call the serious attention of managers of all
publicly held firms in Japan and market participants. The Corporate Value
Study Group, established by the Ministry of Economy, Trade and Industry
(‘METI’) in 2004, released its interim report on 27 May 20057 and on the
same day, guidelines for defensive measures were released jointly by METI
and the Ministry of Justice (‘Guidelines’).8 It must be noted that while the
Nippon Broadcasting case involved a ‘post-bid’ defence, these documents
are for ‘pre-bid’ defensive measures, and public firms began to introduce a
variety of pre-bid defensive measures beginning in mid 2005.
The Guidelines, although they are not the law, list three basic prin-
ciples for the validity of pre-bid defence measures.9 First, the purpose
of such defence measure must be to enhance corporate value and thus
shareholders’ value as a whole. Second, the adoption of such a defence
plan must be based on the shareholders’ will. Finally, such defence

7
Ministry of Economy, Trade and Industry, Corporate Value Study Group Report (27 May
2005).
8
Ministry of Economy, Trade and Industry and Ministry of Justice, Guidelines regarding
Takeover Defenses for the purposes of Protection and Enhancement of Corporate Value
and Shareholders’ Common Interests (27 May 2005).
9
Ibid.
 Tak eov er defences a n d the role of l aw: Japa n 417

measure must be necessary and satisfy proportionality, namely, they

must be a reasonable and non-excessive means to accomplish the pur-
pose. Also, the Guidelines specifically discuss the issuance of stock war-
rants. They provide that if such warrants are issued by a decision at the
shareholders’ meeting, its validity or compliance with the three princi-
ples would be presumed. If such warrants are issued by a board decision
without a shareholders’ meeting, necessity and proportionality would
have to be strictly required.
In the course of these quick developments, a couple of changes in
the relevant statutes were made. First, the Ministry of Justice (‘MOJ’)
promulgated a disclosure rule for defensive measures, effective on 1
May 2005. A joint-stock company is required to disclose its fundamen-
tal policy for its management in its annual business report.10 This rule
applies to the fiscal year ending on or after 1 May 2005, and it means
that most public firms began to disclose such policy in 2006. Second,
the Subcommittee on Corporate Governance at the Liberal Democratic
Party discussed this area in the first half of 2005 and released an import-
ant report on 7 July 2005.11 This report endorsed one type of poison pill
using a trust scheme by making clear of its tax implications. In addition,
the report called for a few changes of tender offer regulation. The bill for
wide-range reform of the Securities and Exchange Act (‘SEA’) (which
includes the tender offer regulation) was passed in the Diet in June 2006,
and the proposed changes by the Subcommittee were included. The rele-
vant part of the regulation became effective on 13 December 2006. In
this connection, the Financial Services Agency (‘FSA’), which has jur-
isdiction over tender offer regulation, made detailed rules under the
amended SEA. Among others, when a tender offer is commenced, the
target board has the legal right to ask questions to the bidder and the
bidder must answer them in their public documents. A European-style
mandatory bid rule (which requires the bidder to bid for all outstanding
shares) was introduced, but only where the bidder attempts to acquire
two-thirds or more of the target shares. Finally, Tokyo Stock Exchange
(‘TSE’) has been serious in promulgating rules and guidelines to avoid
possible confusions in the stock market it operates as a result of possible
hostile battles and unexpected measures that might be taken by both
sides. TSE is still in the process of writing rules and guidelines, but to

10
See Article 127, Ministry of Justice Companies Act Implementation Rule (2005).
11
Report of the Subcommittee on Corporate Governance, Liberal Democratic Party (7 July
2005).
418 Perspectiv es in compa n y l aw

date, it has made several important announcements concerning a few

specific items.12 It is clear that ‘golden shares’ or other ‘dead hand’ poi-
son pills are not permitted for the companies listed on the TSE.
In the course of these developments, two further court decisions were
made. First, a pre-bid defensive scheme using stock warrants, adopted by
the board of Nireco, a provider of various controlling and measuring sys-
tems, was enjoined by the Tokyo District Court and Tokyo High Court in
June 2005.13 Second, a post-bid defence adopted by the board of Nippon
Gijutsu Kaihatsu (Japan Engineering Consultants Co., ‘JEC’), a consult-
ing firm in construction, was approved by the Tokyo District Court in
July 2005.14 In the latter case, on 20 July 2005, Yumeshin, a construction
firm, launched a hostile tender offer for all outstanding shares of JEC.
In response, JEC announced a stock split. JEC asserted that it adopted
an advance warning defence plan (see below) and Yumeshin violated the
process asked for by the plan. At that time, it was unclear whether the bid-
der was permitted under the SEA to change the bid price during the bid
period if an unexpected thing happened, such as a stock split, but eventu-
ally, the FSA permitted such change. This means that a stock split would
have no effect in frustrating Yumeshin’s hostile bid. Under the situation,
on 29 July 2005, the Tokyo District Court decided not to enjoin the stock
split. On the same day, JEC announced an issuance of stock warrants.
After this, JEC found a white knight, which launched a competing bid
with a higher price. Yumeshin’s bid turned out to be unsuccessful (as
Yumeshin ended up with holding 10.59% of JEC stock). Eventually, JEC
withdrew the issuance of warrants, and the battle ended.
With these court decisions and related discussions, many publicly
held firms in Japan moved to adopt two types of pre-bid defence meas-
ures. One is a poison pill scheme using a trust or similar structure, and
the other (more popular one) is a scheme known as advance warning.
As of 25 May 2007, 359 listed firms (out of total of approximately 3,900
listed firms in Japan) have pre-bid defence plans. For listed fi rms on the
TSE Section One, 283 firms out of total 1,753 have adopted such plans.
Among 359 firms, 349 have adopted some form of advance warning
plan, and 10 have trust-type or similar warrant schemes.15

12
See generally Tokyo Stock Exchange, Interim Report of the Advisory Group on
Improvements to TSE Listing System, 27 March 2007.
13
Tokyo District Court Decisions on 1 June 2005 and on 9 June 2005. Tokyo High Court
Decision on 15 June 2005, 1900 Hanreijiho 156.
14
Tokyo District Court Decision on 29 July 2005, 1909 Hanreijiho 87.
15
See the material submitted to the METI Corporate Value Study Group on 29 May 2007.
 Tak eov er defences a n d the role of l aw: Japa n 419

Under a typical trust based scheme, the firm issues stock warrants to
a trust bank with designated shareholders as beneficiaries of the trust.
When a hostile bid occurs, the pill is triggered, and the trust bank trans-
fers the warrants to the shareholders. The warrants have a discrimina-
tory feature and the bidder has no right to exercise them, as the terms
and conditions of the warrants usually provide that the warrants are not
exercisable by the shareholders who own 20% or more of the fi rm’s out-
standing stock.
The advance warning plan varies from company to company but its
typical style is as follows. The board, sometimes with approval of the
shareholders’ meeting, makes a public announcement that if a share-
holder attempts to increase its stake to 20% or more of the firm’s out-
standing stock, before the shareholder does so, the shareholder is
required to disclose and explain, in accordance with the details specified
in the announcement, its intent to hold such stake and what the share-
holder would do for the firm. If the shareholder does not answer these
questions or the target board thinks the shareholder’s explanation to be
unsatisfactory, then a defence measure would be triggered. Such defence
measure is typically to issue stock warrants to all shareholders but the
shareholder having 20% or more cannot exercise the warrants. Instead,
such shareholder’s warrants can be redeemed at a fair price at the option
of the company. Thus, typically, warrant issuance has an effect of ‘cash-
ing out’ the hostile bidder.
In most plans (304 plans out of total 359), judgment for triggering is
to be made by a special committee composed of independent individu-
als. In some companies’ plans, such defence measures are to be triggered
after approval at the shareholders’ meeting.
Because the Tokyo High Court decision on Nippon Broadcasting and
the METI-MOJ Guidelines emphasize shareholder decision, most public
companies adopt defence schemes which ask for a decision at the share-
holders’ meeting either when it introduces a pre-bid defence plan and/or
when it triggers such a plan.16 In practice, in most companies, the board
proposal for introducing an advance-warning-type defence measure was
put for approval at the shareholders’ meeting, and in fact obtained share-
holder approval. For those companies who introduced advance-warning
defence plans, it is unknown whether they will survive a judicial review

16
Out of 359 advance warning plans, 307 plans were introduced by approval at the share-
holders’ meeting. The remaining 42 plans were introduced by board decisions only. See
supra note 12.
420 Perspectiv es in compa n y l aw

when such a plan triggers the pill, because to date, there has been no case
in which that has happened, except in the JEC case noted above.
In May 2007, Steel Partners, a US buy-out fund, commenced a hos-
tile tender offer for all outstanding shares of Bulldog Sauce, a Worcester
sauce producer.17 Bulldog Sauce did not have any pre-bid defence plan.
As a post-bid defence, the board of Bulldog Sauce intended to issue stock
warrants to all stockholders, including Steel Partners and its affi liates
(collectively ‘SP’), with the condition that SP cannot exercise the war-
rants. The warrants have a redemption feature, by which the warrant
holders other than SP receive common stocks in exchange for turn-
ing the warrants into the company whereas SP receives cash. Thus, the
scheme was structured as a scheme diluting the voting right of SP with-
out an economic loss to SP (‘economic’ does not include the value of
voting right). The Bulldog board introduced the proposal at the annual
shareholders’ meeting on 24 June 2007, and the plan was approved by
more than 80% of the shares. SP sued to enjoin the issuance of the war-
rants. The Tokyo District Court held on 28 June 2007 that the scheme
was valid.
The court held that strict judicial scrutiny adopted by the High Court
decision on Nippon Broadcasting case does not apply here because the
defence measure was approved at the shareholders’ meeting. The court
also held that since the defence measure provides ‘just compensation’ to
the hostile bidder, it does not violate the proportionality principle. In other
words, the court’s position is that ‘necessity’ is presumed because share-
holders decided and ‘proportionality’ is subject to judicial review (and it
was held to be satisfied in this case). Steel Partners appealed, but the Tokyo
High Court affirmed on 9 July 2007. Tokyo High Court found that SP was
an ‘abusive bidder’ and held that the defence measure was lawful.
Steel Partners appealed to the Supreme Court. On 7 August 2007, the
Supreme Court affirmed. The Supreme Court’s opinion was somewhat
similar to that of the Tokyo District Court. The highest court held that
because the defence measure was approved by shareholders, the neces-
sity requirement was met, and because it provided SP with just compen-
sation, the proportionality test was satisfied. It also held that because the
measure satisfied the proportionality test, it did not violate the purpose
of the principle of equal treatment of shareholders.

17
For a detailed description and analysis of this case and the court decisions, see S. Osaki,
‘The Bull-Dog Sauce Takeover Defense’, Nomura Capital Market Review, 10 (2007),
No.3, 2.
 Tak eov er defences a n d the role of l aw: Japa n 421

The Steel Partners’ tender offer ended on 23 August 2007. Only 1.89%
of all outstanding shares were tendered. On 30 August 2007, Bulldog
Sauce introduced an advance warning style pre-bid defence plan.
In a similar fashion, in May 2007, Steel Partners launched a hostile ten-
der offer for all outstanding shares of Tenryu Saw Mfg. Co. (‘Tenryu’), a
saw blade manufacturer. In response, Tenryu adopted an advance warn-
ing defence plan with approval of more than 80% shares at the share-
holders’ meeting.18 Steel Partners’ bid was unsuccessful because only
2.69% of all voting shares were tendered (Steel Partners ended up with
11.73% of all voting shares of Tenryu).

III. Characteristics
The developments described above show a few characteristics in this
area in Japan. First, the rule in the statute is not clearly written and as a
result whether and when a given defensive measure is legal is relegated to
proper interpretation of the relevant statutory revisions.19 The most rel-
evant are the provisions under the Companies Act, Articles 210 and 247,
which provide that the issuance of stock or stock warrants is enjoined if
such issuance is significantly unfair. The courts have been struggling to
find an appropriate test of judicial review.
Second, the Japanese discussion and judicial development empha-
size shareholder decision. However, Bulldog Sauce and Tenryu are
exceptional companies in that they apparently have many sharehold-
ers friendly to the management. Usually, it seems not easy to obtain

18
Th is pre-bid plan explicitly stated that the plan does not apply to the tender offer by Steel
Partners which was pending at that time. It applies to all future tender offers and other
stock acquisitions.
19
Under the Companies Act of 2005, defence plans using the class of shares are possi-
ble. For instance, a firm may issue a special class of shares which does not have voting
power for the part of the shares exceeding the 20% stake of all outstanding shares. To
issue such shares, the fi rm’s charter must state its content. A fi rm issuing common shares
may convert them into such special class shares by a charter amendment, which requires
two-thirds approval at the shareholders’ meeting. However, in practice, no company
has introduced such class shares yet. There is discussion in academia as to whether
such shares are always lawful, and the Tokyo Stock Exchange takes the view that such
shares are not appropriate for existing listed firms, as opposed to fi rms making IPOs. In
November 2004, an oil company issued a ‘golden share’ (a special class share) which gave
the holder of the share a veto right over all proposals submitted to its shareholders’ meet-
ings. However, the share was issued to the government, and it was understood that the
oil company should be permitted to issue such shares to the government from a national
public policy standpoint.
422 Perspectiv es in compa n y l aw

two-thirds approval at a shareholders’ meeting. What happens if the

firm obtains simple majority approval at a shareholders’ meeting? What
if the firm introduces a pre-bid defence plan without shareholders’
approval? Indeed, certain firms did introduce such defence plan without
shareholders’ approval, but as noted above, those plans have not yet been
triggered, and thus it is not clear whether the plan will be held valid by
the courts if triggered.
Third, with the important exception of the emphasis on shareholder
decision, the rule developed in recent years is similar to the one which
was shaped in the United States, particularly in Delaware, in the past
twenty-five years. ‘Necessity and proportionality’ is the standard of judi-
cial review. However, to date, the scope of permitted discretion of a tar-
get board seems much narrower in Japan than in the US.
Finally, there has been almost no proposal to clarify the rule, or
improve the situation, by introducing new legislation. The only proposal
that was made in the past was the one to introduce a European style
‘mandatory bid’ rule, and as noted above it was partially recognized in
the amendments to the SEA as effective on 13 December 2006. However,
most of this area has been relegated to judicial development.

IV. Preliminary conclusion

What implications can we draw from all of these developments? In
theory, it is often said that there can be both good and bad takeovers
(although economists might say that distinction between these two
cannot be made). Good or bad must be judged from an economic per-
spective. In this sense, the position of the Guidelines is correct in that
takeovers enhancing corporate value are good ones and those reducing
corporate value are bad ones. Correspondingly, defences for frustrat-
ing hostile bids are justified if the defence enhances corporate value and
they are not justified if the defence decreases corporate value. A far more
important question, however, is who should be the ultimate decision
maker on this point? The board, shareholders or judges?
Rules in this area vary from country to country. They are, however,
within a reasonable range in all jurisdictions. What is different is who
the ultimate decision maker is. Today, for Japan, the most important
question that remains to be resolved is to what extent a target board can
act to frustrate or stop hostile takeover attempts without asking share-
holders’ approval.
 PA RT I I

Perspectives in financial regulation

 SEC T ION 1

European perspectives
 24

Principles-based, risk-based regulation and

effective enforcement
Eilis Fer r an

Enforcement intensity may impinge on capital market competitive-

ness. It also has implications for the development of international
securities regulation, which is increasingly likely to depend on deter-
minations of equivalence as between different national (or regional)
regimes.
The UK Financial Services Authority is not enforcement-led and, in
tune with its principles-based, risk-based approach, it employs a range
of compliance-promoting strategies. Its measured approach to enforce-
ment divides opinion and particular controversy surrounds its appli-
cation in relation to market abuse. Th is chapter reviews the Financial
Services Authority’s enforcement record in this difficult area and identi-
fies challenges that lie ahead.

I. What does principles-based, risk-based

regulation mean?
The essence of the distinction between rules and principles lies in their
specificity.1 At opposite ends of the spectrum lie: a ‘rule’ which is written

1
A rich body of jurisprudence examines this distinction, whether it is meaningful, and the
factors influencing the choice between a rule or a principle as the form in which a partic-
ular requirement is stated. It includes: J.B. Braithwaite, ‘Rules and Principles: A Theory
of Legal Certainty’, Australian Journal of Legal Philosophy, 27 (2002), 47–82; F. Schauer,
‘Prescriptions In Th ree Dimensions’, Iowa Law Review, 82 (1997), 911–22; F. Schauer,
Playing By The Rules: A Philosophical Examination of Rule Based Decision Making in
Law and Life (Oxford: Clarendon Press, 1991); D. Kennedy, ‘Form and Substance in
Private Law Adjudication’, Harvard Law Review, 89 (1976), 1685–1778; L. Alexander and
K. Kress, ‘Against Legal Principles’ in A. Marmor (ed.), Law and Interpretation: Essays
in Legal Philosophy (OUP, 1995), 279, reprinted in Iowa Law Review, 82 (1997), 739–86;
J. Raz, ‘Legal Principles and the Limits of Law’, Yale Law Journal, 81 (1972), 823–54;
R. Dworkin, Taking Rights Seriously (Cambridge, MA: Harvard University Press,
1977), 22–3.
427
428 Perspectiv es in fina ncia l r egu l ation

in such detailed and precise terms that all questions about what conduct
is permissible are settled in advance leaving only factual issues for later
judgment; and a ‘principle’ (or ‘standard’) written in open-textured lan-
guage that leaves open both specification of what conduct is permissible
and judgment on factual issues.2 Many, if not most, regulatory require-
ments will occupy the space between these endpoints showing more (or
less) of the characteristics of a rule (or principle), being as Cunningham
has put it, ‘hybrids along a continuum’.3 The combination of principles,
rules and all points in between within a legal system can, in jurispruden-
tial terms, be seen as a compromise between two social needs: ‘the need
for certain rules which can, over great areas of conduct, safely be applied
by private individuals to themselves without fresh official guidance or
weighing up of social issues, and the need to leave open, for later settle-
ment by an informed, official choice, issues which can only be properly
appreciated and settled when they arise in a concrete case’.4
In recent years, principles-based regulation has come to mean more
than just the form in which regulatory requirements are written. At the
level of regulatory theory, it has been associated with a new style of gov-
ernance that spans the public/private divide, where the regulator defines
polices and goals, cooperates with the regulated industry in determin-
ing how those goals are to be achieved, and leaves room for industry
to innovate whilst still being accountable for its actions.5 New govern-
ance is said to be characterised by collaborative, pragmatic, open-ended
methods and robust communication mechanisms between public and
private actors.6 In the UK financial services context, this extended con-
cept of what principles-based regulation entails has been hardwired
into the institutional culture of the Financial Services Authority (FSA),
which emphasizes a style of supervision that focuses on outcomes rather
than the details of the processes that regulated firms use to achieve them,
and places considerable responsibility on senior management of firms
to develop their own internal compliance policies (rather than being

2
Th is defi nition is derived from L. Kaplow, ‘Rules Versus Standards: An Economic
Analysis’, Duke Law Journal, 42 (1992), 557–629.
3
L. Cunningham, ‘A Prescription to Retire The Rhetoric Of “Principles-Based Systems”’
in ‘Corporate Law, Securities Regulation, and Accounting’, Vanderbilt Law Review, 60
(2007), 1411–1493, at 1492.
4
H.L.A. Hart, The Concept of Law (Oxford: Clarendon Press, 1961), 127.
5
C.L. Ford, ‘New Governance, Compliance, and Principles-Based Securities Regulation’,
American Business Law Journal, 45 (2008), 1–60.
6
Ibid.
 Pr inciples-based, r isk-based r egu l ation 429

told what to do by the regulator).7 This style of supervision is designed

to foster open and cooperative, perhaps more grown-up, relationships
between the regulator and those it regulates.
Risk-based regulation is said to ‘complement’ principles-based reg-
ulation.8 Being risk-based in relation to supervision and enforcement
implies prioritizing resources in areas that pose the biggest threat to the
regulator’s regulatory objectives.9 Thus, in the enforcement context, the
regulator may eschew the temptation to achieve easy gains by going after
the ‘low hanging fruit’ and decide against taking formal enforcement
action against less serious forms of misconduct in areas that are not
strategically important. Working in combination with principles-based
regulation, it may enable the regulator in some cases where a contraven-
tion has occurred to conclude that the issue can be resolved through
open dialogue with the relevant parties or through a fi rm’s internal
disciplinary procedures, and that public disciplinary action to impose
more severe penalties is not needed. The FSA explains its ‘strategic’ use
of enforcement tools in these terms:
We are selective in the cases we choose to investigate. Our considerations
include: whether the misconduct poses a significant risk to our objectives; if
it is serious or egregious in nature or both; if there is actual or potential con-
sumer loss or detriment; if there is evidence or risk of financial crime; and
whether it is an FSA priority to raise standards in that sector or issue.10

The regulatory model developed by the FSA has enjoyed high approval
ratings for a considerable period of time. Within the UK, it fits squarely
within the current government strategy of promoting ‘better regula-
tion’: a risk-based, proportionate and targeted approach to regulatory
inspection and enforcement is a central part of that agenda;11 so too is
the idea that regulations should be clear and simple.12 Internationally, in
7
J. Black, M. Hopper and C. Band, ‘Making a Success of Principles-based Regulation’, Law
and Financial Market Review, 1(3) (2007), 191–206. For the FSA’s own account of what
it means by principles-based regulation: Financial Services Authority, Principles-based
Regulation: Focusing on the Outcomes That Matter (2007).
8
J. Tiner, ‘Chief Executive’s Report’, FSA Annual Report (2006/7).
9
R. Baldwin and J. Black, ‘Really Responsive Regulation’, Modern Law Review, 71 (2008),
59–94, at 65–68.
10
Financial Services Authority, Enforcement Annual Performance Account 2006/07,
para. 8.
11
BERR, Regulators’ Compliance Code: Statutory Code of Practice for Regulators (December
2007).
12
‘The Five Principles of Good Regulation’, Annex B to Better Regulation Task Force,
Regulation – Less is More: Reducing Burdens, Improving Outcomes (2005).
430 Perspectiv es in fina ncia l r egu l ation

a number of reports published in the United States in 2006/7, the UK’s

principles-based, collaborative regulatory environment and its mea-
sured approach to enforcement were singled out as positive features
that appeared to enhance the competitiveness of its capital markets.13
Ben Bernanke, the Chairman of Federal Reserve, added his voice to this
favourable assessment with a speech in May 2007 urging US financial
regulatory authorities to look at the UK as a model for the way markets
might be better regulated.14 Also in 2007, the Japanese Financial Services
Agency was reported to have come out in favour of a shift towards a more
UK-style principles-based regulatory model, to strengthen the country’s
competitiveness as a financial centre.15
The FSA’s reputation was undoubtedly dented by the run on Northern
Rock in late 2007, circumstances that according to one official report
revealed that the FSA ‘systematically failed in its regulatory duty to
ensure that Northern Rock would not pose a systemic risk’.16 The
Authority is now on the back foot in defending itself against the view that
principles-based regulation is flawed.17 Whilst full-scale dismantlement
13
McKinsey & Co, Sustaining New York’s and the US’ Global Financial Services Leadership
(report commissioned by M.R. Bloomberg and C.E. Schumer, January 2007);
Commission on the Regulation of US Capital Markets in the 21st Century, Report and
Recommendations (March 2007); Committee on Capital Markets Regulation, Interim
Report (November 2006).
14
J. Grant, ‘Bernanke Calls for US to Follow UK’s “Principles-based” Approach’, Financial
Times, 16 May 2007, 1.
15
M. Nakamoto, ‘Tokyo Eyes Move Towards UK-style Financial Regulation’, Financial
Times, 25 October 2007, 7. See further Financial Services Agency, Plan for Strengthening
the Competitiveness of Japan’s Financial and Capital Markets, (December 2007), Pt III,
provisional and unofficial translation at www.fsa.go.jp/en/news/2007/20071221/01.pdf
(accessed March 2008).
16
House of Commons Treasury Committee, The Run on the Rock (5th Report of Session
2007–8, HC 56-I, 56-II, January 2008).
17
‘Northern Rock does not mean principles-based regulation is flawed. Indeed, we believe
that a full analysis of the events will support our principles-based approach to regu-
lation, and in particular the importance of both us and fi rms’ management focusing
on the consequences of their actions rather than rigid adherence to detailed rules.’ C.
Briault, ‘Regulatory Developments and the Challenges Ahead’, speech by FSA Managing
Director, Retail Markets, Compliance Institute Annual State of the Nation Conference
30 January 2008. Text available at www.fsa.gov.uk/pages/Library/Communication/
Speeches/2008/0130_cb.shtml (accessed March 2008).
Briault, who led the team overseeing Northern Rock, left the FSA ‘by mutual consent’
in April 2008. The FSA’s internal audit report on Northern Rock supported the general
risk-based approach and high-level, principles-based framework but found failings in
the manner in which it had been applied: FSA Moves to Enhance Supervision in Wake
of Northern Rock (FSA/PN/028/2008, 26 March 2008) (www.fsa.gov.uk/pages/Library/
Communication/PR/2008/028.shtml, accessed 20 October 2008).
 Pr inciples-based, r isk-based r egu l ation 431

of the current system is not likely, the challenges of a changing economic

climate give a new urgency to questions about its overall robustness.

II. Effective enforcement

A successful principles-based regulatory strategy that relies heavily on
ex ante compliance-promoting strategies can reasonably be expected to
produce fewer formal enforcement actions than a system that empha-
sizes the deterrent effect of ex post sanctions. Likewise, relatively little
formal enforcement is consistent with a risk-based approach given that
it implies that the regulator should concentrate on enforcement where it
will have the greatest impact and should not pursue wrongdoers merely
in order to generate more demonstration cases. The influential theory
of responsive regulation moreover teaches that a crude polarization
between persuasion and deterrence strategies is misconceived and that
an escalation in enforcement intensity is a function of failure of lower-
level compliance-promoting strategies.18 It would thus be rash to extrap-
olate from a comparatively low level of formal enforcement activity by
the FSA that non-compliance is endemic in the UK financial services
sector. Not only would such an assessment arguably fail to capture fully
the implications of the FSA’s regulatory culture and style, it is also open
to the criticism that it ignores other compliance-promoting factors that
are at work in the UK, including the role played by other public over-
sight and enforcement bodies and the influence of a powerful institu-
tional investor community, underpinned by certain legal powers for
shareholders that can be more formidable than those found elsewhere.19

18
The ‘enforcement pyramid’ developed by Ayres and Braithwaite has persuasion at its
base and criminal penalties and other punitive sanctions at its apex: I. Ayres and J.
Brathwaite, Responsive Regulation (OUP, 1992).
19
The power for shareholders to remove directors from office by simple majority of those
voting (Companies Act 2006, s. 168) is a powerful control mechanism. L.A. Bebchuk,
‘The Myth of the Shareholder Franchise’, Virginia Law Review, 93 (2007), 675–732 advo-
cates a system for the US in which shareholders have more power to replace or remove
directors and uses the example of the UK (which, he states, ‘has long had such a system’)
to counter ‘doomsday scenarios’ painted by critics of his proposals.
That there is this wide range of public and private forces at work suggests that, in theoreti-
cal terms, it may be more appropriate to think of a ‘three-sided’ pyramid embracing con-
trol exerted by bodies other than State agencies: N. Gunningham and P. Grabosky, Smart
Regulation (Oxford: Clarendon Press, 1998); Baldwin and Black, ‘Really Responsive
Regulation’, (note 9, above). Baldwin and Black also emphasise the importance of taking
account of the constraints and opportunities presented by institutional environments in
shaping enforcement activities.
432 Perspectiv es in fina ncia l r egu l ation

The fact that there is a complex interplay of public and private forces at
work means that whilst it may be the case that, in some countries, formal
enforcement intensity impinges significantly on market competitive-
ness (although this is highly debatable),20 it does not follow that the UK
would necessarily derive competitive advantages from a policy shift by
the FSA in favour of more aggressive enforcement.21
This is not to suggest that the implications of principles-based, risk-
based regulation for enforcement do not need to be taken seriously.22
Some empirical work suggests that the utility of less specific forms of
regulation decreases the more that enforcement depends on formal pros-
ecution but that where the chosen regulatory strategy relies heavily on
firms engaging cooperatively and collaboratively with the regulator in
fashioning compliance procedures and practices, short simple require-
ments are more desirable than those focusing on precision and pros-
ecutability.23 Open-textured principles may put an enforcement agency
into a position where its officers have to make difficult judgement calls
on whether there is sufficient evidence to prove a breach of principles
alone. However, the FSA is adamant that its move away from detailed,
prescriptive rules to principles-based regulation does not undermine its
ability to be tough in appropriate cases, has emphasized its willingness
to take enforcement action based on breach of a principle alone, and has
brought a number of cases on that basis.24 And in much of the debate
thus far around its principles-based regulation agenda, the FSA has had
to defend itself not from accusations that this will mean a less tough

20
J.C. Coffee, ‘Law and the Market: The Impact of Enforcement’, University of Pennsylvania
Law Review, 156 (2007), 229–311. However, note Committee on Capital Markets
Regulation, The Competitive Position of the US Public Equity Market (December 2007),
which examines the erosion in US market competitiveness. This Report reviews closely
a paper on listing premiums by C. Doidge, G.A. Karolyi and R.M. Stulz, ‘Has New York
Become Less Competitive in Global Markets? Evaluating Foreign Listing Choices over
Time’ (Fisher College of Business Working Paper No. 2007–03-012, July 2007), avail-
able at http://ssrn.com/abstract=982193) that (in an earlier version) is an important part
of the evidence on which Coffee builds his enforcement matters thesis. The Committee
identifies a number of concerns with the work.
21
I. MacNeil, ‘The Evolution of Regulatory Enforcement Action in the UK Capital Markets:
A Case of “Less is More”?’, Capital Markets Law Journal 2(4) (2007), 345–69.
22
R. Baldwin, ‘Why Rules Don’t Work’, Modern Law Review, 53 (1990), 321–37, at 328.
23
Ibid. Note also M. Hopper and J. Stainsby, ‘Principles-based Regulation – Better
Regulation?’, Journal of International Banking Law and Regulation, 21 (2006), 387–91,
where the authors note that proving breach of a principle may be more challenging that
establishing breach of a specific rule.
24
See below.
 Pr inciples-based, r isk-based r egu l ation 433

approach to enforcement but from concerns coming from precisely the

opposite direction and which reflect long-recognized and much debated
fears about principles-based enforcement – that it may lead to over-
zealousness and unfair ex post rule making because the open-textured
nature of principles generates uncertainty and unpredictability that the
enforcer may exploit to its advantage when judging conduct with the
benefit of hindsight.25
Does the ability to bring action on a basis of breach of a principle
alone promote effective, credible enforcement? What does being risk-
based in relation to enforcement actually mean in sensitive areas where
there are considerations pulling in different directions? These ques-
tions can be examined by looking at recent FSA enforcement activity
cases relating to market misconduct. Market misconduct, in the form of
insider trading, has been the focal point of recent comparative discus-
sion of enforcement intensity, with the UK appearing to come out badly
by comparison to the US on some measurements, to the extent that it
has been suggested that the existence of significant listing premiums on
the major US exchanges and none on the London Stock Exchange may
be attributable to ‘the failure of the UK to effectively enforce its own
insider trading restrictions’.26 This comment needs to be handled with
care because there is evidence of a listing premium in fact being avail-
able on markets other than the major US exchanges, including on the
London Alternative Investment Market (AIM), which often bears the
brunt of comments about weak enforcement in the UK.27 However, even
though the links between enforcement of insider trading in the UK and
competitiveness may not be fully understood, there are other grounds
for focusing on market misconduct cases to examine the effectiveness of
principles-based, risk-based enforcement in the UK.
Maintaining confidence in the financial system and reducing financial
crime are fundamental, symbiotically related, regulatory objectives.28 It

25
Major critiques of rulemaking though enforcement are: R.S. Karmel, Regulation by
Prosecution: The Securities and Exchange Commission Versus Corporate America (New
York: Simon & Schuster, 1982); H.L. Pitt and K.L. Shapiro, ‘Securities Regulation by
Enforcement: A Look Ahead at the Next Decade’, Yale Journal on Regulation 7 (1990),
149–304. A recent resurgence in principles-based enforcement in the US has been noted:
J.J. Park, ‘The Competing Paradigms of Securities Regulation’, Duke Law Journal, 57
(2007), 625–89.
26
Coffee, ‘Law and the Market’, (note 20, above), 240.
27
Committee on Capital Markets Regulation, The Competitive Position of the US Public
Equity Market (December 2007) makes the point about the AIM listing premium.
28
Financial Services and Markets Act 2000, s. 3 and s. 6.
434 Perspectiv es in fina ncia l r egu l ation

is thus crucial from a public interest perspective for the FSA to prioritize
market cleanliness and to accommodate within its measured risk-based
approach to the imposition of penalties or other formal sanctions a cred-
ible commitment to cracking down on insider dealing and other forms
of deliberate misconduct.29 Although a risk-based approach implies that
some instances of even deliberate wrongdoing may not be prioritized
because they are too low-level to have strategic repercussions, this has to
be balanced against the danger that tolerance could lead to some forms
of malpractice becoming so widespread that their cumulative effect is
strategically dangerous.30 Recent research on market cleanliness that
involves measuring price movements preceding market announcements
by FTSE 350 issuers and price movements prior to takeover announce-
ments makes rather uncomfortable reading for the FSA in that the meas-
urements suggest that the incidence of informed trading prior to takeover
announcements is not lower than it was before the upgrading of the regu-
latory framework by the Financial Services and Markets Act 2000, and
even increased slightly in part of the post-2000 period.31 Whilst the fact
that it has supported the publication of this work reflects well on the cred-
ibility of FSA’s commitment to transparency and to devising well-in-
formed regulatory solutions,32 the substance of the data prompts obvious
questions about whether the FSA has yet struck the right balance so that
29
D. Mayhew and K. Anderson, ‘Whither Market Abuse (in a More Principles-based
Regulatory World)?’, Journal of International Banking Law and Regulation, 22(10)
(2007), 515–31.
30
Baldwin and Black, ‘Really Responsive Regulation’, (note 9, above).
31
B. Dubow and N. Monteiro, Measuring Market Cleanliness (FSA Occasional Paper No
23, March 2006): research on FTSE 350 issuers’ announcements up to 2004 suggested
no change in market cleanliness that could be related to the timing of the new statu-
tory powers; research on takeover announcements indicated a small but statistically
significant increase in informed price movements prior to takeover announcements in
the period up to 2004. N. Monteiro, Q. Zaman and S. Leitterstorf, Measuring Market
Cleanliness (FSA Occasional Paper No 25, March 2007) revised the technical methodol-
ogy and updated the fi ndings to take account of 2005 market data. The new FTSE 350
analysis indicated that the measure of informed trading was very low in the years 2004
and 2005 and was statistically significantly lower than in the period 1998–2000 before
FSMA was introduced, which could suggest that markets had become cleaner. Results
for the takeovers analysis still showed a significant increase in the measure of informed
trading between 2000 and 2004, as reported in the fi rst paper; there was a decline in the
measure between 2004 and 2005, but the level of the measure remained high (23.7% of
takeover announcements in 2005 were preceded by informed price movements, com-
pared to 32.4% in 2004) and it was not lower than it was in 2000 before FSMA came into
force.
32
M. Hopper and J. Stainsby, ‘Measuring Market Abuse: Cleaning Up?’, Practical Law for
Companies, 17(4) (2006), 6–7.
 Pr inciples-based, r isk-based r egu l ation 435

actors who are unlikely to respond to the incentives embedded within

strategies that rely on cooperation and dialogue or who are outside its
reach because they are not part of the regulated community are held in
check effectively through strong deterrence mechanisms. 33
Do high-intensity enforcers perform better? According to a study
conducted by the Financial Times of trading data for the top 100 US
and Canadian deals since 2003, suspicious trading occurred ahead of
49 per cent of all North American deals. Th is study employed differ-
ent methodologies from that used in the UK surveys and the results
are therefore not directly comparable. Furthermore, since the head-
line figure does not distinguish between the US (an outlier in terms of
enforcement intensity) and Canada, too much significance should not
be attached to the fact that the percentage of suspicious trades is some-
what larger than that identified in the UK. Yet, even with these caveats,
the survey does indicate that devising effective enforcement strategies
to stamp out improper informed trading is a problem that is not exclu-
sive to the UK. 34

III. Pursuing market misconduct through criminal

prosecutions: preliminary general comments
It has been argued that because securing convictions on complex
charges that involve fi nancial market malpractices is notoriously dif-
ficult, criminal prosecutors may for strategic reasons choose to focus
on relatively straightforward aspects of wrongdoing, such as document
shredding, or frame their charges in narrow terms of basic fraud. 35

33
As Sally Dewar, then director of the FSA’s markets division, acknowledged: ‘The figures
for takeover announcements, although moving in the right direction, remain a cause for
particular concern. There will be no let up in our efforts to tackle the problems in this
area’. Quoted in J. Quinn, ‘Insider Trading Hits One in Four Deals’, Daily Telegraph, 8
March 2007, 1 (City section).
Similar quantitative research on market cleanliness conducted by the Netherlands
Authority for the Financial Markets on the effects of the Market Abuse Directive has
shown that implementation of the Directive has resulted in a cleaner and more well-
informed market: ‘Netherlands Publishes Study on Effects of Market Abuse Directive’,
Company Lawyer, 29 (2008), 19.
34
V. Kim and B. Masters, ‘ “Suspicious Trading” Ahead of 49% of North American Deals’,
Financial Times, 6 August 2007, 19.
35
D. McBarnet, ‘After Enron Will “Whiter than White Collar Crime” Still Wash?’, British
Journal of Criminology, 46 (2006), 1091–109. A. Alcock, ‘Five Years of Market Abuse’,
Company Lawyer, 28 (2007), 163–71, notes: ‘Even when prosecutions for market miscon-
duct were pursued, the authorities preferred to use more general charges like conspiracy
436 Perspectiv es in fina ncia l r egu l ation

There is a downside to this strategy in that it can mean that the enforce-
ment strategy fails to send out official messages about issues of concern
in relation to complex practices.36 From a principles-based perspective,
even a successful criminal case may thus be a ‘missed opportunity’ to
use enforcement as a mechanism for deepening real learning about the
root causes of compliance failures. 37 Another drawback of a prosecution
strategy is that, if it is pursued in an imbalanced way, this is likely to
inculcate the regulated community with a sense that the system of over-
sight is adversarial, punitive and legalistic, which may, in turn, mean
that people are less willing to engage in open dialogue and cooperation,
thereby making it harder for voluntary compliance strategies to operate
effectively.38 Furthermore, the imposition of disproportionate criminal
sanctions may give rise to perverse incentives for wrongdoers to engage
in more egregious forms of misconduct.39 Th is implies that optimal
stringency in enforcement may well lie somewhere below maximum
stringency.40

IV. Criminal prosecutions in relation to insider dealing and

other forms of market abuse
Insider dealing is a criminal offence under Part V of the Criminal Justice
Act 1993 and the FSA has power to prosecute (in England and Wales).41
Other bodies with power to prosecute in respect of insider dealing are
the Department for Business, Enterprise and Regulatory Reform,42 the

to defraud by rigging a market or provisions of the Theft Act for fear of the technicali-
ties of the specialist crimes.’ But note K.F. Brickey, ‘Enron’s Legacy’, Buffalo Criminal
Law Review, 8 (2004), 221–76, who argues that the vast majority of post-Enron corporate
fraud prosecutions did not focus on peripheral issues.
36
McBarnet, ‘After Enron’, (note 35, above).
37
On the importance of ‘enforcement learning’: Ford, ‘New Governance’, (note 5, above).
38
Baldwin and Black, ‘Really Responsive Regulation’, (note 9, above).
39
Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating
a Statement of Duties (Consultation Paper No 153, 1998), para. 3.81.
See also R.A. Booth, ‘What is a Business Crime?’ (November 2007). Available at SSRN:
http://ssrn.com/abstract=1029667 (arguing for reliance on the criminal law only when
all else fails).
40
Ayres and Brathwaite, Responsive Regulation, (note 18, above), 52.
41
Financial Services and Markets Act 2000, s. 402.
42
As between the Department for Business and the FSA, the FSA is the primary enforcer
and the Secretary of State’s powers will be used only rarely in cases which it would be
inappropriate for the FSA to investigate: Department of Trade, Companies in 2003–
2004, 22.
 Pr inciples-based, r isk-based r egu l ation 437

Crown Prosecution Service and the Serious Fraud Office. General guide-
lines are in place to establish principles to assist these bodies in deciding
which of them should act in cases where there are overlapping powers.43
Between 1987 and 1997 there were thirteen successful convictions
relating to insider dealing.44 However, not all of those cases were upheld
on appeal. From 1997 to February 2006 criminal proceedings were
brought against fi fteen individuals, of which eight were successful.45
Among the successful cases were one in 2005 where the former compli-
ance officer of an investment fi rm was jailed for five years and a 2004
case where a proofreader at a financial printers pleaded guilty to leaking
inside information and was imprisoned for twenty-one months.46 All
of the completed cases to date were brought by prosecuting authorities
other than the FSA. In January 2008 the FSA brought its first criminal
prosecution; the case is ongoing at the time of writing.
Misleading statements and practices can also be pursued through
the criminal law: Financial Services and Markets Act 2000, section 397
(previously the Financial Services Act 1986, section 47). The FSA and
the Department for Business are among the bodies that have power to
institute proceedings under this section.47
The Department of Business (more accurately its predecessor
the Department of Trade and Industry but this paper will use the
Department’s current name) has brought a number of prosecutions
under this section over the years.48 In the most recently reported case,
the CEO of a company admitted to trading on OFEX (now PLUS Quoted)
was sentenced to eighteen months’ imprisonment and disqualified from
holding the office of director for ten years (reduced to seven years on
appeal).49 His offence took place in an interview with a journalist during
which he made a number of statements and forecasts about the com-
pany which were false. The Department also recently used this section to

43
Financial Services Authority, Enforcement Guide, Annex 2.
44
C. Conceicao, ‘The FSA’s Approach to Taking Action Against Market Abuse’, Company
Lawyer, 28 (2007), 43–45.
45
On 13 February 2006, the Department of Trade and Industry issued a Written Answer
to House of Commons Parliamentary Question No. 2005/3120 from Austin Mitchell MP
(Hansard, vol. 442, col. 1635W), which sought information regarding the (a) prosecu-
tions and (b) successful prosecutions for insider trading since 1997.
46
R. Burger and E. King, ‘An Inside Job?’, New Law Journal, 158 (2008), 390.
47
Financial Services and Markets Act 2000, s. 401.
48
For an overview see Palmer’s Company Law (London: Thompson, looseleaf), paras.
11.138–11.145.
49
R v. O’Hanlon [2007] EWCA Crim 3074.
438 Perspectiv es in fina ncia l r egu l ation

prosecute financial journalists who bought shares they were about to tip in
their newspaper column. In this case custodial sentences of between three
and six months were imposed on two of the defendants and a community
service order was made against the third.50 In 2005 the FSA secured convic-
tions in its first criminal prosecution under the section against the CEO (and
Chairman) and CFO of a company listed on the London Stock Exchange
who had issued a false trading statement to the market. However, the
FSA’s success in this case was later tempered when the original custodial
sentences of three and a half years and two years were reduced on appeal
to eighteen months and nine months, respectively, and the defendants
also appealed successfully against confiscation orders.51 In February
2008 the FSA secured a conviction and a fifteen-month prison sentence
against an unauthorized stockbroker, on a number of charges under the
Theft Acts, the Financial Services Act 1986 and Financial Services and
Markets Act 2000, with a further thirty-four offences taken into consid-
eration. He was also disqualified from being a company director for five
years.52
The FSA has been quite open at a senior level in acknowledging the
difficulties in prosecuting insider dealing and other forms of market
abuse: the absence usually of a smoking gun and the need therefore to
rely heavily on circumstantial evidence; practical problems in presenting
complex and often highly technical evidence to a jury; and the challenge
of persuading a jury that they can be satisfied to the criminal standard
that the elements of the crime, in particular that the accused knew that
he had inside information and dealt on that basis, are present.53 For a
risk-based regulator that emphasizes efficiency in its choice of enforce-
ment options and which has limited resources, such considerations mil-
itate strongly against bringing a criminal case, notwithstanding that it
is only a criminal prosecution that offers the possibility of ‘the showcase
effect of getting business leaders behind bars’.54 The FSA is not pursu-
ing an idiosyncratic line in adopting a measured approach in relation
to criminal enforcement of insider dealing and other forms of market
abuse: general principles applicable to all criminal prosecutors in the

50
R v. Hipwell [2006] EWCA Crim 736.
51
R v. Bailey, Rigby [2005] EWCA Crim 3487 and [2006] EWCA Crim 1653.
52
FSA/PN/011/2008.
53
M. Cole, ‘Insider Dealing in the City’. Speech by FSA Director of Enforcement, 17 March
2007. Text available at www.fsa.gov.uk/pages/Library/Communication/Speeches/2Cole
(accessed March 2008).
54
McBarnet, ‘After Enron’, (note 35, above), 1100.
 Pr inciples-based, r isk-based r egu l ation 439

UK provide that the prosecutor must be satisfied that there is enough

evidence to provide a ‘realistic prospect of conviction’ and, if not, it must
drop the prosecution.55 However, there are suggestions that the FSA is at
a particular disadvantage because the range of covert investigative pow-
ers available to it is less extensive than that available to other bodies.56
Senior FSA officials have indicated that it is hampered by not having
power to offer immunity from prosecution to whistleblowers or to enter
into plea bargains.57
There is a perception that the ‘fear factor’ is missing from fi nan-
cial regulation in the UK because the FSA has not made sufficient use
of criminal sanctions.58 The very low incidence of successful prosecu-
tions certainly presents the FSA and the UK’s fi nancial regulatory sys-
tem more generally with at least a credibility problem that needs to be
addressed, including by giving the FSA the appropriate range of powers
that it needs to operate effectively as a criminal prosecutor in such a com-
plex area. The FSA itself acknowledges a need to escalate its deterrence-
oriented work and that the criminal law has a meaningful role to play in
this, albeit as part of a ‘multi-pronged’ approach and not as the exclusive
or even, necessarily, the primary tool.59 Considerations identified in this
section suggest that this is a defensible and pragmatically sensible stance:
the well-known difficulties of securing convictions; the need for care
not to lose the benefits of a principles-based approach though unwar-
ranted over-reliance on aggressive and adversarial prosecution-oriented
strategies; and the continuing elusiveness, notwithstanding advances
in empirical research, of the additional degree of criminal enforcement
intensity that might causally make all the difference in deterrence terms.

55
CPS, Code for Crown Prosecutors.
56
C. Conceicao, H. Hugger and S. Riolo, ‘Deciphering the FSA’s Declining Caseload’,
European Lawyer, 73 (2007), 10–11.
57
L. Saigol and P.T. Larsen, ‘FSA Boss Admits Defeat’, Financial Times, 3 July 2007, 18,
reporting on speech by John Tiner, then the FSA’s CEO. Brickey, ‘Enron’s Legacy’, (note
35, above), 264 notes that all but four of the seventy-three defendants who pleaded guilty
in federal fraud prosecutions between 2002 and 2004 became cooperating witnesses.
58
‘But while these [market surveillance] tools may help Mr Sants and his team at the FSA,
they are unlikely to enhance the fear factor. When he leads one of these dealers away in
glinting handcuffs in front of an array of photographers, then terror might fi nally sink
into the City’s psyche’: L. Saigol, ‘City Must Join Insider Trading Fight’, Financial Times,
23 April 2007, 19.
59
M. Cole, ‘The FSA’s Approach to Insider Dealing’. Speech by FSA Director of Enforce-
ment, FSA, American Bar Association, 4 October 2007. Text available at: www.fsa.gov.
uk/pages/Library/Communication/Speeches/2007/1004_mc.shtml (accessed March
2008).
440 Perspectiv es in fina ncia l r egu l ation

This conclusion derives support from the first-ever report on the FSA’s
performance by the UK National Audit Office, published in 2007, which
concluded that there was no need for the FSA to increase significantly
the proportion of its resources spent on combating fi nancial crime
(although there was room for it to improve the effectiveness with which
it used the current level of resources).60

V. Administrative enforcement of the

market-abuse regime
The Financial Services and Markets Act 2000, Part VIII contains provi-
sions that enable the FSA to impose unlimited fi nancial penalties on, or
to censure publicly, those who engage in market abuse or who encour-
age such behaviour, including persons who are not part of the regulated
community. The FSA can also apply for an injunction restraining market
abuse or seek restitution. The administrative regime was introduced to
complement the criminal law and to cover a wider range of serious mis-
conduct.61 According to one senior FSA official: ‘It was anticipated that a
civil process with the accompanying benefits like a civil burden of proof,
a jury not being required, the ability to settle, a quicker process with
non-custodial outcomes and the ability to have a specialist Tribunal for
difficult issues of fact and law would result in more successful actions
against insider dealing.’62 However, this is not exactly how things have
turned out.
Charges under Part VIII are often described as ‘civil’ offences but it
is clear that proceedings are regarded as ‘criminal’ for the purposes of
safeguards in respect of human rights under the European Convention
on Human Rights (such as the admissibility of statements made to
investigators).63 When it was first enacted, there was considerable dis-
cussion as to whether the standard of proof under Part VIII was crimi-
nal (beyond reasonable doubt) or civil (on a balance of probabilities) as

60
National Audit Office, The Financial Services Authority: A Review under Section 12 of the
Financial Services and Markets Act 2000 (2007).
61
Joint Committee on Financial Services and Markets, Draft Financial Services and
Markets Bill: First Report (HL Paper 50-I, HC 328-I, 1999, vol I) para. 255; Alcock, ‘Five
Years’, (note 35, above).
62
Cole, ‘Insider Dealing in the City’, (note 53, above).
63
Davidson and Tatham v. FSA. That this would be the case was anticipated during the
Parliamentary passage of the Financial Services and Markets Bill, and ECHR-related
safeguards were added: s. 174(2) (admissibility of statements); s. 134 (legal assistance
scheme).
 Pr inciples-based, r isk-based r egu l ation 441

this matter is not dictated by the Convention. Decisions of the Financial

Services and Markets Tribunal have since established that the standard
is properly described as the balance of probability,64 but that the concept
requires some refinement in its application because there is, in effect, a
sliding scale that implies that: ‘The more serious the allegation the less
likely it is that the event occurred and, hence, the stronger should be the
evidence before the court concludes that the allegation is established on
the balance of probability.’65 The Tribunal has indicated that where the
charge is ‘grave’, in a practical sense it may be difficult to draw a mean-
ingful distinction between this standard and the criminal standard.66
The FSA concluded its first Part VIII case in 2004 and by 2007 it had
brought sixteen successful cases with total fines in the region of £19.5
million.67 Eleven of these cases related to the misuse of information,
three related to false and misleading impressions and two were distor-
tion cases.68 The £17 million fine imposed on Shell/Royal Dutch in 2004
for misstating its proved reserves stands out as the single biggest fine to
date. In relation to insider dealing, the FSA’s most notable success thus
far under Part VIII came in 2006 in proceedings against Philippe Jabre,
a hedge fund manager, who was fined £750,000 for market abuse and
breach of the FSA Principles for Approved Persons.69
However, in 2006 the FSA also suffered a high-profile setback in
Davidson and Tatham, where the decision of its Regulatory Decisions
Committee that Davidson and Tatham had engaged in market abuse in
relation to spread betting activity to create a misleading impression of the
demand for, and value of, shares to be admitted to trading on AIM was over-
turned by the Financial Services and Markets Tribunal. The Tribunal also
awarded costs against the FSA, which, by implication, constituted a find-
ing that the FSA had acted unreasonably because the Tribunal has power
to make costs orders only in exceptional circumstances.70 The Tribunal,
which has an original, rather than purely supervisory, jurisdiction and

64
Mohammed v. FSA (2005); Davidson and Tatham v. FSA (2006); Parker v. FSA (2006).
65
H (Minors) (Sexual Abuse: Standard of Proof ), Re [1996] 1 All ER 1 at 16, per Lord
Nicholls.
66 67
Parker v. FSA para. 35. Conceicao, ‘The FSA’s Approach’, (note 44, above), 44.
68
Ibid.
69
His firm, GLG Partners LP, was also fined £750,000 for breach of Principles.
70
Financial Services and Markets Act 2000, sch. 13, para. 13. For comment on this case, see
A. Hart, ‘Paul Davidson and Ashley Tatham v FSA [2006] – The Case and its Implications’,
Journal of International Banking Law and Regulation, 22 (2007), 288–92; C. Band and
M. Hopper, ‘Market Abuse: A Developing Jurisprudence’, Journal of International
Banking Law and Regulation, 22 (2007), 231–9.
442 Perspectiv es in fina ncia l r egu l ation

which can therefore determine itself on the basis of the evidence avail-
able to it whether there is market abuse and, if there is, what the appro-
priate penalty should be, disagreed with the FSA both with regard to the
interpretation of the factual position and on certain of the requirements
needed to satisfy the statutory tests that were in force at that time.71
There is room to believe that the Davidson and Tatham experience
dented the FSA’s confidence in relying on its Part VIII powers as an
enforcement tool. Alcock has pointed out: ‘Whether coincidental or
not, there have been no further market abuse cases reported since the
costs decision in Davidson and Tatham and it could be that the FSA may
become more cautious about all but the most straightforward cases of
insider dealing or deliberate lying to the market.’72 Whilst the Jabre case
was completed in 2006, it was one of only two market abuse cases under
Part VIII that year and it related to activities that took place several years
before.73 In 2007, furthermore, there was no successful market abuse
case apart from one instance where the FSA obtained an injunction to
freeze the proceeds of suspected market abuse.74 At a senior level, the
FSA has been quite candid in admitting that concessions in respect of
ECHR protections and the application of a near-to-criminal standard of
proof have not made its life easy:
It was anticipated that a civil process with the accompanying benefits
like a civil burden of proof, a jury not being required, the ability to settle,
a quicker process with non-custodial outcomes and the ability to have a
specialist Tribunal for difficult issues of fact and law would result in more
successful actions against insider dealing … We have found, in reality,
that a number of the same evidential challenges face us for civil cases.75

71
As discussed in the articles in the previous note. The Tribunal agreed that the behav-
iour was in relation to qualifying investments traded on a relevant market (shares trad-
ing on the grey market prior to admission to AIM). However, the Tribunal disagreed
on whether the behaviour would be likely to be regarded by a regular user of AIM as a
failure to observe the standard of behaviour reasonably expected of persons in such a
position in relation to the market. The Tribunal’s view was that, given that there was no
regulatory obligation to disclose the behaviour, market abuse had not taken place.
72
Alcock, ‘Five Years’, (note 35, above).
73
Conceicao, Hugger and Riolo, ‘Deciphering’, (note 56, above).
74
Ibid. Details of this action are not publicly available, a fact which has been criticized
from a transparency of justice perspective: Mayhew and Anderson, ‘Whither Market
Abuse’, (note 29, above).
75
S. Dewar, ‘Market Abuse Policy and Enforcement in the UK’: speech by FSA Director
of Markets Division, BBA and ABI Market Abuse Seminar, 22 May 2007. Text avail-
able at www.fsa.gov.uk/pages/Library/Communication/Speeches/2007/0522_sd.shtml
(accessed March 2008).
 Pr inciples-based, r isk-based r egu l ation 443

It is against this background that the shift to enforcement on the basis of

principles alone is to be assessed. Principles-based enforcement is more
limited in scope than enforcement under the criminal law or the admin-
istrative regime for market abuse because it can only be pursued against
those who are within the regulated community. On the other hand, it
has the advantage of appearing to circumvent high burdens of proof and
other legal requirements that makes it hard to succeed on other bases.
However, whatever its relative merits, principles-based enforcement
must operate within the rule of law and therefore actions taken and
sanctions imposed must be proportionate and fair.

VI. Sanctions in respect of breach of principles

The FSA Handbook contains certain specific sets of principles, including
those that apply to regulated firms (Principles for Businesses), persons per-
forming certain functions (Principles for Approved Persons), listed entities
(Listing Principles) and sponsors (Principles for Sponsors). In addition, the
FSA is shifting to a more principles-based approach to regulation through-
out its activities, although it continues to recognize the need for prescrip-
tive rules in particular areas and sometimes (i.e. where this is necessary to
implement EC Law) it has no option but to adopt that form.76
Of forty disciplinary cases in 2006/07, twelve (30%) were based on
principles alone and almost all of the remaining cases were based on a
combination of principles and rules.77 These included in the area of mar-
ket protection: Citigroup Global Markets Limited (2005) (the ‘Dr Evil’
trades in European government bonds, £13.96 million financial pen-
alty); Deutsche Bank AG (2006) (proprietary trading while book-build
exercise in progress, £6.36 million financial penalty); Pignatelli (2006)
(individual disseminating information believed to be inside informa-
tion, £20,000 financial penalty); Casoni (2007) (selective disclosure of
information, £52,500 fi nancial penalty). All of these cases were settle-
ments with the FSA, under executive settlement powers introduced in
October 2005.
From a risk- and efficiency-based perspective the incentives to set-
tle that are now built into the FSA’s enforcement framework, whereby

76
Financial Services Authority, Principles-based Regulation: Focusing on the Outcomes
That Matter (2007), para. 2.2 and para. 3.1.
77
Financial Services Authority, Enforcement Annual Performance Account 2006/07,
para. 10.
444 Perspectiv es in fina ncia l r egu l ation

the amount of a financial penalty is discounted by between 30% and

10% depending on when in disciplinary proceedings settlement is
reached, have advantages because settlements support prompt redress
in consumer-related cases, send timely messages to the industry and
achieve swift and effective outcomes, with associated cost savings.78
Between 1 April 2006 and 31 March 2007, thirty-four cases were con-
cluded by executive settlement and the FSA’s expectation for the future
is that ‘most’ cases will settle via executive settlement.79 However, the
quality of the messages sent to the market though this process is open to
question because settlement notices show signs of being heavily negoti-
ated compromises, which diminishes their clarity and precedent value.80
There is an echo here of the concern noted in relation to criminal pro-
ceedings of how strategic choices with regard to enforcement options
may constitute missed opportunities for the transmission of clear sig-
nals and for the deepening of regulatory learning.
Does principles-based regulation and enforcement satisfy the rule
of law? Lord Bingham, the distinguished Law Lord, has identified eight
sub-rules into which the rule of law can be broken down.81 Of these,
the two that have particular relevance in this context are: the law must
be accessible and so far as possible intelligible, clear and predictable;
and questions of legal right and liability should ordinarily be resolved
by application of the law and not the exercise of discretion. Principles
have at least superficial merits in terms of accessibility and intelligibil-
ity – they offer scope for slimming down voluminous and complex rule
books that are a barrier to entry and to compliance82 – but they are more
vulnerable with regard to certainty and predictability. The European
Court of Human Rights has made the point: ‘a norm cannot be regarded
as a “law” unless it is formulated with sufficient precision to enable the
citizen to regulate his conduct: he must be able – if need be with appro-
priate advice – to foresee, to a degree that is reasonable in the circum-
stances, the consequences which a given action may entail’.83 And, with
regard to the second sub-rule, Lord Bingham himself has observed: ‘[t]he
78
Financial Services Authority, Enforcement Annual Performance Account 2006/07,
para. 29.
79
Ibid, paras. 27–31.
80
Mayhew and Anderson, ‘Whither Market Abuse’, (note 29, above); Band and Hopper,
‘Market Abuse’, (note 70, above).
81
Lord Bingham, ‘The Rule of Law’, Cambridge Law Journal, 66 (2007), 67–85.
82
A.M. Whittaker, ‘Better Regulation – Principles vs. Rules’, Journal of International
Banking Law and Regulation, 21 (2006), 233–7.
83
Sunday Times v. United Kingdom (1979) 2 ECHR 245, 271, 149.
 Pr inciples-based, r isk-based r egu l ation 445

broader and more loosely-textured a discretion is, whether conferred on

an official or a judge, the greater the scope for subjectivity and hence for
arbitrariness, which is the antithesis of the rule of law’.84
The outcomes-oriented focus of principles-based regulation and the
onus that it places on firm to develop their own compliance strategies
expose it to the charge that it provides little in the way of legal certainty.85
However, a counterargument is that principles, when taken together with
the shared sensibilities between the regulator and regulated on what it is
expected in particular situations that are fostered by the collaborative and
cooperative style implied by principles-based regulation, can deliver more
legal certainty than detailed rules in complex situations.86 This shared
understanding can also serve to constrain the wide discretion that less
precisely formulated requirements may appear to give to those responsible
for overseeing their application and enforcement. With regard to predict-
ability, again there are competing arguments: one of the regularly cited
benefits of principles is that their flexibility minimizes the scope for ‘crea-
tive compliance’ practices that thrive by exploiting the gaps left by rigidly
prescriptive detailed rules; but the risk of hindsight basis in enforcement
decisions, which may fall to be taken in a politically-charged atmosphere
where they relate to high-profile problems, is a consideration that pulls
in the opposite direction as it implies a high risk of ad hoc enforcement
arbitrariness.87 The FSA is, of course, fully aware of its responsibilities as
a public body and, unsurprisingly therefore, regularly acknowledges the
fundamental nature of the requirement for predictability – ‘[i]n order for
consequences legitimately to be attached to the breach of a principle, it
must be possible to predict, at the time of the action concerned, whether
or not it would be in breach of the principle’88 – but there is a risk that

84
Lord Bingham, ‘The Rule of Law’ (note 81, above), 72.
85
C. Band and K. Anderson, ‘Confl icts of Interest in Financial Services and Markets.
The Regulatory Aspect’, Journal of International Banking Law and Regulation, 22
(2007), 88–100. Th is view is supported by academic writing on legal theory: Raz, ‘Legal
Principles’, (note 1, above).
86
Braithwaite, ‘Rules and Principles’, (note 1, above). See further the ideas of ‘interpretative
communities’ and ‘regulatory conversations developed by Black, in particular: J Black,
Rules and Regulators (Oxford: Clarendon Press, 1997).
87
J. Patient, ‘Treating Customers Fairly: the Challenges of Principles Based Regulation’,
Journal of International Banking Law and Regulation, 22 (2007), 420–25; Black, Hopper
and Band, ‘Making a Success’, (note 7, above).
88
Whittaker, ‘Better Regulation’, (note 82, above) (the author is the FSA’s chief lawyer). To
similar effect: Financial Services Authority, Enforcement Annual Performance Account
2006/07, para. 10; Financial Services Authority, Principles-based Regulation: Focusing on
the Outcomes That Matter (2007), para. 3.2.
446 Perspectiv es in fina ncia l r egu l ation

its actual practice will fall short of this standard. Its emphasis on ‘guid-
ance’ as a predictability-enhancing mechanism is also potentially prob-
lematic.89 The range of materials that is to be regarded as guidance in this
context is so broad that it can reasonably be asked whether in reality this
will provoke a tension with meeting accessibility and intelligibility goals
because people will still need to consult a large volume of paperwork to
understand the FSA’s thinking on any particular point.90
Other potential certainty/predictability problems flow from the fact
the open-textured nature of principles allows for different interpreta-
tions, which raises the possibility of inconsistent decisions between the
FSA and the Financial Services and Markets Tribunal or the Financial
Ombudsman Service (which can award compensation to consumers on
the basis of its own opinion as to what would be fair and reasonable in the
circumstances of the case). The inter-relationship of ‘outcomes’-oriented
principles and enforcement is also unclear in certain key respects: e.g. as
to the basis for determining whether a fi rm has failed to achieve a par-
ticular outcome, and as to the relevance of fault in that determination.91

VII. Risk-based regulation and European

supervisory convergence
The European market integration agenda is another source of tension for
the development of principles-based, risk-based regulation. Risk-based
regulation is not embraced wholeheartedly across Europe: for exam-
ple, the FSA’s policy of only investigating instances of suspected market
abuse where justified on a risk-based assessment is almost unique among
European regulators.92 The FSA has made it clear that it will strongly
resist any tendency for European regulation to fetter its legitimate dis-
cretion of action, particularly in the areas of monitoring and enforce-
ment, or to compromise its ability to pursue risk-based supervision.93
At the moment, it is clear that notwithstanding considerable efforts to

89
Financial Services Authority, Principles-based Regulation: Focusing on the Outcomes
That Matter (2007), para. 3.1 outlines the wide range of FSA material that is to be regarded
as ‘guidance’ in this context. Industry guidance also has a role in enabling fi rms to deter-
mine how best to meet FSA expectations under principles-based regulation: ibid.
90
Hopper and Stainsby, ‘Principles-based Regulation’, (note 23, above).
91
Black, Hopper and Band, ‘Making a Success’, (note 7, above).
92
Conceicao, ‘The FSA’s Approach’, (note 44, above).
93
J. Tiner, ‘Principles-based Regulation: The EU Context’. Speech delivered at APCIMS
Annual Conference Hotel Arts, Barcelona, 13 October 2006. Text available at www.fsa.
gov.uk/pages/Library/Communication/Speeches/2006/1013_jt.shtml.
 Pr inciples-based, r isk-based r egu l ation 447

harmonize the supervisory powers available to national authorities,

some differences remain and that, furthermore, a significant degree of
continuing disparity is found in how the authorities actually exercise
their powers,94 with enforcement of market abuse singled out as an area
where there are particularly noticeable differences between Member
States.95 However, pressure is undoubtedly building for greater consist-
ency in pan-European oversight and enforcement of EC laws96 and this
puts in doubt the extent to which the FSA can maintain its distinctive,
risk-based, stance.

VIII. Conclusion
A recent paper exploring the possible links between competitive-
ness and enforcement intensity refers to the FSA’s ‘relative distaste for
enforcement’.97 Coffee, the paper’s author, is not the first to ponder the
low level of formal enforcement in the UK in relation to insider deal-
ing and other forms of market misconduct. Indeed, quite independently
of the Coffee article, the FSA itself has recognized the need to make a
greater inroad into this difficult area and is employing a number of
compliance-promoting and enforcement strategies with this aim in
mind. It has also invested significantly in upgrading its fraud-detection
system (Surveillance and Automated Business Reporting Engine (Sabre)),
which uses complex soft ware with a view to monitoring transactions and
detecting insider trading and other market abuses as they occur.
The FSA’s first successful prosecution for insider dealing is likely to
have a strong symbolic value. Yet, whilst it is clearly desirable for the FSA
to be a credible prosecuting body (and it should be equipped with all of
the powers that investigating and prosecuting bodies need to operate
effectively), there are many good reasons why criminal sanctions should
play only a limited role in the UK’s overall risk-based, compliance-
promoting strategy. The part played by principles-based enforcement
may prove to be more controversial. Whether principles-based enforce-
ment will enable the FSA to take effectively tough action and, if it does,

94
CESR, An evaluation of equivalence of supervisory powers in the EU under the Market
Abuse Directive and the Prospectus Directive A report to the Financial Services Committee
(FSC), (CESR Ref: 07–334), para. 9.
95
ESME Report, Market Abuse EU Legal Framework and its Implementation by Member
States: A First Evaluation, (2007), 19.
96
N. Moloney, EC Securities Regulation, 2nd edn (OUP, 2008) ch 12.
97
Coffee, ‘Law and the Market’, (note 20, above), 311.
448 Perspectiv es in fina ncia l r egu l ation

how this will be balanced against the need for fairness and proportion-
ality are key issues for which responses will need to be hammered out
on the anvil of practical experience. Managing the tension between
distinctive features of the British approach and the strong forces now
pushing in favour of greater consistency in pan-European oversight and
enforcement of EC laws will also be one of the main challenges that lies
ahead.
 25

The Committee of European Securities Regulators

and level 3 of the Lamfalussy Process
Niamh Moloney

Professor Wymeersch’s long and distinguished career, and his remark-

able influence on EU securities regulation, is well-reflected in his
Chairmanship of the Committee of European Securities Regulators
(CESR). CESR can now be argued to be one of the (if not the) dominant
influences on the recent and explosive development of EU securities
regulation. This chapter seeks to assess the nature of CESR’s activities
at level 3 of the Lamfalussy process and, in particular, whether the bur-
geoning reach of its influence poses accountability and legitimacy risks
or whether CESR has the potential to construct a discrete accountability
model which supports its rapidly developing range of activities.

I. Introduction
It is a truisim to state that the Financial Services Action Plan (FSAP)
period has wrought massive regulatory, institutional and supervisory
change on EC securities markets. One of the main drivers for change
has been the Lamfalussy process for delegated law-making.1 As is well
known, under the Lamfalussy process, the Commission adopts ‘level 2’
rules, which are frequently, although not always, detailed and technical,
based on mandates in the related ‘level 1’ measure (either a directive
or a regulation) which is adopted under the Treaty-based inter-insti-
tutional procedures. The Commission is advised by the Committee of
European Securities Regulators (CESR, composed of national regu-
lators) and supervised by the European Securities Committee (ESC,
composed of Member State representatives). Level 3 of the Lamfalussy
process concerns convergence and consistency in the application of level
1 and 2 rules. Level 4 concerns enforcement. The Lamfalussy process

1
Final Report of the Committee of Wise Men on the Regulation of European Securities
Markets (2001).

449
450 Perspectiv es in fina ncia l r egu l ation

has supported an exponential increase in the content of EC securities

regulation over the FSAP period – whether the quality of the regulatory
regime has increased equally dramatically is less clear.2 But it is clear
that the Lamfalussy process has brought an actor of central importance
to the policy stage in the shape of CESR. This chapter addresses CESR
and its burgeoning influence on EU securities regulation which raises
significant accountability and legitimacy questions.
CESR’s activities at level 2 have, temporarily, come to a close. The
FSAP stage of the level 2 process is now complete with CESR noting
its move from level 2 advisory activities to level 3 supervisory conver-
gence in its June 2006 annual report.3 A vast range of level 2 rules have
been adopted under all of the key measures including the Markets in
Financial Instruments Directive (MiFID),4 the Market Abuse Directive, 5
the Transparency Directive,6 the Prospectus Directive7 and the pre-
FSAP 1985 UCITS Directive.8 The evidence which has recently emerged
on the CESR/Commission/ESC dynamic during the adoption of the fi rst
generation of level 2 rules (during the FSAP period) suggests that CESR’s
advice is heavily influential on the shape of the rules ultimately adopted
by the Commission. But the constitutional controls on level 2 in terms
of Commission, ESC and Parliament oversight of CESR’s advice and the
location of rule-making power in the Commission, appear reasonably
robust. 9 The evidence also suggests that CESR is acutely aware of the

2
For a critique of the effectiveness of the capital-raising rules see E.V. Ferran, Building an
EU Securities Market (Cambridge University Press, 2004).
3
CESR, Annual Report (2005), 5. All CESR references are available on www.cesr-eu.org.
4
Commission Directive 2006/73/EC [2006] OJ L241/26 and Commission Regulation
(EC) No 1287/2006 [2006] OJ L241/1.
5
Commission Defi nitions and Disclosure Obligations Directive 2003/124/EC [2003] OJ
L339/70, Commission Investment Recommendations Directive 2003/125/EC [2003] OJ
L339/73, and Commission Regulation (EC) No 2273/2003 on Buybacks and Stabilisation
[2003] OJ L336/33.
6
Commission Directive 2007/14/EC [2007] OJ L69/27.
7
2004 Prospectus Regulation (EC) No 809/2004 [2004] OJ L149/1. It sets out the detailed
information which must be included in public offer prospectuses. It has been amended
to reflect the decision to postpone the equivalence determination with respect to third
country accounting systems (Commission Regulation (EC) No 1787/2006 [2006] OJ
L337/17). A second revision addresses disclosure by issuers with complex financial histo-
ries (Commission Regulation (EC) No 211/2007 [2007] OJ L61/24).
8
In 2007 the Commission adopted level 2 rules concerning the defi nition of the ‘eligible
assets’ in which a UCITS fund can invest under the UCITS III regime for UCITS invest-
ment. Commission Directive 2007/16/EC [2007] OJ L79/11.
9
For discussion see N. Moloney, EC Securities Regulation, 2nd edn (Oxford
University Press, 2008), Ch. XIII. The Commission has, e.g., reinforced the importance
 Com mittee of Eu ropea n Secu r ities R egu l ators 451

constitutional limitations of its position as an advisory body at level 2

and is not prepared to act outside the level 1 mandates, even where there
is strong market support for level 2 action on a particular issue.10
But the level 2 controls do not apply at level 3 where, in the trouble-
some sphere of supervisory convergence, CESR is increasingly exercis-
ing direct influence over the financial markets. Level 3, which is strongly
associated with supervisory convergence, is designed to support conver-
gence and consistency in the implementation and application of level 1
and level 2 rules. It was initially envisaged by the Lamfalussy Report as
producing guidelines on implementation, developing recommendations
and standards on issues not covered by EU law (a controversial element
which has not been pursued by CESR), and defining best practice. It was
characterized by CESR in its 2004 Level 3 Report as having three strands:
coordinated implementation of EU law; regulatory convergence; and
supervisory convergence.11 As the FSAP shifts from regulation to opera-
tion, level 3 is now commanding attention at the highest political and
institutional levels as the Community’s response to the challenges raised
by supervision of the post-FSAP marketplace and it was at the centre of
the recently concluded 2007 Lamfalussy review.
The recent dramatic evolution of the level 3/supervisory conver-
gence aspect of CESR’s activities is perhaps best described as organic.
Through its level 3 activities, CESR has acquired a degree of influence
over the financial markets which is remarkable given its establishment
in 2001 and given the resource commitment the level 2 advice process

of the level 1 delegation on occasion. Th is was the case with its rejection of CESR’s advice
that the MiFID level 2 regime address the content of the investment fi rm/investor con-
tract on the grounds that, in addition to the national sensitivities and risk of disruption
to national contract-systems, the level 1 delegation did not support such measures. It
also rejected CESR’s advice in relation to the level 2 market-abuse regime that invest-
ment recommendations by journalists be subject to a specific regime given the need
to respect the difficult level 1 compromise achieved on this issue with the European
Parliament. The market-abuse regime also saw the Commission reject CESR’s advice
that credit-rating agencies become subject to the investment research rules of the mar-
ket abuse regime.
10
A notable example relates to the MiFID level 2 consultation on the suitability regime and
CESR’s refusal to treat derivatives as ‘non-complex’ products and as within the ‘suitabil-
ity-free’ execution-only regime, given the exclusion of derivatives at level 1, in the face
of strong market demands for their inclusion. Similarly, CESR refused to give advice
on expansion of the Market Abuse Directive Art 8 stabilization and buy-back regime
beyond its level 1 limits.
11
CESR, The Role of CESR at ‘Level 3’ Under the Lamfalussy Process (2004), CESR/
04–104b.
452 Perspectiv es in fina ncia l r egu l ation

demanded. This has occurred through a range of quasi-regulatory\

supervisory mechanisms, discussed in the following sections, none of
which are specified in CESR’s founding Decision.12
Issuer disclosure provides a good example of CESR’s burgeoning influ-
ence. CESR’s role has developed from providing level 2 advice on the
Prospectus and Transparency Directives, to establishing own-initiative
level 3 guidance on the prospectus regime,13 to developing an innovative
Q and A device to support supervisory convergence, 14 to quasi-enforce-
ment activity with respect to supporting the implementation of IFRS and
consistency in the enforcement of IFRS by national authorities,15 to liais-
ing with the SEC on US GAAP/IFRS reconciliation,16 to driving oper-
ational innovation and supporting market initiatives with respect to the
electronic network of Officially Appointed Mechanisms (with respect

12
Commission Decision 2001/527/EC OJ [2001] L191/43.
13
CESR/05–054b.
14
CESR/07–852. The Q and A is regularly updated (three times over the course of 2007). It
is designed to ‘provide market participants with responses in a quick and efficient man-
ner to ‘everyday’ questions which are commonly posed to the CESR secretariat or CESR
members’, CESR/05–054b.,1.
15
See e.g., CESR’s recommendations on the adoption of Alternative Performance Measures
(CESR/05–178b) and its exhortation that issuers provide clear disclosure on their use of
options in the reporting regime (CESR/05–758). CESR also produced a road map for the
IFRS transition (CESR/03–323e) and has continued to exhort supervisory authorities to
remain vigilant in ensuring compliance with the new regime (CESR/07–121b). Th rough
CESR-Fin, which promotes convergence in the application of IAS/IFRS and has a
strongly operational orientation, CESR produces non-binding standards for the enforce-
ment of IAS/IFRS at national level and supports coordinated enforcement by providing a
forum within which dialogue and cooperation can occur. In 2003, for example, it recom-
mended basic principles for the robust and consistent enforcement of IAS/IFRS by the
Member States (Enforcement Standards on Financial Information in Europe). This was
followed in 2004 by a standard on coordination of national approaches to enforcement
(Co-ordination of Enforcement Activities) which led to a framework for coordinating
enforcement mechanisms and, in particular, to the European Enforcers Co-ordination
Sessions. The Sessions, which support discussion of enforcement decisions and emerg-
ing issues, are designed to support the development of a high level of convergence on
enforcement practices. In a key enforcement initiative, CESR has also established a data-
base which includes national enforcement decisions on IAS/IFRS application in order to
support supervisory convergence on the application and enforcement of the standards
and consistency in the use of the standards on the marketplace.
16
CESR/06–434. The work programme was established to promote the development of
high-quality accounting standards, the high quality and consistent application of IFRS
worldwide, consideration of international counterparts’ positions regarding application
and enforcement, and the avoidance of confl icting regulatory decisions on the appli-
cation of IFRS and US GAAP. Consistent application of IFRS is a central concern of
the work programme which includes discussion by the SEC and CESR of issuer-specific
matters in an attempt to avoid diverging interpretations.
 Com mittee of Eu ropea n Secu r ities R egu l ators 453

to issuer disclosure)17 and, potentially, providing a supervisory capacity

with respect to the electronic network.18 All of this occurred without any
substantive change to CESR’s founding Decision and Charter.19 It might
appear to be but one step from here to prospectus-approval capacity – a
role which CESR had earlier identified in the Himalaya Report.20 But it
is also clear that CESR is acutely sensitive to the accountability and legit-
imacy risks and is developing a multi-faceted response (discussed later
in this chapter) which, the 2007 Lamfalussy Review suggests, enjoys
institutional and political support.

II. Range of activities at level 3

A. Agenda-setting and quasi-regulatory activity
CESR’s range of activities at level 3 is becoming formidable and its rhet-
oric, of considerable symbolic importance,21 is increasingly that of an
established regulator/supervisor. Its 2005 Annual Report noted that
2006 would ‘witness CESR’s metamorphosis from being primarily a
regulatory advisory body to becoming a body which is well on its way
to becoming an operational network of supervisors.’22 The 2006 Annual
Report adopted a similar tone and asserted that CESR ‘was entering a
new phase’.23 Its 2007 Work Programme was similarly ambitious and

17
The Commission described CESR as pivotal to the development of the network dur-
ing ESC discussions on the Recommendation which governs the electronic net-
work (Commission Recommendation 2007/657/EC on the electronic network of
officially appointed mechanisms for the central storage of information referred to in the
Transparency Directive [2007] OJ L267/16): ESC Minutes 13 September 2007. CESR’s
generally pragmatic and market-facing advice on the design of the network (CESR/06–
292), which followed an earlier orientations document (CESR/05–150b), was reflected in
the Recommendation.
18
The Commission suggested in the Recommendation that the network could be super-
vised by a college of supervisors (either CESR or a specially constituted body) but rejected
this solution as being outside the scope of the level 2 powers granted to the Commission
under the Transparency Directive with respect to the storage of regulated information.
19
CESR 06/289c.
20
CESR, Preliminary Progress Report, Which Supervisory Tools for the EU Securities
Market? An Analytical Paper by CESR (2004), CESR 04–333f.
21
Th is point has been well made by Professor Langevoort in connection with the US SEC.
See e.g., D. Langevoort, ‘Structuring Securities Regulation in the European Union:
Lessons from the US Experience’ in G. Ferrarini and E. Wymeersch (eds.), Investor
Protection in Europe. Corporate Law Making, the MiFID and Beyond (Oxford University
Press, 2006), 485.
22
CESR, Annual Report (2005), Foreword by the Chairman, 5
23
CESR, Annual Report (2006), Foreword by the Chairman, 3.
454 Perspectiv es in fina ncia l r egu l ation

was sharply directed towards level 3 activities, with CESR noting the
‘marked shift in focus’ towards operational activities.24
The range of guidelines adopted at level 3 (adopted without a formal
mandate) stands out as a striking example of the reach of CESR’s influ-
ence. They now cover the UCITS regime with respect to eligible assets25
and the transition to the UCITS III regime26, the prospectus regime27,
and, in some detail, the market abuse regime.28 The MiFID regime is
strongly characterized by amplification at level 3 and includes guide-
lines on the MiFID passport 29, on inducements30, on best execution31,
and on the MiFID record-keeping regime.32 CESR has also produced
guidance on MiFID’s transaction-reporting regime.33 Standards have
been adopted in conjunction with the European System of Central
Banks with respect to clearing and settlement, 34 although these have
proved particularly troublesome, generated considerable tensions with
the Parliament, and have yet to be formally adopted. Standards have
also been adopted with respect to fi nancial reporting, 35 in support of the
enforcement of the IFRS reporting regime.36
These guidelines have in common their considerable level of detail,
extensive consultation, market support (for the most part), as well as a
(generally) practical, market-facing, and operational orientation which
points to CESR’s ability to build consensus and develop pragmatic solutions
to problems generated by the regulatory regime.37 But, and aside from con-
cerns as to their effectiveness (given their tendency to increase the opacity of
the regime and their non-binding status), the guidelines also share consid-
erable accountability and legitimacy risks, not least given CESR’s tendency
to use level 3 to achieve solutions which were subsequently either rejected,
or regarded as not appropriate for level 2.38 While guidance is formally

24
CESR, 2007 Work Programme for the Committee of European Securities Regulators
(2006), CESR 06–627, 2.
25 26 27
CESR/07–44. CESR/04–434b. CESR/05–054b.
28
CESR/04–505b and CESR/06–562b.
29
CESR/07–337 and CESR/07/337b.
30 31 32
CESR/07–228b. CESR/07–320. CESR/06–552c.
33 34
CESR/07–301. CESR/04–561.
35
CESR/03–073 and CESR/03–317B.
36
See note 15, above.
37
As was the case, e.g. with respect to its resolution of double reporting by branches under
MiFID’s transaction reporting regime under CESR’s Branch Protocol (CESR/07/672).
38
There are elements of this in CESR’s level 3 guidance on the UCITS III eligible assets
regime e.g., and in its 2007 level 3 guidance on the determination of inside information
under the market abuse regime. In the latter, CESR included guidance on the definition
of inside information in the form of examples of how inside information might arise;
 Com mittee of Eu ropea n Secu r ities R egu l ators 455

non-binding, regulatory guidance has traditionally been regarded by the

market as tantamount to regulatory fiat. CESR has also recently become
more confident in its assertions as to the potential effects of level 3 and
in seizing the initiative as to the appropriate characterization of level 3,
which remains elusive.39 It has suggested, in the context of the MiFID Q
and A project, that while level 3 is not legally binding its ‘legal effects’
could include: being used by courts and tribunals in interpreting level
1 and 2 measures; being ‘of relevance’ in enforcement action taken by
a competent authority; and ‘creating relevant considerations and legit-
imate expectations’, particularly with respect to the predictability of
actions taken by competent authorities.40 Given that the MiFID level 3
matrix includes best execution Q and A guidance by CESR to the effect
that connection by an investment fi rm to one execution venue might
meet the best execution obligation, which seems, optically at least – firms
remain subject to competitive pressures – to subvert the concentration-
abolition principle on which MiFID is based, this is not an assertion
to be taken lightly. Similarly, it has suggested that its level 3 guidance
on the transparency regime might provide a safe-harbour for market
participants.41 While the ambitious reach of CESR’s characterization of
its guidance may represent a degree of wishful thinking by CESR, it is
also unlikely that CESR’s pronouncements, as authoritative statements
from Europe’s regulators, will be ignored in judicial and enforcement
proceedings.
But the guidance is generally rooted in the level 1 and 2 regime
(although this was not the case with the ill-fated clearing and settle-
ment initiative), is typically stated not to conflict with or subvert level
1 and 2 rules, and level 2 discussions have seen the Commission and
ESC negotiations move particular standards to level 3, as was the case
with the UCITS III regime. CESR’s efforts to bolster the legitimacy of
the guidelines are also clear, as discussed later in this chapter. A more
tentative approach to the adoption of guidance also appears to be emerg-
ing. CESR’s July 2007 Call for Evidence on the Transparency Directive
level 3 regime suggested some reluctance to engage in an extensive

these are closely based on the additional guidance provided by CESR in its earlier level 2
advice and which was not adopted at level 2.
39
See e.g., City of London Group, Level 3 of the Lamfalussy Process. Submission to the
Inter-Institutional Monitoring Group By a Group in the City of London (2007), www.
cityoflondon.gov.uk.
40
CESR/07–704c, 3.
41
CESR/07–043.
456 Perspectiv es in fina ncia l r egu l ation

programme,42 while its post-consultation Feedback Statement (February

2008) was similarly restrained, reflecting some market support for no
action at level 3 given the premature state of the regime.43
Perhaps in a reflection of the accountability risks of its guidance,
as well as CESR’s growing sophistication in developing level 3 tools,
it has also embraced softer forms of intervention. The prospectus
regime, for example, has seen the adoption of a regularly updated and
well-received Q and A document which allows CESR to respond rap-
idly to market and supervisory concerns.44 It does not require a con-
sensus CESR position and identifies dissenting opinions – although,
in a reflection of CESR’s potential to build supervisory convergence,
these are reducing. A FAQ document has also been used to explain the
Accepted Market Practice regime which is of central importance with
respect to the determination of market manipulation under the market
abuse regime.45 The development of a MiFID Q and A is a priority for
CESR’s MiFID level 3 agenda.46 But while FAQ initiatives carry consid-
erable benefits in terms of speed and practicality, they also, in common
with level 3 guidance more generally, have the potential to complicate
further the already dense regulatory environment and obscure the dis-
tinction between binding and non-binding measures, increasing legit-
imacy and accountability risks.
CESR’s influence over regulatory policy extends beyond level 3 guid-
ance and level 2 advice. It has been closely involved in the preparation
of the reviews and reports required of the Commission with respect to
controversial MiFID provisions under MiFID Article 65 and which will
frame future revisions to MiFID. In particular, it has been a significant
actor in the sensitive discussions on whether MiFID’s transparency
regime should be extended to the debt markets. Although CESR has
adopted a measured approach,47 in principle the risks attached to CESR’s
legitimacy are added to the momentum risks which already attach to
Article 65.
Although the Commission has shown some signs of avoiding over-
reliance on CESR, perhaps in an attempt to limit its influence, it has also
turned to CESR to develop new policy solutions, notably with respect to
the reforms to the UCITS summary prospectus in which CESR is play-
ing a key role in developing and, importantly, market testing disclosure
formats. Most notably, perhaps, the turmoil in world credit markets in

42 43 44 45
CESR/07/487. CESR/08–066. CESR/07–852. CESR/05–365.
46 47
CESR/07–704c, 2. CESR/07–284b.
 Com mittee of Eu ropea n Secu r ities R egu l ators 457

2007 saw the Commission turn to CESR for policy advice, particularly
with respect to the rating by credit rating agencies of structured prod-
ucts.48 While this development augurs well for the quality of new policy
design post-FSAP, it also deepens CESR’s influence and the legitimacy
risks it poses.

B. Agenda-setting and policy activities

In the level 3 policy sphere, CESR is, notwithstanding the lack of a
specific mandate, fast-developing a distinct policy towards the retail
investor, including outreach activities to encourage investor involve-
ment in law-making and investor education.49 Th is development sees
CESR acting independently as quasi-policy-maker and supporting
the nascent retail investor interest. It also points to its ambitions in
the policy sphere and its ability to take ownership over a high-profi le
policy area which carries considerable potential for institutional and
political influence.
CESR has also been quick to exploit the blurred boundaries between
securities market regulation and corporate governance, perhaps in a
reflection of the current political high profi le of corporate governance
reform. It has drawn cross-border takeovers, which carry considerable
potential for political sensitivity, into its ambit through its, thus far,
relatively benign discussions on the practical operation of the takeover
regime.50 Auditors have also come within its ambit, with CESR’s own-
initiative activities including a survey of its members with respect to the
relationship between the auditor and the public which asked, provoca-
tively, whether direct communications between auditors and the public
should be enhanced.51
Less controversially, CESR has also developed a monitoring role with
respect to EC financial markets more generally. Its 2006 Report contains

48
Commissioner McCreevy requested that CESR examine the rating of structured-
fi nance products as a ‘matter of urgency’: letter from Commissioner McCreevy to
CESR (11 September 2007), attached to CESR’s 12 September 2007 Press Release on
the Commission’s Additional Request to Review the Role of Credit Rating Agencies,
CESR/07–608.
49
CESR’s 2007 Work Programme, e.g., highlighted ‘engaging retail investors more effec-
tively’ and ‘investor information’ as specific priorities: CESR/06–627. Notable initiatives
include CESR’s MiFID guide for retail investors: CESR, A Consumer’s Guide to MiFID.
Investing in Financial Products (2008).
50
CESR, 2007 Interim Report on the Activities of CESR (2008), CESR/07–671, 27.
51
CESR, 2007 Interim Report on the Activities of CESR (2008), CESR/07–671,14.
458 Perspectiv es in fina ncia l r egu l ation

an extensive discussion of overall market trends and risks.52 While this

might appear to be among the less glamorous and contentious of its level
3 activities, it nonetheless cements CESR’s position as an authoritative
voice on financial market policy.
Chief among its general policy initiatives, however, are those in sup-
port of supervisory convergence and, in particular, the development of
a European ‘supervisory culture’. CESR has been charged with report-
ing on progress on supervisory convergence to the Council’s Financial
Services Committee, which places it at the heart of the efforts to sup-
port convergence. More mundane practical CESR initiatives, but which
should reap considerable convergence benefits, include the develop-
ment of staff exchange-programmes between CESR members and the
development of a joint-training programme, which the 3L3 committees
are developing under their Joint Steering Committee on Training.53

C. Monitoring and quasi-enforcement

CESR’s monitoring activities are directed towards its members, in sup-
port of supervisory convergence, but they are also, and more controver-
sially, market-facing.
In one of its most notable institutional contributions to supervisory
convergence, CESR’s Peer Review Panel, established in 2003 but recom-
mended by the Lamfalussy Report, reviews the implementation by CESR
members of CESR guidelines and standards and, where requested by
the Commission, of Community rules. The Panel, which represents an
innovative, self-disciplining technique for monitoring CESR members,
has the potential to drive strong convergence, although only as long as
peer pressure and reputational dynamics are effective.
But there is also a more troublesome market-facing dimension to
CESR’s quasi-enforcement activities. Notably, it reviews compliance by
credit rating agencies with the 2004 IOSCO Code of Conduct for Rating
Agencies. This innovative joint venture between CESR and the industry,
based on a voluntary agreement, gives CESR the colour of a European
regulatory and supervisory agency. Its first report in January 2007
included, for example, a warning to the industry concerning the lack of
progress in the separation of rating business from other business lines
in order to manage confl icts of interests.54 CESR also carries out a more

52 53
CESR, Annual Report (2006), 10–19. CESR, Annual Report (2006), 26.
54
CESR/06–545.
 Com mittee of Eu ropea n Secu r ities R egu l ators 459

indirect and lighter monitoring role, in conjunction with other actors,

with respect to the Code of Conduct on Clearing and Settlement through
the Code’s Monitoring Group.

D. Supporting supervision, enforcement action, and

institutional innovation
CESR’s supervisory-convergence activities are supported by its rapidly
developing operational structures which support supervision and the
coordination of national enforcement strategies. The MiFID regime, for
example, is notable for the practical initiatives adopted by CESR to sup-
port passport notifications and the supervision of branches.
With respect to enforcement, the market abuse regime is notable for
the operational structures which have been developed by CESR-Pol, a
permanent operational group within CESR which addresses the sur-
veillance of securities markets and cooperation concerning enforce-
ment and information exchange. Key operational developments include
the establishment of the Urgent Issues Group and the Surveillance and
Intelligence Group and the construction of an enforcement database.
Operational innovation is also evident in the financial reporting sphere
where CESR-FIN, a permanent operational group which coordinates
enforcement of IFRS by CESR members, has established the European
Enforcers’ Co-ordination Sessions as well as a database on enforce-
ment decisions. In a significant move towards the promotion of stronger
supervisory convergence, CESR has also developed a mediation mecha-
nism to support supervisory convergence and resolve supervisory dis-
putes between national authorities.55 Particular care appears to have
been taken here to respect institutional sensitivities. A concern not to
subvert institutional competences, particularly with respect to the inter-
pretation of rules, can be seen in the development of the mechanism.56

E. Operational initiatives: supporting trading

transparency and issuer disclosure
One of the most striking features of post-FSAP securities regulation
has been the extent to which EC securities regulation has begun, slowly,
to encompass operational measures in support of regulatory objec-
tives. While the operational regime is, as yet, embryonic, CESR has
55
CESR/06–286b.
56
CESR, Annual Report (2005), 48–9 and CESR, Annual Report (2006), 53–4.
460 Perspectiv es in fina ncia l r egu l ation

considerable potential to provide an operational capacity which sup-

ports the post-FSAP regulatory regime and to provide a focal point for
the articulation of industry and regulatory interests.
In particular, CESR has emerged as a key player in the development
of the electronic network of Officially Appointed Mechanisms, which
is designed to consolidate the distribution of ongoing issuer disclo-
sure. CESR has also supported the development of a pan-EC dissemi-
nation system for trading transparency disclosures (under MiFID) by
adopting level 3 guidelines which govern dissemination channels and,
significantly, are designed to support the consolidation of informa-
tion flows. Both initiatives are characterized by their hybrid nature:
high-level principles are designed to support market-led innovation.
While the success of this approach remains to be seen, it represents an
important sea-change in the regulatory orientation of EC securities
regulation.
MiFID’s transparency and transaction reporting regime has also
seen considerable operational innovation led by CESR-Tech. Notably,
the TREM (the Transaction Reporting Exchange Mechanism) project,
although problematic, has seen the construction of a system which
allows CESR members to exchange reports and adopts particular format
and coding standards for reports.57 CESR also maintains a series of data-
bases which support MiFID obligations, chief among them the Database
on Shares Admitted to Trading on a Regulated Market,58 which includes
the important list of ‘liquid shares’ which are key to the application of
MiFID’s transparency regime.

F. A distinct supervisory capacity?

CESR’s level 3 activities thus far have been confined to supporting super-
visory convergence within the network of home and host supervisors
which police EC securities regulation. The scale of these activities alone
gives some pause. But, and leaving on one side the debate as to the appro-
priateness of a Euro-SEC, there have been some straws in the wind which,
given CESR’s tendency to acquire influence organically, and its broadly

57
CESR/07–739 and CESR/07–627b. TREM is used to exchange reports between CESR
members but the project also acts as a platform for trialling technical issues concerning
national transaction reporting, particularly with respect to the technical codes used by
firms. For a discussion see CESR, Annual Report (2006), 46.
58
CESR/07–718. CESR has also published a guide on how the database can be used
(CESR/07–370b).
 Com mittee of Eu ropea n Secu r ities R egu l ators 461

positive relationship with the market, might, if only tentatively, point to

a more formal, limited supervisory capacity were political conditions to
change.
The development of the issuer-disclosure dissemination regime, for
example, saw some suggestions that CESR might act as the supervisor of
the new electronic network, although the Commission ultimately resiled
from this approach in favour of a ‘workable solution’ based on network
supervision. CESR initially harboured far-reaching ambitions in this
regard. Although the Himalaya Report rejected the central supervisor
model, it initially floated whether CESR should acquire a capacity for
‘EC decision making’, including with respect to pre-clearance of innova-
tive products and approval of, for example, standardized UCITS and the
supervision of trans-European infrastructures.59 More recently, however,
a sharper awareness of the legitimacy risks to its position, and perhaps,
a realization of the possibilities afforded through level 3, appears to have
reduced its enthusiasm for the political maelstrom any such transfer of
power would generate.60

G. Institutional and market links

CESR’s influence and capacity to drive supervisory convergence is only
likely to increase as cross-sector links strengthen, new advisory bodies
are developed post-FSAP, and as the institutional structure which sup-
ports fi nancial market policy development fragments, thereby increas-
ing CESR’s influence as the actor with policy links across all the major
actors. It has, for example, observer status on the European Securities
Markets Expert Group which advises the Commission on fi nancial
market policy. It has close links with the European Central Bank, as is
clear from its clearing and settlement activities. It sits on the Monitoring
Group which oversees market implementation of the novel Code of
Conduct on clearing and settlement. The level 2 process has seen it
develop close links with the Commission and the Parliament. Formal
links have been made with its parallel 3L3 committees in the banking
and insurance/pensions area through the 3L3 Joint Work Programme
on issues of common concern, such as credit rating agencies, financial

59
Himalaya Report 2004, 17.
60
In its 2007 Securities Supervision Report CESR stated clearly that it was ‘not advocat-
ing for the creation of an EU single regulator embedded within the Treaty’: CESR, A
Proposed Evolution of Securities Supervision Beyond 2007 (2007), CESR/07–783, 6.
462 Perspectiv es in fina ncia l r egu l ation

conglomerates and regulatory arbitrage in product regulation.61 CESR

is also developing considerable political influence and contacts. It
increasingly acts as a high-level adviser to the Council by reporting to
its Financial Services Committee on supervisory convergence and to
the Financial Stability Table of the Council’s Economic and Financial
Committee on issues related to the overall stability of the EU fi nancial
system.62
Through its extensive consultation procedures, CESR has driven
largely national, if vocal and well-resourced, market interests to adopt
more sophisticated and networked pan-EC lobbying models.63 It now
has strong links to the markets which are only likely to intensify. This
is all the more the case as it seems to be in the very early stages of devel-
oping a quasi-lobbying role for market interests under the level 3 pro-
spectus regime, where CESR has suggested that market reaction to the Q
and A could act as a driver for supervisory convergence.64 Support from
the market could also act as a bulwark against accountability charges,65
although there are some indications of nervousness in some quarters as
to the extent of CESR’s reach, particularly with respect to its market abuse
initiatives.66 Tellingly, CESR engaged in an extensive consultation over
2007 on the industry’s and stakeholders’ assessment of CESR’s activities
from 2001–7.67
61
See, e.g., CESE, CEBS, CEIOPS, 3L3 Medium Term Work Programme. Consultation
Paper (2007) (CESR/07–775).
62
CESR’s FST reports have covered market conditions as well as cross-sector reviews (with
CEBS and CEIOPS) of the bond markets, financial conglomerates, regulatory arbitrage,
and offshore fi nancial centres (CESR, Annual Report (2006), 65, 74).
63
See e.g. the London Investment Banking Association’s (LIBA) construction of
networks with other European trade associations in order to engage more effec-
tively with CESR’s MiFID consultations. LIBA, Annual Report (2005), Chairman’s
Statement.
64
Th is is clear from the dissenting views of competent authorities on particular questions
which were identified in the 2006 Q and A (along with the Commission’s position in
some cases). The 2007 Q and A, by contrast, did not contain any dissenting opinions
in the new material included, suggesting that CESR’s view that publication of the dis-
senting views would ‘foster a wider debate among market participants which the CESR
members with diverging views might find useful in considering their previous positions’
was well-founded: CESR, CESR’s Report on the Supervisory Functioning of the Prospectus
Directive and Regulation (2007), CESR/07–225, 9.
65
See e.g. market support for further CESR convergence activities under the prospectus
regime: Supervisory Functioning of the Prospectus Report 2007, 3.
66
See e.g. the response by APCIMS to CESR’s 2006 consultation on what would become the
2007 level 3 guidance in which it expressed a wish that no further guidance be adopted
and noted a general view to that effect. Available on www.cesr-eu.org.
67
CESR/07–499.
 Com mittee of Eu ropea n Secu r ities R egu l ators 463

Although the consumer interest remains lamentably and dangerously

under-represented in financial market consultations, CESR is also build-
ing links to the nascent retail investor lobbying community through ini-
tiatives such as its MiFID Consumer Day, its commitment to preparing
consumer-friendly versions of consultation papers, and its recent initia-
tives to develop investor governance and education.
CESR’s growing stature and influence also reflects deepening trans-
atlantic links. Although high level and increasingly successful politi-
cal contacts between the Commission and the SEC occur through the
US–EU Financial Markets Regulatory Dialogue,68 CESR is emerging as
the main point of contact for regular, operational SEC negotiations and
has entered into an agreement with the SEC on cooperation and collabo-
ration on market risks and regulatory policy.69 It has also entered into a
formal agreement with the SEC on the enforcement of IFRS application,
which placed it close to the highly sensitive but ultimately successful EU/
US negotiations on IFRS/US GAAP reconciliation. Its links with IOSCO
are also deepening, as its January 2007 report on credit rating agencies
makes clear. CESR’s ambitions in this sphere are considerable. It regards
itself as increasingly the ‘advocate of common interests’ of CESR mem-
bers internationally and has called for a more direct role in international
negotiations, in order to limit supervisory competition with respect to
third country market access in particular. Notably, it has called for a role
in the developing negotiations with the SEC on the mutual recognition
of supervisory regimes – one of the most significant recent developments
in international securities regulation – and suggested that it play a more
direct role in the US–EU Financial Markets Regulatory Dialogue.70
CESR therefore sits at the centre of an increasingly complex institu-
tional web and is developing strong links to market and consumer inter-
ests. It looks set to have a unique institutional and market perspective
and influence on policy formation.

68
For a review of its current activities see Commission, Single Market in Financial Services
Progress Report 2006, SEC (2007) 263, 7–9. The resolution in early 2007 of the dispute
concerning the de-listing of EU issuers from US exchanges in the wake of Sarbanes-
Oxley, as well as the November 2007 decision by the SEC to lift the US GAAP recon-
ciliation requirement for accounts prepared in accordance with IFRS, count as major
successes of the Dialogue.
69 70
CESR, Annual Report (2006), 70. CESR, Securities Supervision Report (2007), 6.
464 Perspectiv es in fina ncia l r egu l ation

III. Accountability and legitimacy risks

All this has developed organically from the original 2001 Commission
Decision which established CESR as part of the Lamfalussy proc-
ess and as an independent advisory group on securities, to advise the
Commission, either on the Commission’s initiative or on its own ini-
tiative, in particular with respect to level 2 measures (Article 2). The
Decision does not refer directly to supervisory convergence activities,
although they are covered in CESR’s Charter.71 The Lamfalussy Report
simply recommended that level 3 produce guidelines on implementa-
tion, develop recommendations and standards on issues not covered
by EU law, and define best practice. CESR has deepened and widened
this initial characterization of level 3 through its 2004 Level 3 Report
and the Himalaya Report and, more tellingly, by its recent practice.
Although both 2004 Level 3 reports were, for the most part, accepted by
the institutions,72 recent practice suggests that CESR’s influence now has
an organic and dynamic character. But there is no formal legal basis for
CESR’s activities.
CESR’s formal accountability is minimal.73 It is not formally account-
able to the Member States or the EU institutions and sits somewhat adrift
in the institutional structure. It declares itself as independent74 and the
foundation Decision establishing CESR simply required CESR to present
an annual report to the Commission (Article 6) and to maintain close
operational links with the Commission and the ESC (Article 4).

71
Art. 4 provides that CESR is to ‘foster and review’ common and uniform day-to-day
implementation and application of Community legislation, issuing guidelines, recom-
mendations and standards to be adopted by CESR members in their regulatory practices
on a voluntary basis (Art. 4.3). It also provides for the establishment of the Review Panel.
Level 3 is also reflected in Art. 4.4 which provides that CESR is to develop effective opera-
tional network mechanisms to enhance day-to-day consistent supervision and enforce-
ment of the single market for fi nancial services.
72
See e.g.: Commission, The Application of the Lamfalussy Process to EU Securities Market
Legislation (2004), 10; European Parliament, Van den Burg Resolution on the Current State
of Integration of EU Financial Markets (2005), T6–0153/2005 (based on the Economic
and Monetary Affairs Committee, Van den Burg Report (2005) (A6–0087/2005)), B.12;
and ESC Minutes 15 December 2004, albeit that all, presciently, expressed reservations
as to accountability.
73
For a recent exploration of accountability in the context of the comitology process (which
CESR engages in at an early stage through its level 2 advice to the Commission) see D.
Curtin, ‘Holding (Quasi-) Autonomous EU Administrative Actors to Public Account’,
European Law Journal, 13 (2007), 523.
74
CESR’s Annual Report for 2004 describes CESR as ‘an independent Committee of
European Securities Regulators’: CESR, Annual Report (2004), 66.
 Com mittee of Eu ropea n Secu r ities R egu l ators 465

Very little is known as to the dynamics of CESR decision-making at

level 2. This difficulty persists at level 3 (and with respect to the adoption
of CESR guidance in particular) where consensus (unanimity minus
one or two)75 dominates. This opacity as to its regulatory philosophy and
decision-making dynamics therefore obscures the interests and tradi-
tions which inform the quasi-regulatory and supervisory choices it
makes for the integrated financial market. The stakes are high as the
constitutional controls exerted by the level 2 process and Commission/
ESC/Parliament oversight are removed and given the rate at which CESR
has acquired influence over the markets.
The institutions have, however, become more alert to the growing
influence of CESR,76 with concern that CESR may operate in a ‘grey zone
where political accountability is unclear’.77 The European Parliament was
the most vocal in the initial calls for greater CESR accountability. In the
2005 Van den Burg Resolution, and in order ‘to guarantee democratic
accountability’, it called for CESR (and CEBS and CEIOPS) to report semi-
annually to the Parliament.78 Somewhat more aggressively, Parliament
attached the utmost importance to ‘guaranteeing the political account-
ability of the supervisory system’ and noted ‘gaps in parliamentary
scrutiny and democratic control particularly with respect to work under-
taken at level 3’. It urged all 3L3 committees ‘to pay the utmost attention
to providing a sound legal basis for their actions, avoiding dealing with
political questions and preventing prejudice to upcoming Community
law’.79 Given the relatively limited reach of level 3 in 2005, Parliament’s
hostile reaction can be linked to its severe criticism in 2005 of the CESR-
ESCB Standards on Clearing and Settlement which launched an inter-
institutional fracas, given the attempt to embue the Standards, which do
not derive from a level 1 or level 2 measure, with a quasi-binding quality,
and which saw the Parliament deliver a stinging rebuke to CESR as to the
need for its actions to have a legal base and for stronger accountability. 80

75
CESR, Securities Supervision Report (2007), 4.
76
Prior to the explosion in level 3 activities, the reaction was more sanguine. The Council’s
Economic and Financial Committee reported in 2002 that accountability mechanisms
employed by CESR (in the form of reporting obligations and consultation procedures)
were adequate: EFC, Report on Financial Regulation Supervision, and Stability (2002), 19
77
As described by certain (unidentified) ESC delegations: ESC Minutes 15 December
2004.
78
Van den Burg Resolution 2005, B.14. 79 Van den Burg Resolution 2005, B.19.
80
European Parliament, Resolution on Clearing and Settlement in the EU (2005), P6_
TA(2005)0301, paras 18–22.
466 Perspectiv es in fina ncia l r egu l ation

The Commission also, albeit less vocally, has raised accountability

concerns, as has the European Central Bank.81 In its 2004 Report on the
Lamfalussy Process, for example, the Commission expressly addressed
level 3 accountability risks and called for a clearer articulation of the
role of level 3, particularly with respect to protecting the institutional
prerogatives of the Council, Parliament and Commission.82

IV. Constructing an accountability model

A. Institutional links
But CESR’s political antennae appear to be sensitive. It clearly feels the
need to develop a model for its accountability and legitimacy, perhaps in
order to avoid the imposition of an unattractive model. Recent Annual
Reports, for example, contain repeated references to CESR’s efforts to
develop accountability structures.83
CESR initially responded by ‘establish[ing] clearer accountability
links with Council Committees and with the European Parliament’
over 2005. A new accountability framework with the Parliament was
formalized in September 2005 which is, in essence, based on frequent
reporting by CESR to the Parliament. Parliamentary relations are a
recurring theme of CESR’s annual and interim reports.84 Annual and
half-yearly reports are addressed to the Commission, as required in
CESR’s founding Decision, but also to the Parliament and the Council.
CESR has also developed close links with Council’s Financial Services
Committee through its supervisory convergence reports. CESR regards
these reports as strengthening its accountability,85 although they might be

81
European Central Bank, Review of the Application of the Lamfalussy Framework to EU
Securities Market Legislation (2005), 7–8.
82
Commission Lamfalussy Process Report 2004, 4. Writing in 2005 Internal Market
Director General Schaub warned that level 3 could not prejudice the political process:
A. Schaub, ‘The Lamfalussy Process Four Years On’, Journal of Financial Regulation and
Compliance, 13 (2005), 110–16.
83
The 2005 Annual Report contains a section on accountability and reporting to the EU
institutions (CESR, Annual Report (2005), 72–3, while accountability is prominent in the
Chairman’s statement (at 5). The 2006 Report contains extensive discussion of CESR’s
reports to the European Parliament: CESR, Annual Report (2006), 75.
84
The 2007 Interim Report e.g. notes the concern of CESR’s Chairman to build on the
good relationship established with the European Parliament: CESR, Interim Report
(2007), 30.
85
See e.g. CESR, First Progress Report on Supervisory Convergence in the Field of Securities
Markets for the Financial Services Committee (2005), CESR/05–202, 2.
 Com mittee of Eu ropea n Secu r ities R egu l ators 467

better regarded as opportunities for CESR to extend its political influ-

ence: CESR has publicly characterized the 2006 ECOFIN conclusions on
supervisory convergence86 as ‘explicit support for the work of CESR’.87
As discussed below with respect to MiFID, it also now appears to be
anxious to engage the Commission more fully in its decision making
and to capture, albeit informally, the legitimacy which may flow from
the Commission’s tacit approval, if not endorsement, of its activities. This
approach may be wise. Recent evidence from the Commission’s approach
to the development of policy in new and sensitive areas such as bond mar-
ket transparency, hedge funds and private equity, sees the Commission
drawing on a wide range of market and institutional opinion and reduc-
ing the risks of over-reliance on CESR. The Commission’s somewhat
benign public statements on CESR’s problematic accountability model
(certainly by comparison with the Parliament’s trenchant views) appear
to have been counter-balanced by an institutional determination in prac-
tice not to yield too much power to CESR. In its initial strategy report on
the highly-sensitive extension of MiFID’s transparency regime beyond
the equity markets,88 the Commission’s consultation strategy included
advice from CESR but also from ESME, FIN-USE (on retail interests) and
other expert groups. Although CESR has since become the first port of call
for large-scale regulatory design questions (such as the UCITS disclosure
review) and live policy challenges (with respect to the ‘credit crunch’),
the Commission now has a variety of expert groups as its disposal.

B. The MiFID example

Attempts to build an accountability model can also be traced in CESR’s
recent level 3 activities which represent a more careful attempt to address
the legitimacy of its actions than earlier pronouncements.89 Although

86
2726th ECOFIN Meeting, 5 May 2006, Press Release 8500/06.
87
CESR, Interim Report (2006), 24.
88
Commission, Call for Evidence, Pre- and post-trade transparency provisions of MiFID in
relation to transactions in classes of financial instruments other than shares (2006).
89
CESR initially related the legitimacy of its level 3 role, rather tenuously, to the ‘fact that
CESR members take decisions on a daily basis that create jurisprudence. This bottom-up
approach relates to the normative nature of concrete decision-making activities of the
supervisors. The impact of precedents on decisions is determined by the law and can-
not be fully controlled by legislators. In addition, in an integrated European market,
the jurisprudence created by supervisors produces effects that cannot be limited to
national jurisdictions and therefore must be considered at EU level: A.-D. Van Leeuwen,
(first CESR Chairman) and F. Demarigny, (CESR Secretary General), ‘Europe’s
468 Perspectiv es in fina ncia l r egu l ation

CESR is clearly anxious to protect its level 3 agenda (it has stated in
uncompromising terms that it is ‘master of its own agenda’ at level 3)90 it
appears acutely aware of the accountability risks of its level 3 guidance
and seems to be developing a response. The MiFID level 3 regime is par-
ticularly instructive in this regard.
In October 2006 CESR presented its fi rst MiFID level 3 agenda,91
following an earlier consultation which revealed considerable mar-
ket unease as to its scale.92 The MiFID level 3 process has emerged as
largely driven by the Commission and by ‘cascades’ from level 1 and
level 2, rather than by CESR-driven initiatives. A substantial propor-
tion of the initial level 3 agenda concerned the extensive reporting and
review obligations required of the Commission under MiFID Article 65.
Cross-sector convergence was also a dominant theme; the initial agenda
included a number of initiatives of common concern to the banking,
pension, insurance and securities sectors.
The more troublesome quasi-regulatory standards or guidance also
formed a central part of the initial MiFID level 3 agenda. But it yields
intriguing evidence as to CESR’s approach to legitimacy risks. The induce-
ments regime, in particular, saw CESR harnessing the Commission to
its cause and thereby cloaking its quasi-regulatory activities with the
mantle of the Commission’s authority. The Guidance notes that the
Commission participated in CESR’s development of the recommenda-
tions on inducements as an observer, that CESR discussed the interpreta-
tion of relevant MiFID legal obligations with the Commission, and that
the Commission agreed with CESR’s interpretations and considered that
the recommendations did ‘not go beyond the MiFID regime but flow[ed]
from a normal, natural reading of MiFID and the Level 2 Directive’.93
This might be tentatively described as a quasi-endorsement process had
CESR not already vehemently rejected any institutional endorsement of
its level 3 standards under the market abuse regime.94 It might be better

securities regulators working together under the new EU regulatory framework’, Journal
of Financial Regulation and Compliance, 12 (2004), 206 (at 4 of the online version).
90
CESR, 2006 Report on Supervisory Convergence in the field of Securities Markets (2006),
CESR/06–259b, Summary (in the context of the market abuse regime).
91
CESR/550b.
92
See the joint response of a group of leading fi nancial market trade associations to CESR’s
consultation (12 September 2006). It expressed concern that the work programme was
‘more extensive and ambitious than necessary’.
93
CESR/07–228b, 3.
94
One respondent to CESR’s initial consultation on the market abuse level 3 guidance sug-
gested that the AMP list being drawn up by CESR members in accordance with CESR’s
 Com mittee of Eu ropea n Secu r ities R egu l ators 469

described as an aspect of the multi-level, evolutionary, and pragmatic

accountability model which CESR is beginning to develop. It also reflects
CESR’s concern to bolster the validity of its guidance in the face of fierce
market hostility, particularly where questions arise as to the legal base of
its activities. The inducements regime generated severe market hostility
as to its scope and its relationship with the MiFID regime (in particu-
lar its basis in the Article 19(1) ‘best interests’ obligation rather than in
the narrower MiFID conflict-of-interest regime) and appears to have led
CESR to rely on the Commission to buttress its authority.
CESR’s October 2007 Protocol on the Supervision of Branches,
adopted just prior to the application of MiFID in November 2007, is also
revealing.95 In an example of a developing dynamic between CESR and
the Commission which supports accountability, and under which the
Commission provides additional guidance on the scope of legal obli-
gations and CESR develops operational responses (the best execution
regime, discussed below, provides another example), CESR asked the
Commission for an interpretation as to the meaning of Article 32(7),
and the division of responsibilities between home and branch Member
States, on which it could build a practical mechanism for the supervi-
sion of branches.96 This followed in the Commission’s June 2007 advice
on Article 32(7).97 But CESR’s heightened sensitivity to accountability
risks, and its concern to maintain its independence, are both apparent
in its subsequent Protocol. It took some care to distance itself from the
Commission’s advice and to place the Protocol in the context of its previ-
ous level 3 guidance on the passport. CESR noted that the Commission’s
advice was a ‘helpful contribution’ that set out various scenarios and
which it used as background in developing the Protocol, but that the
advice did not form part of any CESR arrangements. A concern to avoid
a perception of over-reaching its competences at level 3 seems implicit in
the robust statement that it was not for CESR to address the legal inter-
pretation of Article 32(7) and that it neither endorsed nor challenged the
Commission’s advice.98 The Protocol does not therefore address the diffi-
cult questions as to which competent authority is responsible for branch

level 3 procedures be approved by the European legislature. CESR trenchantly responded

that there was no legal or other justification for this: CESR/05–274, 9.
95
CESR/07/672.
96
CESR/07–337, 7.
97
Commission, Supervision of Branches under MiFID (2007), MARKT/G3/MV D (2007).
98
CESR/07–337, 2.
470 Perspectiv es in fina ncia l r egu l ation

activity in specific cases, but establishes a cooperation framework which

supports close coordination between competent authorities.
Although the Branch Protocol might suggest some distance between
CESR and the Commission, evidence has emerged from the best-execu-
tion guidance of workman-like dialogue between the Commission and
CESR in the construction of level 3 standards, which supports account-
ability. CESR made clear in its early position paper on best execution in
February 2007 that its objective was ‘supervisory convergence and not
the making of new rules’.99 Following deadlock in CESR as to the treat-
ment of dealer markets, it also sought and received clarification from the
Commission on the scope of the MiFID best-execution regime to anchor
its work.100 In addition, rather than adopt additional formal guidance
in a highly controversial area which is already heavily regulated at level
1 and 2, CESR proceeded through a ‘process-driven’101 Q and A for-
mat which is designed to ‘present [CESR’s] views in a user-friendly way
that facilitates compliance by firms and convergence among competent
authorities…it presents CESR’s answers to practical questions raised by
firms and competent authorities’.102 This is a practical and, in principle,
‘light touch’ response to the best execution issue and is designed not to
impose additional obligations but to ‘explain CESR’s views on how firms
can comply with the [MiFID regime] in the particular circumstances
and situations that stakeholders have raised’.103 In practice, however,
market participants are likely to treat this guidance as a binding rule to
reduce regulatory risk.
A restrained approach continued in CESR’s 2007–8 MiFID work pro-
gramme.104 Notably, CESR’s approach to the sensitive ‘thematic’ work-
stream which covers level 3 guidance and standards was economical and
reflective of market concerns. Noting that the market and supervisors
required time to adjust to the recent regulatory changes, it de-empha-
sized the guidance strand, focusing only on those areas highlighted
by stakeholders as requiring guidance, including confl icts of interest,
best execution, and soft commissions and unbundling. CESR has also

99
CESR/07–050b, 4.
100
CESR/07–050b, 4. The Commission responded at length. Letter from David Wright,
Commission to CESR Chairman (19 March 2007), http://ec.europa.eu/internal_market/
securities/isd/mifid_en.htm.
101
CESR, Interim Report (2007), 18.
102
CESR/07–320, 3.
103
CESR/07–320, 3.
104
CESR/07–704c. An earlier consultation took place (CESR/07–704).
 Com mittee of Eu ropea n Secu r ities R egu l ators 471

frequently cautioned against moving measures from level 2 to level 3,

even though level 3 gives more freedom to CESR. It was particularly
concerned during the MiFID level 2 discussions that level 3 not be used
to escape from political decisions at levels 1 and 2 and, in a clear concern
to avoid legitimacy risks, that any transfer from level 2 to level 3 be made
explicit in the level 2 measure ‘in order to have the political backing of
the EU institutions’.105

C. Consultation
Accountability is also enhanced through CESR’s increasingly sophis-
ticated consultation procedures. More indirectly, CESR has prompted
market interests to adopt more sophisticated and networked lobbying
models which should ensure that genuine European market expertise
and legitimate concerns are reflected in its initiatives – as long as CESR
remains uncaptured by the market interests which dominate consulta-
tions. The recent strengthening of its resources and capacity for cost–
benefit analysis through the establishment of ECONET in summer
2006106 should act as a counter-balance. CESR is also actively promoting
the development of a retail lobby through its governance and education
initiatives. The striking move by CESR into retail policy may, indeed,
give considerable political weight to CESR’s activities in the long term as
well as dilute the risk that the well-organized market lobby could engen-
der a market-facing bias in CESR’s activities.

D. Tests for level 3 intervention

CESR has also voluntarily adopted a suitability test for deciding which
activities it will undertake at level 3. It will only undertake work which
meets three ‘rigorous criteria’: (i) a risk threshold (in that the issue
addressed at level 3 represents a significant market failure or a repeated
or major regulatory or supervisory failure); (ii) an EU threshold (in
that the issue is likely to have an EU-wide impact on market partici-
pants or end-users and on the smooth functioning of single market); and
(iii) an effectiveness threshold (in that CESR can contribute positively by
105
ESC Minutes, 23 February 2005.
106
ECONET was established in August 2006 as part of the wider reforms to CESR’s
operation. It is to evaluate, develop and maintain CESR’s approach to impact analy-
sis, in line with CESR’s commitment to more extensive use of economic analysis and
evidence-based methodologies.
472 Perspectiv es in fina ncia l r egu l ation

creating change or through ‘collective direct action’ by CESR members).107

Internal limits have therefore been imposed on the reach of level 3.

E. Charter reform
July 2006 saw CESR make the first changes to its Charter since its incep-
tion and a major change to CESR’s decision-making structure.108 The
most important reforms concern CESR decision making. Article 5 of the
CESR Charter109 now provides for qualified majority voting with respect
to level 2 advice. But the Charter also now provides that level 3 work
which is expressly requested by Community legislation, or is directly
related to Community legislation, must be subject to a unanimous vote
where one or more members so requests. Where unanimity cannot be
reached, the Commission must be informed.110 Although this reform
suggests the possibility of formal vetoes in limited circumstances, con-
sensus is likely to remain the primary method for addressing level 3.

V. The 2007 Lamfalussy Review

The accountability and legitimacy of the level 3 process emerged again
in the important 2007 Lamfalussy Review which saw input from the
market,111 think tanks112 and the institutions.113 Although radical insti-
tutional changes to the supervision structure were not suggested,114
important reforms designed to strengthen accountability were proposed.
107
CESR, Supervisory Convergence Report (2006), 2–3.
108
CESR, Press Release 2 August 2006, CESR/06–303.
109
CESR, Charter of the Committee of European Securities Regulators (2006), CESR/06–
289c. Further reforms followed in 2008 after this book went to press.
110
Charter, Art 5(7).
111
See e.g. City of London Group 2007 and Deutsche Bank, Towards a New Structure for
EU Financial Supervision, EU Monitor 48 (2007), 3.
112
See e.g. E. Ferran, and D. Green, Are the Lamfalussy Networks Working Successfully? (A
Report by the European Financial Forum) (2007) and the opinions issued by EUROFI
for its December 2007 conference on Achieving the Integration of Financial Markets in
a Global Context.
113
The major reports and reviews included: Parliament Van den Burg Resolution 2007
(P6_TA (2007) 0338); the Commission, Review of the Lamfalussy Process. Strengthening
Supervisory Convergence (2007); Inter Institutional Monitoring Group, Final Report
Monitoring the Lamfalussy Process (2007) (which was based on consultation with
the institutions and other key stakeholders, including market interests); and CESR,
Securities Supervision Report (2007).
114
The Commission e.g. argued that more ambitious institutional changes, such as the
granting of independent rule-making power to the level 3 committees were not
 Com mittee of Eu ropea n Secu r ities R egu l ators 473

But the essential legitimacy of the level 3 process and of CESR’s activities
was supported.
Reinforcement of the status of the level 3 committees, including
CESR, was a recurring theme of the review which saw discussion of a
possible strengthening of the level 3 committees through the regula-
tory framework115 and through voting reforms – in particular greater
use of qualified majority voting – although positions varied.116 Related
accountability concerns were also prevalent. Proposed reforms included
the adoption by the institutions of general mandates for the 3L3
committees,117 institutional endorsement of 3L3 work programmes by
the EU institutions, and the submission of progress reports and reasons
for failure to meet objectives.118 The accountability discussion was also,
and for the first time, framed in terms of national supervisors, with sup-
port for national supervisory mandates to refer to supervisory conver-
gence obligations.119
CESR’s approach to the Review warrants some attention given its
earlier attention to developing its own accountability model. Despite
its care to address accountability sensitivities, it has recently become
more assertive in pointing to the limits of its non-binding level 3 guid-
ance and the related threat to its credibility, particularly on the mar-
ketplace.120 But it has opted for an approach which builds on peer

feasible given lack of agreement among Member States and stakeholders: Commission
Lamfalussy Report (2007), 3.
115
Inter Institutional Monitoring Group (2007), 14; Commission Lamfalussy Report
(2007), 8; Van den Burg Resolution 2007, 55.
116
The Inter Institutional Monitoring Group supported consensus as the default voting
method, but suggested that the 3L3 committees operate under QMV in respect of spe-
cific delegations under level 1 and 2: Inter Institutional Monitoring Group (2007), 18.
The Commission was more radical, concerned as to the difficulties posed by consensus
decision making, and suggested that QMV be used for any measure aimed at fostering
convergence: Commission Lamfalussy Report (2007), 9. The Parliament also supported
QMV decision-making: Van den Burg Resolution 2007, para. 55.
117
Commission Lamfalussy Report (2007), 7; Van den Burg Resolution 2007, para. 55.
118
Inter Institutional Monitoring Group (2007), 17; Commission Lamfalussy Report
(2007), 7; and Financial Services Authority and HM Treasury, Strengthening the EU
regulatory and supervisory framework: A Practical Approach (2007), 7.
119
Inter Institutional Monitoring Group (2007), 18; and Commission Lamfalussy Report
(2007), 8.
120
CESR argued that ‘there is a gap between an informal (de facto) EU mandate given to
CESR creating the expectation that rules will be applied in the same manner in the
market, and the legal national accountability obligations of each CESR member that
governs their daily activities. Uniform supervisory behaviour should not be expected
by market participants within the current framework as CESR members may have no
474 Perspectiv es in fina ncia l r egu l ation

pressure dynamics, and which reflects its generally nuanced approach to

accountability risks, rather than calling for binding status to be, some-
how, afforded to its guidance. It has maintained its commitment to con-
sensus-led decisionmaking for level 3 initiatives.121 But in addition to
supporting the comply-or-explain technique with respect to findings of
non-compliance by the Review Panel, it has also suggested that it adopt
enforcement instruments, ‘fundamentally reputational’ in design.122
Any ‘enforcement-style’ decisions would be subject to a qualified major-
ity vote. This represents a significant hardening of CESR’s peer pressure
mechanisms. CESR has also called in aid from the enforcement pow-
ers of the Commission, suggesting that the Commission indicate that it
would not ignore the existence of level 3 when exercising its enforcement
powers. Building on its earlier attempts to establish a tailored account-
ability model, CESR also called for national supervisory mandates to
include compliance with supervisory convergence – a shrewd move
which allows CESR to strengthen compliance with its level 3 initiatives
without opening the Pandora’s Box which embuing level 3 guidance
with binding force would involve.
The review process culminated with the important December 2007
ECOFIN Conclusions123 which broadly reflect these themes and CESR’s
proposed reforms. The Conclusions did not support major institutional
change, but represented a strong statement of political support for super-
visory convergence/level 3 and for the work of the 3L3 committees. The
key accountability recommendations included ECOFIN’s call for the
Commission to clarify the role of the 3L3 committees and to consider
‘all options’ to strengthen them – but with the caveat that the institu-
tional structure must not be unbalanced.124 Accountability was further
addressed by the traditional reporting model developed by CESR, with
ECOFIN inviting the 3L3 committees to submit a draft work programme
to the Council, Commission and Parliament and to report annually
on the achievement of the objectives set.125 The non-binding effect of
level 3 guidance, the voluntary nature of convergence, and the extent to
which national supervisors could be bound against their will were also

alternative but to respect legitimate national discretions’: CESR Securities Supervision

Report 2007, 2.
121
CESR, Securities Supervision Report (2007), 4.
122
CESR, Securities Supervision Report (2007), 5.
123
2836th ECOFIN Meeting, 4 December 2007, Press Release 15698/07.
124
December 2007 ECOFIN Conclusions, 17.
125
December 2007 ECOFIN Conclusions, 17.
 Com mittee of Eu ropea n Secu r ities R egu l ators 475

major themes of the Conclusions. ECOFIN took a compromise position

and requested the 3L3 committees in order to enhance the efficiency
and effectiveness of their decision-making procedures, to introduce the
possibility of qualified majority voting. But it also acknowledged that
decisions would remain non-binding and suggested that, as proposed
by CESR, the comply-or-explain model be used to drive compliance.126
ECOFIN also supported the adoption of supervisory-convergence man-
dates in national supervisory mandates, although it was not prescriptive
and simply recommended that Member States consider including in the
mandates of national supervisors the task of cooperating within the EU
and working towards supervisory convergence.127
CESR’s careful attempts to address accountability risks appear there-
fore to have reaped dividends as, overall, CESR has emerged strength-
ened from the 2007 Review (not least given the ECOFIN commitment
to strengthening its funding model and addressing the severe resource
strain under which CESR now operates). The Commission’s strong sup-
port for supervisory convergence, and its enthusiasm for CESR’s deci-
sions to be afforded akin-to-binding authority (through its support of
qualified majority voting in particular) during the Review, suggests
that it had reached an accommodation with CESR’s burgeoning pow-
ers, while the European Parliament also appears more sanguine as to
accountability and legitimacy risks.128 The 2007 Review also saw strong
political support for CESR’s activities which suggests that CESR mem-
bers should not face too many domestic political confl icts. The risk of a
change in the political climate cannot, however, be ruled out. Although
some tensions persist, notably with respect to CESR’s voting mecha-
nisms and its role in international relations, the scale of CESR’s activities
at level 3 now appears to have institutional backing.
The range of CESR’s activities, and its key role as the driver of super-
visory convergence, raises complex accountability and legitimacy issues
which reflect the wider complexities of the dynamic process whereby the
disciplines of the financial markets are established by a range of actors.
CESR’s accountability model looks set to develop as a hybrid, based for
the most part on indirect, reporting and consultation accountability

126
December 2007 ECOFIN Conclusions, 17.
127
The FSC and EFC were mandated to consider this issue.
128
The 2007 Van den Burg Resolution ‘welcomed’ the work of the 3L3 committees at level
2 and their progressing of the convergence agenda ‘without overstepping their remit’ or
attempting to replace the legislators, and argued that their work must be encouraged:
Van den Burg Resolution 2007, para. 53.
476 Perspectiv es in fina ncia l r egu l ation

links, but also placed cleverly within national supervisory and account-
ability structures. The current dynamic period may well see the emer-
gence of an optimal model which reflects the particular functions CESR
exercises and the particular accountability risks it poses. The indications
also continue to suggest that CESR will remain careful to tread lightly
in expanding the boundaries of level 3. Notably, CESR members appear
to be uncertain as to the wisdom in seeking binding status for level 3,129
reflecting a grasp of political realities which augurs well for its future
stability.
129
CESR, Securities Supervision Report (2007), 7.
 26

Market transparency and best execution:

bond trading under MiFID
Guido Fer r ar ini

The relationship between best execution and market transparency

deserves careful consideration in an analysis of MiFID.1 Best execu-
tion has mainly been studied with respect to equity trading, which is
generally exchange based and widely regulated also with respect to
market transparency.2 In this chapter, however, I focus on bond trad-
ing, which takes place predominantly over-the-counter (OTC) and is
not subject to MiFID’s transparency provisions. After introducing the
topic (Section I), I offer a critical view of the transparency requirements
applicable to equity trades and their formation (Section II). I then exam-
ine the recent policy discussion on non-equities market transparency,
as reflected in the Report issued by the European Commission under
Article 65 (1) of the MiFID,3 examining whether the requirements for
pre-trade and post-trade information should be extended to non-equities
markets (Section III). I finally consider the role of best execution in bond
markets, focussing on the impact of transparency on order execution for
retail investors (Section IV). In Section V, I draw some conclusions.

1
See Directive 2004/39/EC of the European Parliament and of the Council on markets in
fi nancial instruments (MiFID) [2004] OJ L 145.
2
See R. Davies, A. Dufour and B. Scott-Quinn ‘The MiFID: Competition in a New
European Equity Market Regulatory Structure’, in G. Ferrarini and E. Wymeersch (eds.),
Investor Protection in Europe: Corporate Law Making, the MiFID and Beyond, (Oxford
University Press, 2006), 163–97; G. Ferrarini, ‘Best Execution and Competition between
Trading Venues – MiFID’s Likely Impact’, Capital Markets Law Journal, 2 (2007), 404–13;
C. Gortsos, MiFID’s Investor Protection Regime: Best Execution of Client Orders and
Related Conduct of Business Rules, in E. Avgouleas (ed.), The Regulation of Investment
Services in Europe under MiFID: Implementation and Practice (Haywards Heath, West
Sussex: Tottel Publishing, 2007), 101–37; for the US, J. Macey and M. O’Hara, ‘The
Law and Economics of Best Execution’, Journal of Financial Intermediation, 6 (1997),
188–233.
3
DG Internal Market and Services, Working Document, Report on non-equities market
transparency pursuant to Article 65 (1) of Directive 2004/39/EC on Markets in Financial
Instruments (MiFID) (3 April 2008).

477
478 Perspectiv es in fina ncia l r egu l ation

I. Introduction
A few introductory remarks may help to set this study in context. First of
all, the type of instrument traded and the structure of the relevant market
have an impact on best execution, as also recognized by the MiFID and
its implementing Directive.4 Shares, to start with, are generally traded
in order-driven and centralized markets, such as stock exchanges (and,
to a lesser extent, MTFs).5 Only a fraction of listed shares are traded fre-
quently, mainly in small sizes.6 Liquidity is high and continuous for the
most traded shares, while price formation is based around a dominant
trading venue (usually an exchange).7 Bonds, on the contrary, are mainly
traded off-exchange, in quote-driven and decentralized markets.8 Only
a minority of bonds are traded frequently, while trading sizes are large
in a majority of cases.9 Liquidity depends on issuer, size of issue, rat-
ing, etc., while price formation occurs through competitive ‘requests for
quotes’ (RFQs) in OTC markets, which are closely correlated with credit
derivatives markets.10 Therefore, best execution criteria shall be imple-
mented differently for shares and bonds, to the extent that, for instance,

4
See Article 21 of Directive 2004/39/EC on markets in fi nancial instruments (MiFID)
and in particular its para. 1, which defi nes the best execution obligation as requiring
that ‘investment fi rms take all reasonable steps to obtain, when executing orders, the
best possible result for their clients taking into account price, costs, speed, likelihood of
execution and settlement, size, nature or any other consideration relevant to the execu-
tion of the order’. See also the 70th considerandum of Commission Directive 2006/73/
EC of 10 August 2006, implementing Directive 2004/39/EC of the European Parliament
and of the Council as regards organizational requirements and operating conditions
for investment fi rms and defi ned terms for the purposes of that Directive (the MiFID’s
Implementing Directive), which states: ‘The obligation to deliver the best possible result
when executing client orders applies in relation to all types of fi nancial instruments.
However, given the differences in market structures or the structure of fi nancial instru-
ments, it may be difficult to identify and apply a uniform standard of and procedure for
best execution that would be valid and effective for all classes of instrument.’
5
See CESR, Response to the Commission on non-equities transparency (June 2007), 4;
L. Harris, Trading and Exchanges. Market Microstructures for Practitioners (Oxford
University Press, 2003), 32 et seq.
6
See Harris, Trading and Exchanges, (note 5, above), 45.
7
See CESR, Response to the Commission on non-equities transparency, (note 5, above), 4.
8
See the Report of the Technical Committee of IOSCO, Transparency of Corporate Bond
Markets (May 2004), 3: ‘Trading in many corporate bond issues has tended to remain
predominantly bilateral between dealers and their clients. Even when bonds are listed,
the majority of trading frequently occurs off-market’; CEPR, European Corporate Bond
Markets: Transparency, Liquidity, Efficiency, report by B. Biais, F. Declerk, J. Dow,
R. Portes and E. von Thadden (City of London, May 2006), 28 et seq.
9
CESR, Response to the Commission on non-equities transparency, (note 5, above), 4.
10
Ibid.
 bond tr a ding u nder mifid 479

most shares have a dominant trading venue, whereas bonds are traded
exclusively or predominantly OTC.11
Furthermore, market transparency has an impact on best execution.
Firstly, transparency contributes to price discovery making markets
more efficient, to the extent that prices fully reflect the information avail-
able.12 As argued with respect to equity markets, transparency enhances
liquidity: the more price setters know about the order flow, the better
they can protect themselves against losses to insiders, so allowing them
to narrow their spreads.13 The role of informed traders, however, is less
important in bond markets.14 Moreover, there are situations in which
transparency may have a negative impact on liquidity. For instance, in
the case of a block trading of securities, immediate publication of the
relevant data may expose the dealer to an adverse market movement, as
other market participants will try to exploit the relevant information.15
Secondly, transparency can improve liquidity if customers have to
search for the best quotes:16 since it is costly to search for quotes, in opaque

11
See again the 70th considerandum of the MiFID’s Implementing Directive, which speci-
fies: ‘Best execution obligations should therefore be applied in a manner that takes into
account the different circumstances associated with the execution of orders related to par-
ticular types of financial instruments. For example, transactions involving a customized
OTC financial instrument that involve a unique contractual relationship tailored to the
circumstances of the client and the investment firm may not be comparable for best execu-
tion purposes with transactions involving shares traded on centralized execution venues’.
12
See the report by the Division of Market Regulation of the SEC, Market 2000: An
Examination of Current Equity Market Developments (Jan. 1994), IV-17, also highlight-
ing that transparency contributes to the fairness of markets, as all investors have access
to information.
13
See M. Pagano and A. Röell, ‘Transparency and Liquidity: A Comparison of Auction
and Dealer Markets with Informed Trading’, Journal of Finance, 51 (1996), 579–611.
These authors argue that transparency also depends on market microstructure, to the
extent that order-driven markets are ‘inherently’ more transparent than quote-driven
ones. Requiring transparency from the latter markets may force changes to their micro-
structure, as was sometimes argued in the discussion which finally led to the regulation
of equity market transparency in the Investment Services Directive: see G. Ferrarini,
‘The European Regulation of Stock Exchanges: new Perspectives’, Common Market Law
Review, 36 (1999), 569–98, 580.
14
See CEPR, European Corporate Bond Markets, (note 8, above), 9, arguing that the opti-
mal fi nancial contracting literature has shown that corporate bonds are designed to
minimize adverse selection, relative to stock.
15
Ibid., 7, noting that an argument used against transparency is that it could deter liquid-
ity. In transparent markets, once a trader has purchased shares, his competitors may
opportunistically quote a high price for liquidity, making it difficult for the trader to
unwind its inventory.
16
See the 76th considerandum of the MiFID’s Implementing Directive, stating inter alia:
‘Availability, comparability and consolidation of data related to execution quality
480 Perspectiv es in fina ncia l r egu l ation

markets customers may end up choosing to trade with a dealer even if it

does not have the best quotes.17 Competition between dealers is reduced
as a result. Recent empirical research18 concerning TRACE19 finds that
transparent bonds have lower transaction costs than non-transparent
bonds and that transaction costs decrease when bonds become price
transparent.20 One of these studies suggests that in 2003, when $2 trillion
in bond issues were traded for which prices were not published on a con-
temporaneous basis, investors would have saved a minimum of $1 billion
per year had the relevant prices been TRACE-transparent.21
Thirdly, if significant post-trade information is not readily available,
investors have difficulties in assessing best execution by their brokers.22

provided by the various execution venues is crucial in enabling investment firms and
investors to identify those execution venues that deliver the highest quality of execution
for their clients.’
17
See X. Yin, ‘A Comparison of Centralized and Fragmented Markets with Costly Search’,
Journal of Finance, 60 (2005), 1567–90.
18
See A. Edwards, L. Harris and M. Piwowar, ‘Corporate Bond Market Transaction
Costs and Transparency’, Journal of Finance, 67 (2007), 1421–51; H. Bessembinder, W.
Maxwell and K. Venkataraman, ‘Market Transparency, Liquidity Externalities, and
Institutional Trading Costs in Corporale Bonds’, Journal of Financial Economics, 82
(2006), 251–88; M. Goldstein, E. Hotchkiss and E. Sirri, ‘Transparency and Liquidity:
A Controlled Experiment on Corporate Bonds’, Review of Financial Studies, 20 (2007),
235–73.
19
TRACE (Trade Reporting and Compliance Engine) was created in 2002 by the National
Association of Securities Dealers (NASD), under pressure from Congress, buy-side
traders, and the SEC by requiring dealers to report all OTC bond transactions through
it. As a result, within two and a half years after the start of TRACE operations, prices
from about 99 per cent of all trades representing about 95 per cent of the dollar value
traded were disseminated within 15 minutes: see A. Edwards, L. Harris and M. Piwowar,
‘Corporate Bond Market Transaction Costs and Transparency’, (note 18, above), at
1422, citing SEC Release No. 34–49920 and File No. SR-NASD-2004–094, with the
specification that this figure does not include the trades of the Rule 144a market, which
is still opaque.
20
See Edwards, Harris and Piwowar, ‘Corporate Bond Market Transaction Costs and
Transparency’, (note 18, above), at 1425, stating that their study complements the results
of at least three other studies: G. Alexander, A. Edwards and M. Ferri, ‘The Determinants
of Trading Volume of High-yield Corporate Bonds’, Journal of Financial Markets, 3
(2000), 177–204 (transparent high-yield bonds can be fairly liquid); Bessembinder,
Maxwell and Venkataraman, ‘Market Transparency, Liquidity Externalities, and
Institutional Trading Costs in Corporale Bonds’, (note 18, above) (declines in transac-
tion costs for insurance company trades in corporate bonds after the introduction of
TRACE); Goldstein, Hotchkiss and Sirri, ‘Transparency and Liquidity’, (note 18, above)
(declines in transaction costs due to transparency for all but the smallest trade size
groups in a matched-pair analysis of BBB bonds).
21
See Edwards, Harris and Piwowar, ‘Corporate Bond Market Transaction Costs and
22
Transparency’, (note 18, above), 1423. Ibid.
 bond tr a ding u nder mifid 481

I will develop this intuition in Sections IV and V, arguing that market

transparency is also needed for best execution and its enforcement, par-
ticularly with respect to retail investors, whose presence is substantial in
some countries and could be enhanced in others by EU-wide post-trade
transparency.23

II. MiFID’S equity market transparency

Market transparency was regulated for the first time at EC level with the
ISD,24 which included minimum standards for post-trade transparency
in regulated markets and provided considerable latitude for Member
States in the implementation of those standards, particularly with respect
to bonds and other debt instruments.25 Moreover, the Directive allowed
Member States to require transactions in equity securities to be car-
ried out on a regulated market.26 As a result, some Member States, such
as France, Italy and Spain, maintained ‘concentration rules’, i.e. rules
mandating exchange execution of listed securities trades as a require-
ment for the best execution of transactions by investment intermediar-
ies.27 However, these domestic provisions were frequently criticized as
anticompetitive by market participants and policy makers, whilst stock

23
On the retail market for corporate bonds in Europe, see CEPR, European Corporate
Bond Markets, (note 8, above), 32, stating that direct holdings of fi xed income securities
by households vary a lot across countries in Europe: ‘While in Italy they can be as high
as 20% of total fi nancial holdings or even higher, in Germany they are between 10% and
15%, and in other countries they will typically be lower than 5%.’ In the latter coun-
tries, investments in fi xed income securities take place primarily through funds. See
FSA, ‘Trading Transparency in the UK Secondary Bond Markets’, Discussion Paper 05/5
(September 2005), 9 et seq.
24
Directive 93/22/EEC of 10 May 1993, on investment services in the securities field
[1993], OJ L 141. See, for diff use analysis, N. Moloney, EC Securities Regulation, (Oxford
University Press, 2002), 295 et seq.
25
See Article 21 (2) ISD, providing inter alia: ‘The competent authorities may also
apply more f lexible provisions, particularly as regards publication deadlines, for
transactions concerning bonds and other forms of securitized debt.’ On the ISD
implementation, E. Wymeersch, ‘The Implementation of the ISD and CAD in
National Legal Systems’, in G. Ferrarini (ed.), European Securities Markets: The
Investment Services and Beyond (London: Kluwer, 1998), 3–44.
26
See Article 14 (3) ISD.
27
See Ferrarini, ‘The European Regulation of Stock Exchanges: new Perspectives’, (note
13, above), 583, noting that other Member States, such as the UK, did not provide for the
mandatory concentration of transactions on exchanges, leaving the investors and their
intermediaries free to transact off-board.
482 Perspectiv es in fina ncia l r egu l ation

exchanges took advantage of the same to consolidate their market power

in domestic equities trading.
Th roughout the MiFID’s formation political agreement was reached,
despite strong opposition from some exchanges and banking circles in
the Continent, to dismantle national barriers and promote competi-
tion in the offer of trading services between regulated markets, MTFs
and intermediaries internalizing trades of listed securities. 28 As a
result, the new Directive allows internalization of orders and, at the
same time, regulates this practice with provisions concerning trans-
parency, order handling, confl icts of interest and best execution.29
Transparency obligations, in particular, are aimed at remedying the
fragmentation of markets which derives from competition in the offer
of trading services. 30 As listed shares can now be traded through mul-
tiple venues (or entities), information concerning both on- and off-
exchange transactions must be published by the relevant venue (or
entity) under MiFID’s post-trade transparency requirements. These
requirements are similar for regulated markets, 31 MTFs32 and invest-
ment fi rms that execute transactions in shares admitted to trading on

28
See G. Ferrarini and F. Recine, ‘The MiFID and Internalisation’, in Ferrarini and
Wymeersch (eds.), (note 2, above), 117, 120 et seq., analysing the MiFID’s formation and
the interplay of interest groups either favouring concentration of trades or opposing the
same as anticompetitive.
29
See Ferrarini and Recine, ‘The MiFID and Internalisation’, (note 28, above), 139 et seq.;
J. Köndgen and E. Thyssen, ‘Internalisation under MiFID: Regulatory Overreaching
or Landmark in Investor Protection?’, in Ferrarini and Wymeersch (eds.), Investor
Protection in Europe, (note 2, above), 271–96; N. Moloney, ‘Effective Policy Design for the
Retail Investment Services Market: Challenges and Choice Post FSAP’, in Ferrarini and
Wymeersch (eds.) (note 2, above), 381–442.
30
On post-trade transparency as a remedy to market fragmentation, see the Report from the
Technical Committee of IOSCO, Transparency and Market Fragmentation (November 2001).
31
See Article 45 (1) MiFID stating that Member States shall, at least, require regulated mar-
kets to make public the price, volume and time of the transactions executed in respect
of shares admitted to trading. Article 45 (2) specifies that the competent authority may
authorize regulated markets to provide for deferred publication of the details of transac-
tions based on their type or size, in particular of those that are large in scale compared
with the normal market size.
32
See Article 30 (1) MiFID stating that Member States shall, at least, require that
investment firms and market operators operating an MTF make public the price,
volume and time of the transactions executed under its systems in respect of shares
which are admitted to trading on a regulated market. Article 30 (2) specifies that the
competent authority may authorize investment firms or market operators operating
an MTF to provide for deferred publication of the details of transactions based on
their type or size, in particular of those that are large in scale compared with the
normal market size.
 bond tr a ding u nder mifid 483

a regulated market outside a regulated market or MTF. 33 Common

requirements as to post-trade transparency are also foreseen by the
Commission Regulation implementing the MiFID. 34
Pre-trade transparency proved to be a much more controversial
subject, as already seen for the ISD.35 However, political agreement
was not too difficult to reach for MiFID concerning regulated markets
and MTFs, 36 probably reflecting increased consensus on the merits of
organized markets’ transparency and also the fact that market micro-
structures are today mainly order-driven. The real controversy centred
around whether pre-trade transparency should be imposed upon inter-
nalizers. Answers to this question largely depended on attitudes taken
towards national concentration rules and their impact on competi-
tion. Those supporting similar rules (including Continental exchanges
and banking associations) advocated that internalization should in
any case be subject to rigorous pre-trade transparency requirements.
Those objecting to trading concentration also objected to the introduc-
tion of pre-trade information requirements as unduly interfering with
markets.37

33
See Article 28 stating that Member States shall, at least, require investment firms which,
either on own account or on behalf of clients, conclude transactions in shares admitted
to trading on a regulated market outside a regulated market or MTF, to make public the
volume and price of those transactions and the time at which they were concluded.
34
See Article 27 (Post-trade transparency obligation), Commission Regulation (EC) No
1287/2006 of 10 August 2006, implementing Directive 2004/39/EC of the European
Parliament and of the Council as regards record-keeping obligations for investment
firms, transaction reporting, market transparency, admission of fi nancial instruments to
trading, and defi ned terms for the purpose of this Directive [2006], OJ L 241/7 (MiFID’s
Implementing Regulation), which applies to investment fi rms, regulated markets, and
investment firms and market operators operating an MTF. See also Article 28 (Deferred
publication of large transactions) of the same Regulation.
35
The following text reflects Ferrarini and Recine, ‘The MiFID and Internalisation’, (note
28, above), 246 et seq.
36
See Articles 29 and 44 of the MiFID, concerning pre-trade transparency requirements
respectively for MTFs and regulated markets.
37
See Ferrarini and Recine, ‘The MiFID and Internalisation’, (note 28, above), 240,
describing the MiFID’s ‘political economy’ as follows: ‘On the one hand, stock exchanges
(particularly those operating in Continental Europe) fight to defend their national fran-
chises, which are in some Member States protected by concentration rules. On the other,
investment banks (often belonging to American groups or European fi nancial conglom-
erates) seek wider territories of action. The business model is that of the City of London,
where the Stock Exchange, ATS and internalising fi rms offer different trading func-
tionalities to institutional and retail investors. On the whole, investment banks defend
the rents generated by internalised trades against the stock exchanges protecting their
quasi-monopolies in the trade of domestic equities.’
484 Perspectiv es in fina ncia l r egu l ation

The European Commission, in its 2002 consultation document on the

ISD revision, suggested that internalized market orders and limit orders
left unexecuted by internalizers should not be reported.38 However, in
its proposal for a directive published later that year,39 the Commission
accepted, through a last-minute coup de scène, the opposite view and
included provisions mimicking the US pre-trade transparency rules.40
The ‘quote rule’, in particular, was adopted by the SEC in 1978 requir-
ing broker-dealers who maintain quotes for a security to promptly dis-
seminate and honour the same; in 1996, the SEC extended this rule to
apply to Nasdaq market makers who posted quotes in ECN.41 The ‘limit
order display rule’ was adopted in 1996 with the Order Handling Rules42
and requires dealers who accept limit orders and specialists to display
these orders, including their full size, when the order is placed at a price

38
See European Commission, ‘Revision of Investment Services Directive (93/22/EEC),
Second Consultation’; for an analysis of this document, E. Wymeersch, ‘Revision of
the ISD’, Financial Law Institute, Ghent University, Working Paper 2002–11 (August
2002).
39
See the Proposal for a Directive of the European Parliament and of the Council on
Investment Services and Regulated Markets, and amending Council Directive 85/611/
EEC, Council Directive 93/6/EEC and European Parliament and Council Directive
2000/12/EC, 19 November 2002, COM(2002) 625, 8.
40
According to the press, the change was due to the personal intervention of Mr. Prodi,
president of the European Commission: Lex Column ‘The Prodi Plot’, Financial Times
(19 November 2002). Indeed a Commission informal draft widely circulated on 3
September 2002 did not envisage any pre-trade transparency obligation for investment
firms.
41
SEC Rule 11Ac1–1. Prior to 1978, the quotes disseminated on Nasdaq by market mak-
ers did not specify the number of shares to which the quote applied. In addition, mar-
ket makers did not always honour their quotes, refusing to trade at the specified price.
See J. Coffee and J. Seligman, Securities Regulation, 9th edn. (New York: Foundation
Press, 2003), 652–3.
42
The Order Handling Rules were an important step in the development of the National
Market System (NMS), envisioned by the 1975 Securities Acts Amendments (which
also contemplated the abolition of fi xed commission rates), that would ensure inves-
tors competitive markets and best execution of their trades: see Coffee and Seligman,
Securities Regulation, (note 41, above), 650–653; for early analysis of the NMS from a
European perspective, E. Wymeersch, Le contrôle des marches de valeurs mobilières dans
les États members de la Communauté européenne. Rapports sur les systèmes de contrôle
nationaux. Partie II, (Commission des Communautés Européennes, Série concurrence –
Rapprochement des legislations, 1981), 219–308. The Amendments fi xed five basic goals
for the SEC to pursue in implementing the national market system: (i) economically
efficient execution of transactions; (ii) fair competition among broker-dealers, among
exchanges and between exchanges and other markets; (iii) ready availability of quota-
tion and transaction information to broker-dealers and investors; (iv) ability of broker-
dealers to execute orders in the best market; (v) opportunity for investors to execute
orders without the participation of a dealer (Section 11A).
 bond tr a ding u nder mifid 485

superior to the market maker or specialist’s own quotations.43 Therefore,

if the prices quoted by market makers left an artificially wide spread, a
new source of competition would be introduced by allowing customers
to introduce a price quotation that would narrow the bid/ask spread.
As a result, brokers holding market orders from their clients would be
required by their duty of best execution to execute their trades against
these limit orders.44
The Commission’s proposal of rules similar to the American provi-
sions just cited generated an intense political debate. Investment inter-
mediaries, often based in the City of London, insisted that the abolition
of concentration rules could be effective only in the absence of other
hindrances to off-exchange trading. On the contrary, banks in the
Continent supported the imposition of pre-trade transparency obliga-
tions on dealers in order to create a level playing field between trading
venues or entities. The stock exchanges hit by the abolition of concentra-
tion rules defended pre-trade transparency requirements as a means to
achieve efficient price discovery in fragmented markets. A compromise
solution was found, at last, in the European Parliament. The proposed
European ‘limit order display rule’ was limited to share trading. The
‘quote rule’ was restricted to cases of ‘systematic internalization’ and
to transactions of a ‘standard market size’, while the duty to quote was
referred only to the internalizing firm’s clients.
As a result, Article 22 (2) MiFID requires investment firms to make
public, in a manner that is easily accessible to other market partici-
pants, limit orders concerning shares admitted to trading on a regulated
market, which are not immediately executed under prevailing market

43
Coffee and Seligman, Securities Regulation, (note 41, above), 653, make the following
example: if the market maker’s quotation were $18 bid and $19 asked, and a customer
placed a limit order with him to buy at $18.50, the market maker’s bid quotation would
become $18.50 bid and $19 asked. If $18.50 were the highest bid price submitted to
Nasdaq and $18.75 the lowest asked quotation, then the NBBO (National Best Bid and
Offer) would become $18.50 and $18.75, and all transactions would be done at this price
until the orders were exhausted or a still superior price were quoted.
44
Ibid. The Order Handling Rules were introduced after a pricing collusion was discovered
amongst Nasdaq’s market makers, under which they avoided odd-eighths quotes. An
empirical study by W. Christie and P. Schultz, ‘Why Do Nasdaq Market Makers Avoid
Odd-Eighth Quotes’, Journal of Finance, 49 (1994), 1813, examined an extensive sam-
ple of bid-ask spreads for 100 of the most active Nasdaq stocks in 1991 and found that
spreads of one-eighth were virtually non-existent for a majority of this sample. In the
authors’ opinion, the fact that market makers enforced a minimum spread of $0.25 for a
majority of large stocks could partially explain why previous research had found trading
costs to be higher for Nasdaq than for the New York Stock Exchange.
486 Perspectiv es in fina ncia l r egu l ation

conditions. As CESR explained, this provision should facilitate and

accelerate the execution of client limit orders, whilst contributing to
price discovery.45
Concerning the ‘quote rule’, Article 27 MiFID requires internalizers
to publish firm quotes only if a number of conditions are met. Firstly, the
relevant instruments must be shares admitted to trading on a regulated
market and for which there is a liquid market. Secondly, the internal-
izing firm must be a systematic internalizer for shares, i.e. ‘an invest-
ment firm which, on an organized, frequent and systematic basis, deals
on own account by executing orders outside a regulated market or an
MTF’. Thirdly, the transaction size must be up to standard market size.
Moreover, Article 27 (3) requires systematic internalizers to execute their
clients’ orders at the price quoted when receiving the order. However,
in the case of orders from professional clients, systematic internaliz-
ers may execute those orders at a better price, provided that such price
falls within a range close to market conditions and the orders are of a
size bigger than that customarily undertaken by a retail investor. One
of the main criticisms of the quote rule throughout the MiFID’s pre-
paratory works was the potential exposure of investment firms to credit
risks towards unknown counterparties. Article 27 (5) aims to avoid this
occurrence by allowing systematic internalizers to choose ‘on the basis
of their commercial policy’ which investors should have access to their
quotes, provided that they proceed ‘in an objective non-discriminatory
way’. In essence, systematic internalizers are charged with a duty to deal
45
See CESR, Technical Advice on Possible Implementing Measures of the Directive 2004/39/
EC on Markets in Financial Instruments (April 2005), 72. However, the European context
is profoundly different from that in the US, where following the 1975 Securities Acts
Amendments transaction and quotation information from different markets was con-
solidated into a single stream of data available to all market participants and investors.
In Europe, a similar consolidated information system is lacking, whilst stock exchanges
often perform a similar function at national level. Under MiFID, also trade informa-
tion and execution systems other than regulated markets and MTF could be used by
internalizers: for example, a bilateral system operated by the same internalizing fi rm
or a trade execution system operated by an information provider. See Article 31 of the
MiFID’s Implementing Regulation, stating that an investment firm shall be considered
to disclose client limit orders that are not immediately executable if it transmits the order
to a regulated market or MTF that operates an order book trading system, or ensures that
the order is made public and can be easily executed as soon that market conditions allow.
Th is would make it often difficult for investors to fi nd the relevant information, save that
efficient consolidation systems would develop at the initiative of information vendors.
See Article 32 of the MiFID’s Implementing Regulation, stating amongst others that any
arrangement to make information public must facilitate the consolidation of the data
with similar data from other sources.
 bond tr a ding u nder mifid 487

with all market participants and can derogate from this duty only for
reasons concerning the credit and counterparty risks deriving from their
internalization activities. Therefore, systematic internalizers are placed
in a position similar to other ‘trading venues’ such as regulated markets
and MTFs, which are also subject to principles of non-discrimination
with respect to investment intermediaries.46
The reasons for a similar treatment of internalization are made clear by
the formation process of the MiFID: on the one side, the rules just exam-
ined (including those on transparency) have satisfied the incumbent
exchanges’ request for a level playing field; on the other, the internalizers’
duty to deal with all investment intermediaries in a non-discriminatory
fashion has reduced the fear (typical of small- and medium-sized inter-
mediaries in Latin countries) that internalization by large investment
banks may subtract liquidity from the stock exchanges thereby forcing
local intermediaries out of their traditional markets. However, the limits
of the MiFID’s response to internalization are apparent: first, the rele-
vant duties are subject to restrictive conditions, such as the requirement
for internalization to be ‘systematic’ and for shares to be ‘liquid’; second,
the content of these duties has been diluted through the MiFID’s nego-
tiation to the point that their regulatory bite is relatively modest (even
the ‘antidiscrimination’ rule admits for exceptions which can be not too
difficult to invoke in practice).

III. Should MiFID’s transparency requirements

be extended to bond markets?
The MiFID’s transparency rules examined in the preceding paragraph
do not include debt instruments in their scope; also the policy debate
which led to the transplant of the US ‘quote rule’ and ‘limit order
rule’ into European law was limited to share trading. No doubt, the
interest groups involved in the discussion were different for bonds,
which are predominantly traded OTC, with transactions on listed
instruments mainly occurring off-exchange.47 The stock exchanges,
therefore, had small interests at stake with respect to bond trading,
whilst investment and commercial banks joined forces to defend

46
See Ferrarini and Recine, ‘The MiFID and Internalisation’, (note 28, above), 263.
47
See IOSCO, ‘Transparency of Corporate Bond Markets’, (note 8, above), 4–6, specifying
that in Europe the majority of corporate bonds are listed on exchange and yet are traded
off-exchange to a significant proportion.
488 Perspectiv es in fina ncia l r egu l ation

the rents that opaque trading allows them to extract.48 As a result, the
question whether transparency requirements should also apply to bond
markets was set aside under Article 65 (1) MiFID, which provides that
‘the Commission shall, on the basis of public consultation and in the
light of discussions with competent authorities, report to the European
Parliament and Council on the possible extension of the scope of pro-
visions of the Directive concerning pre- and post-trade transparency
obligations to transactions in classes of financial instruments other than
shares’.49 In order to comply with this provision the Commission pub-
lished, in June 2006, a call for evidence that posed a range of questions
relating to possible policy rationales for mandating transparency.50 In
August 2006, the Commission requested CESR to provide initial assist-
ance by conducting a fact-finding exercise in relation to cash bond mar-
kets. Having been requested for further assistance,51 CESR conducted a
public consultation which led the same to issue, in June 2007, an advice
reflecting the comments received.52
The core question dealt with by CESR in its advice, also in light of the
consultations conducted by the same Committee and the Commission,
was whether there would be ‘convincing evidence of a market failure with
respect to market transparency in any of the instrument markets under

48
On rents for dealers see CEPR, European Corporate Bond Markets, (note 8, above), 20,
assuming that bond dealers privately acquire information, which results in differences
of information as ‘some dealers end up with better signals than the others. Th is creates
a winner’s course problem for the latter. They risk getting a better fi ll rate for less profit-
able trades. To make up for these losses, relatively uninformed dealers will widen their
spreads. Th is, in turn, reduces the competitive pressure faced by the better informed
dealers, who also widen their spreads. Such wide spreads generate rents for the deal-
ers’. For a similar analysis, see R. Bloomfield and M. O’Hara, ‘Can Transparent Markets
Survive?’, Journal of Financial Economics, 55 (2000), 425–59.
49
See also the 46th considerandum of MiFID’s Preamble stating: ‘A Member State may
decide to apply the pre- and post-trade transparency requirements laid down in this
Directive to fi nancial instruments other than shares …’.
50
European Commission, Call for Evidence: Pre- and Post-trade Transparency Provisions
of the Markets in Financial Instruments Directive (MiFID) in Relation to Transactions
in Classes of Financial Instruments Other than Shares (12 June 2006). See also the DG
Internal Market and Services working paper including the Feedback statement concern-
ing this consultation (13 November 2006).
51
See the Commission’s Mandate to CESR for technical advice on possible extension of the
scope of the provisions of Directive 2004/39/EC concerning pre- and post-trade trans-
parency obligations to transactions in classes of fi nancial instruments other than shares
(27 November 2006). A similar mandate was given to the European Securities Markets
Expert Group (ESME) on the same date.
52
CESR, Response to the Commission on non-equities transparency, (note 5, above). A similar
report was published by ESME, Non-equity Market Transparency (June 2007).
 bond tr a ding u nder mifid 489

review’.53 The vast majority of the respondents in the consultations felt that
there was no market failure affecting wholesale participants in the second-
ary bond markets that could be attributed to transparency levels. However, a
number of respondents, particularly the private investors group, noted that
bond markets might be a difficult environment for direct retail investors,
who have no access to transparency information on the same basis as other
participants: ‘They might receive less data, or the data they did obtain might
be more delayed, meaning they would be a step behind other participants.’54
The low level of transparency might indeed be the cause of the low level of
direct retail involvement in bonds. CESR further specified that the extent of
information asymmetry may differ depending on the instruments traded.
For more liquid bonds (such as government bonds, supranational and
large corporate issues) the ability to access trading information tends to be
greater.55 As transparency levels reduce, market failures may become more
likely: ‘Price discovery, and thus the ability to assess prices for best execu-
tion purposes, will tend to become more difficult, particularly for smaller
players.’56 CESR’s general answer to the core question at issue was that there
is no evident market failure in respect of market transparency in bond mar-
kets. Yet, smaller participants, including retail investors, might benefit from
receiving access to greater trading transparency, which could also encour-
age higher levels of retail participation in the markets.57 Nonetheless, ‘any
increase in transparency would need to be carefully tailored to ensure that
liquidity provision and levels of competition were not damaged as a result of
dealers reducing or withdrawing their commitment to the markets’.58
The Commission’s Report, which was subsequently published under
Article 65 (1) MiFID, reached similar conclusions.59 With respect to

53
CESR, Response to the Commission on non-equities transparency, (note 5, above), 6,
where possible market failures (such as information asymmetry and market power) are
considered. See also, for an analysis of possible market failures, the ESME’s Report to the
European Commission, (note 52, above).
54
CESR, Response to the Commission on non-equities transparency, (note 5, above), 8.
55
Ibid., this being due to higher levels of multilateral trading and the greater number of
56
two-way quotes made available by dealers. Ibid.
57
Ibid., 9. See, for a similar conclusion, ESME, Non-equity Market Transparency, (note 52,
above), 13, identifying some evidence of sub-optimality with respect to market transpar-
ency in retail bond markets.
58
Ibid., also noting (at 11) that the perspective of mandated pre-trade transparency caused
concern for the risk of a negative impact on dealers’ willingness to provide the markets
with liquidity.
59
DG Internal Market and Services, Working Document, Report on non-equities market
transparency pursuant to Article 65 (1) of Directive 2004/39/EC on Markets in Financial
Instruments (MiFID) (3 April 2008).
490 Perspectiv es in fina ncia l r egu l ation

the retail bond markets, the Commission services accepted CESR’s and
ESME’s view that investors have ‘sub-optimal’ access to price informa-
tion: ‘Clearly, without ready access to bond market prices retail clients
are in no position to check the quality of execution they receive from
their intermediaries, including the competitiveness of the prices they
are quoted.’60 With respect to wholesale markets, the Commission serv-
ices similarly accepted the argument that no convincing case of a market
failure has been made out.61 As a general conclusion, the Commission
argued that there does not seem to be, at this time, a need for expand-
ing the MiFID’s transparency requirements to financial instruments
other than shares.62 Assuming, however, that there is an issue with
respect to retail access to bond market prices, the Commission services
accepted that market participants appear to be well-placed to address
the same through self-regulatory initiatives. Moreover, the Commission
encouraged ‘all designers and implementers of self-regulatory solutions,
including ICMA and SIFMA, to consider carefully the design param-
eters so that retail access to realistic and up-to-date prices is broadened
and deepened to the fullest extent possible consistent with ensuring that
liquidity is not impaired’.63
A few comments may help to better understand the consultations’
outcome. Firstly, a majority of interventions came from trade associa-
tions of banks, securities firms and other professionals.64 This suggests
some degree of caution in assessing the view that wholesale bond mar-
kets would be immune from market failures. No doubt, also buy-side
participants, such as investment fund managers, often concurred in
this view.65 However, they may have acted strategically, fearing that the
costs of regulation, including the potential loss of liquidity from deal-
ers, could be higher than the benefits deriving from increased market
transparency. Secondly, almost all participants shared the view that
retail investors might suffer from information asymmetry, even though
the concept of ‘sub-optimality’ seemed more appropriate than that of
market failure. Broad consensus emerged, however, on the need for rem-
edying this asymmetry through a market-led disclosure mechanism
similar to TRACE. The Commission’s fi nal recommendation was in the

60
Ibid., 10, also specifying that ‘for many retail customers it would be totally impractical
in terms of transaction costs to engage multiple intermediaries and secure competing
quotes prior to each transaction, as institutional investors tend to do’.
61 62 63
Ibid., 10–11. Ibid., 13. Ibid.
64
See CESR, Response to the Commission on non-equities transparency, (note 5, above), 7.
65
See DG Internal Market and Services, (note 50, above), 2.
 bond tr a ding u nder mifid 491

same direction, suggesting self-regulation of post-trade transparency.

Pre-trade transparency did not appear fit for regulation, which would
also require the introduction of an obligation to quote for price infor-
mation to be meaningful. A similar obligation would create problems
like those already seen for the MiFID’s quote rule66 and would adversely
impact bond markets’ microstructures. Thirdly, best execution emerged
as one of the key arguments supporting enhanced market transparency,
which would improve retail investors’ ability to control order execution
by their intermediaries, in addition to helping the latter to comply with
best execution requirements. I will try to develop this argument in the
rest of the chapter, by examining the interaction between transparency
and best execution.

IV. Best execution in transparent bond markets

MiFID is aimed at enhancing competition between trading venues.
As seen with respect to equity markets, the Directive’s opposition to
domestic concentration rules was motivated by competitive concerns.
Moreover, mandatory transparency was introduced to remedy the nega-
tive impact of market fragmentation on price discovery;67 also best exe-
cution was regulated in view of promoting competition between trading
venues, in addition to protecting individual investors. However, as I tried
to show in another paper, the principle of best execution was specified in
ways which could make competition in share trading more difficult for
new entrants and in the end protect the incumbent exchanges.68 After
summarizing the core arguments of my previous paper (a), I will analyse
three examples of bond trading from a best execution and transparency
perspective (b).
(a) MiFID offers a broad definition of best execution69 which deserves
approval, for it is often acknowledged that order execution should be

66
See the preceding paragraph.
67
See Section III.
68
Ferrarini, ‘Best Execution and Competition between Trading Venues – MiFID’s Likely
Impact’, (note 2, above), 404–13.
69
Under Article 21 (1) MiFID, investment firms are required to ‘take all reasonable steps
to obtain, when executing orders, the best possible result for their clients taking into
account price, costs, speed, likelihood of execution and settlement, size, nature or any
other consideration relevant to the execution of the order’. This is a best endeavour obli-
gation, which is met by complying with the provisions foreseen in the following para-
graphs of Article 21. See the AMF, Enforcing the Best-execution Principles in MiFID and
its Implementing Directive (25 July 2006), 7, speaking of a ‘best efforts’ obligation.
492 Perspectiv es in fina ncia l r egu l ation

assessed also on the basis of criteria other than price.70 A flexible concept
of best execution makes competition between trading venues easier, to
the extent that exchanges, MTFs, internalizing firms and other liquid-
ity providers compete both as to price and other aspects of trading. As
a result, new execution venues or entities will emerge and offer trad-
ing functionalities different from those already provided by exchanges.
However, other provisions of the MiFID and the implementing Directive
constrain the flexibility of best execution by making its requirements
more specific.71 Particularly in the case of execution of orders for retail
clients, the best execution factors enumerated by Article 21 (1) of the
MiFID are incorporated, at level 2, in the narrower criterion of ‘total
consideration’.72 Reference to ‘total consideration’ is justified on two
counts. First, it is an easy test to apply for retail clients wishing to moni-
tor the quality of order execution by an investment firm. Second, retail
orders are generally small and relatively easy to execute. Therefore, get-
ting the best price for an instrument and the lowest costs for trading
the same should suffice for best execution purposes. Th is approach has
70
See FSA, Best Execution, Consultation Paper 154 (October 2002); J. Macey and M. O’Hara,
‘The Law and Economics of Best Execution’, Journal of Financial Intermediation, 6
(1997), 188.
71
First, the order execution policy (offering information on execution venues and how to
choose among them) ‘shall at least include those venues that enable the investment fi rm
to obtain on a consistent basis the best possible result for the execution of client orders’
(Article 21 (3) MiFID). It is not enough for investment firms that, for example, internal-
ize execution of orders to refer to the prices made in the exchange where the securities are
listed. Their execution policy should also ‘include’ this exchange (assuming it assures ‘on
a consistent basis’ the best possible result for the firm’s clients). Therefore, the investment
firm should be ready to trade on the relevant exchange and, in any case, should monitor
the prices of internalized trades by periodically comparing the same with those made
in the exchange at issue. Secondly, investment firms should obtain the ‘prior consent’
(which could also be tacit)[71] of their clients to their execution policy and inform the
same about the possibility, when foreseen by this policy, to execute their orders outside a
regulated market or MTF. Moreover, investment firms should obtain the ‘prior express
consent’ of their clients before proceeding to execute their orders outside a regulated
market or MTF. Similar requirements protect the incumbent exchanges by alerting cli-
ents against the risks of off-exchange transactions. At the same time, they underline that
exchange markets offer liquidity and price efficiency. In brief, domestic concentration
rules are replaced by ‘consent’ requirements and by the duty to include the best perform-
ing exchange in a firm’s execution policy.
72
Article 44 (3) of the Commission Directive requires, in similar cases, to determine the
best possible result in terms of total consideration ‘representing the price of the financial
instrument and the costs related to execution, which shall include all expenses incurred
by the client which are directly related to execution of the order, including execution
venue fees, clearing and settlement fees and any other fees paid to third parties involved
in the execution of the order’.
 bond tr a ding u nder mifid 493

an impact on competition between trading venues, to the extent that

reference to the traded instruments’ price puts established and more
liquid venues at a competitive advantage.73
The impact on competition of a narrow best execution concept, such
as that embodied in the total consideration criterion, is manifest when
considering the possibility of including a single execution venue in a
firm’s policy. As argued by CESR in a consultation document, ‘there may
be circumstances in which only one particular execution venue or entity
will deliver the best possible result on a consistent basis for some instru-
ments and orders’.74 It may also be that for other instruments or orders
there are other potential venues. However, the cost of accessing more
than one execution venue directly, to the extent that it would be passed
on to clients, ‘may outweigh any price improvement an alternative venue
might offer’.75 CESR considered that, in similar circumstances, it may
be ‘reasonable’ to decide not to connect to these other venues; nonethe-
less, the investment firm should always consider also the advantages of
indirect access (i.e. transmitting its client orders to another execution
intermediary rather than executing those orders itself).76 In its final doc-
ument CESR, whilst confirming that an investment firm may include a
single entity in its policy, adopted a more general stance by asking the
same ‘to show that this allows it to satisfy the overarching best execution
requirement’.77
(b) Three examples show the complexity of best execution analysis in
bond trading. The first refers to bonds which are only traded OTC, with
liquidity provided by one or more dealers. When the retail customer
asks her broker to buy similar bonds, the latter will look for the best offer
available and execute the transaction with the relevant dealer.78 Given
the transaction’s likely small size, there will generally be no negotiation
of the price with the dealer. If there is no pre-trade transparency, as pres-
ently is generally the case in OTC markets, the broker will ask the deal-
ers for a quote and possibly compare the same with quotes from other

73
No doubt, total consideration also includes transaction costs and, where there is
more than one execution venue, the trading firm’s commissions and costs for execut-
ing an order on each of the eligible venues shall be taken into account (Article 44 (3)
Commission Directive).
74
CESR, ‘Best Execution under MiFID’, Public Consultation (February 2007), 10.
75 76
Ibid. Ibid.
77
CESR, ‘Best Execution under MiFID’, Questions and Answers (May 2007), 8.
78
See, for more information on the microstructure of the European corporate bond
market, CEPR, (note 14, above), 29.
494 Perspectiv es in fina ncia l r egu l ation

dealers through an information provider (such as Bloomberg). If there is

post-trade transparency, as is sometimes the case in domestic bond mar-
kets also for OTC transactions79 and was suggested by the Commission,
the broker will find his task easier and the customer will be able to exer-
cise better monitoring on her order’s execution by the broker. The situ-
ation gets more complex when either the broker is also a dealer for the
security in question or the dealer and the broker belong to the same
group of companies. In similar cases, the relevant provisions on conflict
of interests will also have to be complied with.80
The second hypothetical case refers to bonds which are admitted
to trading on a regulated market and are actually traded on the same
market and on another venue (regulated market or MTF). Assuming
that the broker has access to both venues and that they offer both pre-
trade and post-trade transparency, as often happens with regulated
markets and MTFs also for bond trading, 81 compliance with best exe-
cution will be relatively easy, with order execution taking place in the
venue offering the best price. However, the broker might also choose to
trade bonds on a single venue, in which case best execution is satisfied
by trading on this venue, provided that the performance of the same
is periodically compared with that of the other venue, so as to check
the possibility for the broker to keep only one venue in his execution
policy.82
The third hypothesis is a combination of the previous two. Assume
that bonds are admitted to trading on a regulated market and are traded
both on- or off-exchange. Further assume that the regulated market
offers pre-trade and post-trade transparency, whilst off-exchange trans-
actions are not published under the applicable rules. Briefly, this is a case
of competition between a transparent and an opaque market. Economic
theory predicts that the opaque market will prevail, as dealers in this
market exploit their informational advantage to quote narrower spreads
and earn more profits than their more transparent competitors. In addi-
tion, most dealers choose to be of lower transparency, if allowed to do
79
See CESR, Response to the Commission on non-equities transparency, (note 5, above),
Annex ‘Existing trading transparency in Europe for listed bonds’.
80
See Articles 13 (3) and 18 MiFID, and Ch. II, sec. 4, MiFID’s Implementing Directive. For
a critical view, see L. Enriques, ‘Confl icts of Interest in Investment Services: The Price
and Uncertain Impact of MiFID’s Regulatory Framework’, in Ferrarini and Wymeersch,
Investor protection in Europe, (note 2, above), 321–338.
81
See the Annex, ‘Existing trading transparency in Europe for listed bonds’, (note 79,
above).
82
See CESR’s criteria, (notes 74 and 77, above), and accompanying text.
 bond tr a ding u nder mifid 495

so.83 From a best execution perspective, the broker in our example will
choose the best offer from either market; assuming that opaque dealers
quote the best prices, the broker will transact off-exchange. However,
the broker is not bound to ask all dealers, if there are information costs.
Moreover, the client will have difficulties in assessing the quality of
order execution, if the off-exchange market is opaque and the exchange
prices are often worse that those made for off-exchange transactions.
If post-trade transparency were mandated for all transactions, the two
markets would compete on a level playing field and the clients would
better monitor the quality of their brokers’ order execution.

V. Conclusion
The examples just analysed confirm that transparency is important for
best execution in bond trading and that market-led solutions directed to
enhance post-trade transparency deserve approval. In the case of regu-
lated markets and MTFs, both pre-trade and post-trade transparency are
often already available. For OTC transactions pre-trade transparency is
more difficult to obtain, as changes to the market microstructure may be
needed. Post-trade transparency, on the contrary, is feasible for OTC mar-
kets. However, a crucial question needs to be answered, concerning the
time when the relevant information should be published.84 In view of the
Commission’s consultation, the International Capital Markets Association
(ICMA) sent a questionnaire to its members concerning possible market-
led mechanisms for bond market transparency.85 The questionnaire set
out two non-mutually exclusive options, which were designed to help
retail investors, while avoiding liquidity problems for firms: ‘Option 1
is a Price Service, which would involve publishing, at the end of the day,
an average of the closing bid and offer quotes for each reportable security
and the high, low and average prices for each bond trade which has been
reported to ICMA. Option 2 is a Single Trade Publication Service, which
would involve publishing trades in large investment grade bonds above a
specified minimum level and below a specified upper size limit.’86
These proposals show some of the core questions to be addressed
when setting-up post-trade disclosure for debt securities. First, should
83
See Bloomfield and O’Hara, ‘Can Transparent Markets Survive?’, (note 48, above).
84
See, for an analysis, CEPR, European Corporate Bond Markets, (note 8, above), 68–69.
85
‘The ICMA Bond Market Transparency Questionnaire: Assessment of Responses’ (21
May 2007).
86
See, for details of these options, Annex B of the Questionnaire.
496 Perspectiv es in fina ncia l r egu l ation

real-time or end-of-day publication of data be chosen? No doubt, delayed

publication is favoured by most dealers; however real-time (or close to
real-time) information would be more helpful from a best execution per-
spective.87 Second, should post-trade transparency only apply to liquid
bonds or also to illiquid ones? Again, dealers tend to favour limiting
transparency to markets which are already liquid; yet, from an investor’s
perspective, the benefits of transparency would emerge particularly in
the case of illiquid markets.88 Third, what size of transactions should be
covered? If the principal aim is to protect retail investors, information
should also be published for relatively small sizes, while trade informa-
tion concerning blocks is less needed (and dealers would no doubt object
to real time publication of the same). The Commission, despite being
aware of the numerous trade-offs between transparency and liquidity,
restrained from doing more than suggesting a ‘careful’ design for self-
regulatory initiatives.89 It remains to be seen, however, whether market
participants will be able to solve their collective action problems and
strike the right balance between transparency and liquidity, without
regulators intervening either to ‘inspire’ self-regulation informally or to
set a general framework for market-driven solutions.90

87
See, however, ESME, Non-equity Market Transparency, (note 52, above), 16, stating that
‘it does not appear that there would be significant additional benefit to retail investors
from the provision of real-time publication’.
88
See however CEPR, European Corporate Bond Markets, (note 8, above), 65, arguing
that for less liquid bonds the impact of transparency on liquidity could be a real issue;
ESME, Non-equity Market Transparency, (note 52, above), 16, stating that ‘information
is unlikely to be of much value [to retail investors] in illiquid markets where a bond may
go for weeks or months without being traded’.
89
See the text accompanying note 63, above.
90
This is the case of Consob in Italy, which requires regulated market operators and MTFs
to include in their market rules ‘adequate’ provisions on pre- and post-trade transparency
for non-equity instruments (Article 32 of Consob’s Markets Regulation), and systematic
internalizers to similarly adopt transparency mechanisms differentiated depending on
market microstructure, type of instrument and type of investor (Article 33). On the Italian
approach to bond market regulation, see C. Salini, ‘Bond Markets in Italy: Transparency
and Regulatory Issues’ (19 March 2007), available at www.consob.it.
 27

The statutory authority of the European

Central Bank and euro-area national central
banks over TARGET2-Securities*
Peter O. Mülbert and R ebekk a M. Wieman n

I. Introduction
As an academic as well as a banking and securities regulator, the dedica-
tee of this volume has made significant contributions to the integration
of European fi nancial markets. Accordingly, the topics of his publi-
cations reflect the ongoing integration process of European fi nancial
markets and of European securities markets, in particular. While, at
the outset, his interests focused on securities regulation in Europe,1 he
has recently turned to studying the various initiatives to render clearing
and settlement in Europe more efficient.2 Indeed, while safe and efficient
clearing and settlement systems are universally acknowledged as being
an essential factor in the creation of an integrated European fi nancial
market, 3 numerous obstacles still exist that render cross-border securi-
ties transactions costly and less efficient than ultimately possible.
TARGET2-Securities (in fi nancial jargon ‘T2S’) is one of the most
advanced steps towards a more efficient and sound clearing and set-
tlement infrastructure for the European securities market. The project

* May 2008. Any subsequent developments could not be taken into account.
1
E. Wymeersch, ‘Securities Market Regulations in Europe’ in A.M. George, and I.H. Giddy
(eds.), International Finance Handbook (New York: Wiley, 1982), 1–51; idem, ‘Europese
Effectenreglementering’, in J. R. Schaafsma and E. Wymeersch (eds.), Bescherming van
beleggers ter beurze, Vereniging Handelsrecht (Zwolle: W.E.J. Tjeenk Willink, 1986),
271–392; idem, ‘The EEC and the Eurosecurities Markets’, Singapore Conference on
International Business Law (1987).
2
E. Wymeersch, ‘Securities Clearing and Settlement: Regulatory Developments in
Europe’, in G. Ferrarini and E. Wymeersch (eds.), Investor Protection in Europe, (Oxford
University Press, 2006), 465 et seq.
3
See the European Commission, Financial Services: Implementing the Framework for
Financial Markets: Action Plan (1999), http://ec.europa.eu/internal_market/fi nances/
docs/actionplan/index/action_en.pdf).

497
498 Perspectiv es in fina ncia l r egu l ation

undertaken by the Eurosystem, i.e., the European System of Central

Banks (ESCB) known as ‘the European Central Bank (ECB) and the
national central banks (NCBs) of those Member States whose currency
is the euro’4, aims at creating a settlement service for securities transac-
tions linked to the existing Europe-wide cash settlement system known
as TARGET2. The project is praised as being ‘ground-breaking’5 or even
as an ‘opportunity to jointly shape the future’,6 but has also met with
severe criticism,7 sometimes to the point of outright rejection.
One of the controversial issues raised almost at the outset was whether
European law confers the statutory authority on the euro-area central
banks (CBs), i.e. the ECB and the euro-area NCBs, to develop a securi-
ties settlement infrastructure. Although those denying the Eurosystem’s
legal power – in practice critics doubted the ECB’s power in particular –
have become fewer and most market participants seem to accept the
Eurosystem’s initiative, the question of whether the euro-area CBs can
claim a sufficient legal basis for setting up and operating such a facility
remains essential for the realization of the entire project.
This chapter, in seeking to provide a definite answer, is organized
as follows. Starting with a brief overview of the other initiatives in
the field of clearing and settlement (Section II), it goes on to give a
brief description of TARGET2-Securities and to explain some per-
tinent key features (Section III). The main section (Section IV) then
examines whether the euro-area CBs are empowered to implement
TARGET2-Securities. It first sets out basic assumptions offering
inter alia some clarifications as to the relationship between the ESCB
and the Eurosystem, on the one hand, and the interplay between the
Eurosystem and the ECB/NCBs, on the other hand. Building on that
analysis, it then examines in some detail the relevant provisions that
might confer the authority on the euro-area CBs to set up and oper-
ate TARGET2-Securities. The essay ends by offering some concluding
remarks (Section V).

4
Hence, the term ‘Eurosystem’ is not only a shorthand for ‘the ECB plus the euro-area
NCBs’, but denotes a particular version of the ESCB. As to this interpretation, see infra
IV.A. in more detail.
5
M. Godeff roy, ‘Ten frequently asked Questions about TARGET2-Securities’ (available at
www.ecb.int/paym/t2s/defi ning/outgoing/html/10faq.en.html).
6
J. Tessler, ‘An Opportunity to jointly shape the Future’, TARGET2-Securities Newsletter
No. 2, August 2007, 3 (available at www.ecb.int/paym/t2s/pdf/T2S_Newsletter_070829.
pdf).
7
E.g., J. Mérère, ‘The Devil is in the Detail’, Finanzplatz (January 2007), 18.
 Statutory author it y ov er TA RGET-Secu r ities 499

II. Overview of other initiatives in the

field of clearing and settlement8
Taking existing EU legislation as a starting point, some directives con-
tain provisions relevant for certain aspects of securities clearing and set-
tlement activities. This is particularly true for the Settlement Finality
Directive (SFD) of 1998,9 but also for the Collateral Directive of 2002,10
and – to a certain extent – the (recast) Banking Directive of 200611 and
the (recast) Capital Adequacy Directive of 2006.12 Even some provi-
sions of the Markets in Financial Instruments Directive (MiFID)13 have
an effect on the clearing and settlement infrastructure, e.g. Article 34,
which gives a right of access to an investment firm in one Member State,
on a non-discriminatory basis, to the clearing and settlement system
of another Member State. However, these provisions do not consti-
tute a comprehensive framework for securities clearing and settlement
activities, but rather form a partial patchwork regulating only specific
problems.
The European Commission, following its Financial Services
Action Plan of 1999,14 set up a group of financial market experts,
chaired by Alberto Giovannini, to analyse the status quo of the
European financial market. The Giovannini Group, in its first report
on clearing and settlement within the EU, identified fifteen barri-
ers rendering cross-border securities transactions inefficient (often
called Giovannini barriers), and, in its second report on the same
topic, suggested a set of actions to eliminate these barriers.15 Building

8
For more details see Wymeersch, ‘Securities Clearing and Settlement’, (note 2, above),
470–83; K.M. Löber, ‘The Developing EU Legal Framework for Clearing and Settlement
of fi nancial Instruments’, European Central Bank, Legal Working Paper Series, No. 1,
February 2006; H. Beck, ‘Clearing und Settlement im Fokus europäischer Rechtspolitik’,
in K.P. Berger, G. Borges, H. Heermann, A. Schlüter, and U. Wackerbarth (eds.), Zivil-
und Wirtschaftsrecht im Europäischen und Globalen Kontext (Berlin: De Gruyter, 2006),
669–95.
9
Directive 98/26/EC [1998] OJ L 166/45.
10
Directive 2002/47/EC [2002] OJ L 168/43.
11
Directive 2006/48/EC [2006] OJ L 177/1.
12
Directive 2006/49/EC [2006] OJ L 177/201.
13
Directive 2004/39/EC [2004] OJ L 145/1.
14
European Commission, Financial Services: Implementing the Framework for Financial
Markets: Action Plan (note 3, above).
15
The Giovannini Group, Cross-Border Clearing and Settlement Arrangements in the
European Union, Brussels (November 2001); idem, Second Report on EU Clearing and
Settlement Arrangements, Brussels, April 2003, http://ec.europa.eu/internal_market/
fi nancial-markets/docs/clearing/second_giovannini_report_en.pdf.
500 Perspectiv es in fina ncia l r egu l ation

on the second Giovannini report, the European Commission in its

Second Consultative Communication on Securities Clearing and
Settlement16 proposed the preparation of a framework Directive on
Clearing and Settlement and the establishment of three groups of
experts: the Clearing and Settlement Advisory and Monitoring Expert
Group (CESAME), the Legal Certainty Group (LCG) and the Fiscal
Compliance Expert Group (FISCO).17
In the meantime, since the former goal of removing the Giovannini
barriers within a time period of three years has proved to be unreal-
istic, the European Commission has reversed its approach. Instead of
pursuing the preparation of a framework Directive, the Commission
has asked the market participants to agree on a Code of Conduct18 that
contains specified commitments of trading and post-trading infra-
structure providers. According to the European Commission’s report
to the ECOFIN in July 2007,19 the Code of Conduct has already had
a positive impact. However, this does not imply that further activi-
ties are unnecessary. Quite the contrary, the FISCO report of October
200720 will serve the Commission as a basis for further discussions
with Member States on future EU initiatives to simplify and mod-
ernize tax procedures applied to financial assets. Likewise, the LCG
report, due in mid-2008, is expected to outline proposals for substan-
tial EU legislation – probably either in the form of a Directive or a
Regulation – dealing with substantive legal aspects of clearing and
settlement.
A working group was established by the European System of Central
Banks (ESCB) in collaboration with the Committee of European
Securities Regulators (CESR) to elaborate common standards or recom-
mendations for securities settlement systems and to enhance the safety

16
Clearing and Settlement in the European Union – The way forward, Communication
from the Commission to the Council and the European Parliament, COM(2994) 312
fi nal.
17
For further information on the expert groups, see http://ec.europa.eu/internal_market/
fi nancial-markets/clearing/index_en.htm.
18
European Code of Conduct for Clearing and Settlement of 7 November 2006, http://
ec.europa.eu/internal_market/fi nancial-markets/docs/code/code_en.pdf.
19
Improving the Efficiency, Integration and Safety and Soundness of Cross-border Post-
trading Arrangements in Europe, Report to the ECOFIN, 25 July 2007, http://ec.europa.
eu/internal_market/financial-markets/docs/clearing/ecofi n/20070725_ecofi n_en.pdf.
20
The Fiscal Compliance Experts’ Group, Solutions to Fiscal Compliance Barriers Related
to Post-trading within the EU, Second Report 2007, http://ec.europa.eu/internal_market/
fi nancial-markets/clearing/compliance_en.htm.
 Statutory author it y ov er TA RGET-Secu r ities 501

and efficiency of cross-border securities clearing and settlement activities

within the EU. Building on the CPSS/IOSCO recommendations,21 but
seeking to adapt these global recommendations to European circum-
stances, the group elaborated the Standards for Securities Clearing and
Settlement within the European Union,22 nineteen standards aimed
at rendering securities clearing and settlement systems within the
European Union safer, more efficient and sound.23
Still further initiatives within Europe are undertaken by the European
Financial Markets Lawyers Group (EFMLG), a group established in
1999 following a Eurosystem initiative and composed of European
lawyers working for major credit institutions active in the European
financial market. The EFMLG’s work aims at promoting the harmoni-
zation of EU financial market activities through legal initiatives. In its
report ‘Harmonisation of the legal Framework for Rights evidenced by
book-entries in respect of certain financial Instruments in the European
Union’24 the EFMLG observed barriers to cross-border securities
transactions similar to those identified by the Giovannini Group. The
EFMLG formulated recommendations calling for further EU legislation
in the form of directives and supporting the (as it was called at the time)
EU Securities Account Certainty Project, proposed by the Giovannini
Group.
Looking beyond Europe, some global initiatives show parallels to the
work currently being undertaken in the EU, e.g. the ‘Convention on the
Law Applicable to certain Rights in respect of Securities held with an
Intermediary’25 concluded by the Hague Conference in 2002 and signed
by two signatories – Switzerland and the US – in 2006 (dealing with
matters that are addressed albeit differently within the EU by the SFD
and other EC legal acts). Another initiative is UNIDROIT’s project on
Intermediated Securities. The original text of the ‘Preliminary draft

21
CPSS/IOSCO, Recommendations for Securities Settlement Systems, November 2001,
www.bis.org/publ/cpss46.pdf.
22
The ESCB-CESR Standards for Securities Clearing and Settlement in the European
Union, www.ecb.int/pub/pdf/other/escb-cesr-standardssecurities2004en.pdf.
23
Critical, then, Bundesverband Deutscher Banken, Europäische Wertpapiermärkte –
Konsolidierung des Rechtsrahmens, Berlin, January 2006, 34.
24
European Financial Markets Lawyers Group, Harmonisation of the legal Framework
for Rights evidenced by book-entries in Respect of certain financial Instruments in the
European Union, European Central Bank, June 2003.
25
Hague Conference on Private International Law, ‘Convention on the Law Applicable to
Certain Rights relating to Securities held with an Intermediary’, 5 July 2006, www.hcch.
net/index_en.php?act=conventions.text&cid=72.
502 Perspectiv es in fina ncia l r egu l ation

Convention on harmonized substantive Rules regarding Securities held

with an Intermediary’ of 2004 was further developed during the inter-
national negotiation process that took place between May 2005 and May
2007. In September 2008, a diplomatic conference is planned to be held
in Geneva to adopt a ‘Convention of substantive rules regarding inter-
mediated securities’.26

III. TARGET2-securities: main features of the project27

On 7 July 2006, the ECB’s Governing Council announced that the
Eurosystem is evaluating opportunities to provide settlement services
for securities transactions. Having drafted the project’s rough features,
the Eurosystem launched feasibility studies which came to the conclu-
sion that the project was operationally, legally, economically and techni-
cally feasible.28 A first consultation paper, that framed the cornerstones
of TARGET2-Securities by setting up twenty principles and sixty-seven
high-level proposals, was published in March 200729 on which market
participants could comment by June 2007.30 Working groups, designed to
allow a variety of institutions to participate, elaborated the user require-
ments which were fully articulated by the end of 2007.31 A second public
consultation was launched in December 2007. Market participants were
invited to comment on the TARGET2-Securities user requirements

26
For the Preliminary Draft and further information on Study 78 on intermediated
securities, see www.unidroit.org/english/workprogramme/study078/item1/main.htm.
27
As to the following, cf. Godeff roy, ‘Ten frequently asked questions about TARGET2-
Securities’ (note 5, above); ECB, TARGET2-Securities, The Blueprint (8 March 2007),
www.ecb.int/pub/pdf/other/t2sblueprint0703en.pdf; ECB, T2S Progress Report (26
October 2007), www.ecb.int/pub/pdf/other/t2s-progressreport200710en.pdf.
28
The feasibility studies are available at www.ecb.int/paym/t2s/decisions/html/
nextphase.en.html.
29
ECB, T2S Consultation Paper: General Principles and high-level Proposals for the User
Requirements (26 April 2007), www.bundesbank.de/download/zahlungsverkehr/t2s_
us_070426.pdf.
30
For an overview of the market participants’ reactions see I. Terol, ‘How have the
Principles and Proposals been reviewed after the Consultation?’, presentation, T2S info
session 29 August 2007, www.ecb.int/paym/t2s/pdf/outgoing/t2s_infosession_070829_
presentation1.pdf.
31
ECB, T2S – The User Requirements (12 December 2007), www.ecb.int/ecb/cons/shared/
fi les/T2S_urd_chapters.pdf; a summary of the user requirements can be found at www.
ecb.int/ecb/cons/shared/fi les/T2S_urd_management_summary.pdf. For a description
of the TARGET2-Securities governance structure cf. TARGET2-Securities Newsletter
No. 1, June 2007, www.ecb.int/paym/t2s/pdf/T2S_Newsletter.pdf, 3 et seq. or the
(shorter) overview at www.ecb.int/paym/t2s/defi ning/html/index.en.html.
 Statutory author it y ov er TA RGET-Secu r ities 503

and the methodology for the assessment of the economic impact of the
project by April 2008.32 The ECB assumes the project will be concluded
by 2013, at the latest.33
The objective of TARGET2-Securities is to maximize safety and
efficiency in the settlement of euro-denominated securities transac-
tions. The main features of the project, as so far determined, are as
follows:
TARGET2-Securities will be a single, purely technical platform pro-
viding harmonized IT settlement services to central securities deposito-
ries (here below referred to as ‘CSDs’) based on the TARGET2 platform, 34
a technical platform for the settlement of payment instructions. It will
be established as well as fully owned by the Eurosystem35 and techni-
cally operated on behalf of four of the Eurosystem NCBs (Bundesbank,
Banque de France, Banca d’Italia and Banco de España).36 TARGET2-
Securities will allow the simultaneous (real-time) booking of both legs of
a transaction in securities , i.e. the payment in (exclusively) central bank
money and the transfer (of title) of the securities on a single IT-platform
(integrated model). In more detail:
The ECB/Eurosystem will not operate as a CSD37 since it will not
legally maintain securities accounts for CSDs, 38 or even less for banks
that are clients of such a CSD. Instead, the account and legal relation-
ships remain exclusively between CSDs and their clients, i.e. the banks
holding securities accounts with the CSDs also manage the account
relationships among the different CSDs (the legal arrangements
between CSDs will, however, be affected by the harmonized terms and
conditions governing the settlement services provided by TARGET2-
Securities)39. From this it follows that cross-border and cross-CSD
securities transactions will still be effected by book entries in securities

32
ECB Press Release of 18 December 2007, www.ecb.int/press/pr/date/2007/html/
pr071218.en.html.
33
Speech by G. Tumpell-Gugerell, Member of the Executive Board of the ECB at the
Journal of Financial Transformation dinner London, 27 September 2007, www.ecb.int/
press/key/date/2007/html/sp070927.en.html.
34
General Principles (note 29, above), 4, principle 2.
35
ECB Press Release 7 July 2006, www.ecb.int/press/pr/date/2006/html/pr060707.en.html;
General Principles (note 29, above), 4, principle 1.
36
Questions and Answers on TARGET2-Securities, 8 March 2007, www.ecb.int/press/
pressconf/2007/html/is070308.en.html#t2s.
37
General Principles (note 29, above), 4, principle 3.
38
General Principles (note 29, above), 5, principle 4.
39
General Principles (note 29, above), 7, principle 15.
504 Perspectiv es in fina ncia l r egu l ation

accounts held by CSDs’ clients with CSDs or by CSDs with one another.
Moreover, the question of whether the T2S’s booking of a security from
one account to another perfects a transfer of title, and at what point
in time it does so, lies outside the scope of TARGET2-Securities, and
is determined solely by the national law(s) applicable to the transac-
tion. In this respect TARGET2-Securities will neither alter the present
situation nor will national legislative adaptations be necessary for the
implementation of TARGET2-Securities (even if legal harmoniza-
tion would be desirable to improve integration).40 However, T2S may
increase (even in the absence of legal harmonization of substantive law)
the predictability of and legal certainty on the completion of the legal
transfer, due to the transfer order fi nality on both sides of a cross-sys-
tem transaction and the standardized simultaneous settlement in T2S
in the accounts of both CSDs involved resulting in the legal exchange of
cash and securities.
What the ECB/Eurosystem will provide is the TARGET2-Securities
platform, i.e. the integrated IT-platform allowing for the simulta-
neous booking of cash transactions in cash accounts held with the
Eurosystem central banks by CSDs or their customers, as well as
securities transactions in securities accounts held with the CSDs. The
database functionality required will be restricted to the basic role of
collocating and electronically storing account-related data in a com-
mon technical location.41 All CSDs are eligible under equal-access
conditions 42 to participate in TARGET2-Securities,43 but not required
to do so. TARGET2-Securities will operate on a non-profit-making
basis.44 As regards the relationship between cash transactions and
securities transactions, TARGET2-Securities is planned to operate fol-
lowing the so-called Delivery versus Payment (DVP) model 1, which in
T2S means simultaneous real-time delivery versus payment settlement
in central bank money for domestic and cross-border transactions of
securities.45

40
TARGET2-Securities, Legal Feasibility Study (8 March 2007), 6. Admittedly, the study
assumes that the soundness and efficiency of TARGET2-Securities could be strength-
ened by further harmonization in this respect (available at www.ecb.int/pub/pdf/other/
t2slegalfeasibility0703en.pdf).
41
TARGET2-Securities, Legal Feasibility Study (note 40, above), 1.
42
General Principles (note 29, above), 7, principle 14, principle 12.
43
General Principles (note 29, above), 7, principle 13.
44
General Principles (note 29, above), 8 principle 18.
45
TARGET2-Securities, Legal Feasibility Study (note 40, above), 2.
 Statutory author it y ov er TA RGET-Secu r ities 505

IV. Legal assessment

A. Basics
The starting point for a legal analysis of TARGET2-Securities is a seem-
ing puzzle. On the one hand, as mentioned above, the Eurosystem is said
to be the full owner and operator of TARGET2-Securities, whereas, on
the other hand, critics have disputed the legal authority of the ECB (and
the NCBs) to operate the system.
These divergences obviously beg the question whether the
Eurosystem is a separate actor from the ECB and the NCBs, or whether
the term is just an abbreviation for denoting the ECB and the NCBs.
The problem is compounded by the fact that the EC Treaty as well as the
Statute of the European System of Central Banks and of the European
Central Bank (‘ESCB/ECB Statute’) only deal with the ESCB but do
not employ the term Eurosystem at all. Moreover, both the EC Treaty
as well as the ESCB/ECB Statute invest the ESCB with tasks and, in
order for these tasks to be carried out, confer certain legal powers on
the ECB and the NCBs.
Against this backdrop, any meaningful discussion of the question
whether the EC Treaty and/or the ESCB/ECB Statute actually confer the
legal authority required on the actor owning and operating TARGET2-
Securities presupposes some prior clarifications as to the nature of the
Eurosystem and its relationship with the ESCB on the one hand and the
ECB on the other hand.

1. ESCB and the Eurosystem

The Eurosystem according to the definition given in Article 9 Sentence
2 of the Rules of Procedure of the ECB46 means ‘the European Central
Bank (ECB) and the national central banks of those Member States
whose currency is the euro’. By contrast, the EC Treaty and the ESCB/
ECB Statute only refer to the European System of Central Banks defined
by Article 107 (1) EC Treaty as being ‘composed of the ECB and of the
central banks’ of all Member States.
However, this neither implies that the Eurosystem lacks a legal foun-
dation in primary community law nor that the ESCB and the Eurosystem
form two different organizations existing alongside one another. In par-
ticular, it would be misleading to conceive of the Eurosystem as a subset
of the ESCB. Rather, it is more appropriate to say that the EC Treaty as

46
Decision ECB/2004/2 [2004] OJ L 080/33.
506 Perspectiv es in fina ncia l r egu l ation

well as the ESCB/ECB Statute – despite the defi nition given by Article
107 (1) EC Treaty – attribute two different meanings to the term ‘ESCB’.
Depending on the Article in question, the term ‘ESCB’ must be con-
strued either in the sense of Article 107 (1) EC Treaty as ‘the ECB and
the NCBs of all Member States’ or, as is most often the case, in the sense
of Article 9 Sentence 2 of the Rules of Procedure of the ECB, i.e. as ‘the
ECB and the euro-area NCBs’. Moreover, the term ‘Eurosystem’ does
not denote any distinct organization existing apart from the ESCB but
denotes the ESCB in its latter quality, i.e. the ESCB comprising the ECB
and euro-area NCBs.
Art. 122 (3) and (4) EC Treaty and Art. 43 (1), (3) and (4) ESCB/ECB
Statute determine for the provisions of the EC Treaty and the ESCB/ECB
Statute respectively whether those provisions address the ESCB in the
sense of Art.107 (1) EC Treaty or in the sense of the ‘Eurosystem’. The
reading depends on whether those provisions according to the defi ni-
tion given by Art. 122 (3) and (4) EC Treaty and Art. 43 (1), (3) and (4)
ESCB/ECB Statute refer to (the NCBs of) all Member States or only to
(the NCBs of) euro-area Member States.

2. Legal nature of the ESCB/Eurosystem

The ESCB/Eurosystem, as is universally admitted, has no legal personal-
ity of its own. This follows a contrario from Article 107 (2) EC Treaty and
Article 9.1 ESCB/ECB Statute which, both, award legal personality only
to the ECB.
Most commentators even assert that the ESCB/Eurosystem has no
existence of its own, i.e. that it does not exist as a separate organiza-
tion. Instead, the ESCB/Eurosystem is labelled as being an institutional
framework of rules establishing a link between the ECB and the (euro-
area) NCBs,47 or even reduced to the status of being nothing more than
an abbreviation denoting the ECB and the (euro-area) NCBs.48
On the other hand, according to the ECB’s presentation, TARGET2-
Securities will be fully owned and operated by the Eurosystem. In line
with this, recital 4 of the ECB’s guideline on a Trans-European Automated
Real-time Gross settlement Express Transfer system (TARGET2) pro-
vides for the ECB, ‘[a]cting on the Eurosystem’s behalf’, to enter into a
47
H.K. Scheller, The European Central Bank – History, Role and Functions, 2nd edition
(Frankfurt: ECB, 2006), 42.
48
W. Kahl and U. Häde, ‘Art. 107 EC Treaty’ in C. Callies and M. Ruffert, Das
Verfassungsrecht der Europäischen Union, 3rd edition (Munich: Beck, 2007), No. 2 (with
further references).
 Statutory author it y ov er TA RGET-Secu r ities 507

contract with a service provider.49 Both documents strongly hint at the

ECB’s willingness to accept the Eurosystem as an organizational actor in
its own right, even though these statements would not be in line with the
primary Community law just described if they meant to attribute to the
Eurosystem a legal personality of its own.
Indeed, primary Community law, i.e., the provisions of the EC Treaty
and those of the ESBC/ECB Statute, the latter being a Protocol to the EC
Treaty and therefore also part of primary Community law,50 is rather
ambiguous as to the nature of the ESCB/Eurosystem.
At a first glance, the ESCB/Eurosystem seems to form an organiza-
tional entity, being endowed with certain tasks, members, and deci-
sion-making bodies which, for the lack of a legal personality of its own,
cannot as such enter into any legal relationship with third parties, i.e.,
non-members. According to this interpretation, the tasks are set out
in Article 105 (2) EC Treaty as well as in Article 3 ESCB/ECB Statute,
whereas Article 107 (1) EC Treaty determines membership. With regard
to the system’s own decision-making bodies, Article 107 (3) EC Treaty
entrusts the decision-making bodies of the ECB with governing the
ESCB/Eurosystem, as well. Thus, while the ESCB/Eurosytem arguably
lacks institutions (‘Organe’) of its own, it is governed (cf. Art. 105 (1) EC
Treaty) internally through the pertinent decision-making bodies of the
ECB. Whereas, the operational tasks are carried out by the central banks
forming part of the Eurosystem (Art 9.2., Art 16 et seq. ESCB/ECB-
Statute) putting, under the principle of decentralization, an emphasis
on the NCBs with regard to the fulfi lment of operational tasks (Art 12.1
(3) of the ESCB-Statute). Put differently, with regard to inner-organiza-
tional decisions the ESCB/Eurosystem – as opposed to the ECB – takes
decisions by relying on the latter’s decision-making bodies. By contrast,
with regard to activities vis-à-vis third parties, Articles 18 et seq. ESCB/
ECB Statute confer the power to act on the ECB and euro-area NCBs as
legal persons.
Serious doubts still remain. Even if one were to conceive of the ESCB/
Eurosystem as an organizational entity in its own right, the existence

49
Guideline ECB/2007/2 [2007] OJ L 237/1.
50
R. Smits, ‘Art. 105 EC Treaty’, in H. von der Groeben and J. Schwarze (eds.), Vertrag
über die Europäische Union und Vertrag zur Gründung der Europäischen Gemeinschaft,
commentary, 4 vols., 6th edn (Baden-Baden:, Nomos, 2003), vol. III, No. 20; B. Kempen,
‘Article 105 EC-Treaty’, in R. Streinz (ed.), EUV/EGV Vertrag über die Europäische Union
und Vertrag zur Gründung der Europäischen Gemeinschaften, commentary (Munich:
Beck, 2003), No. 15 (referring to Article 311 EC-Treaty).
508 Perspectiv es in fina ncia l r egu l ation

of such a system would not entail any practical consequences, at all. To

begin with, any decisions taken on behalf of the ESCB/Eurosystem are
at the same time decisions taken by the ECB, since the latter’s decision-
making bodies also govern the ESCB/Eurosystem. Article 110 (1) EC
Treaty is testimony to this, since it explicitly stipulates that, in order to
carry out the tasks entrusted to the ESCB, the ECB shall make regula-
tions, take decisions and make recommendations. Moreover, the actions
of the system’s members, i.e. of the ECB and the NCBs, are not governed
by the decision-making bodies of the ESCB/Eurosystem, but by those
of the ECB. With respect to the NCBs, Article 14.3 ESCB/ECB Statute
provides for the ECB (by way of its decision-making bodies) to issue
guidelines and instructions for the NCBs to follow when acting in their
capacity as an integral part of the ESCB/Eurosystem.
On balance, then, in line with the prevailing interpretation, the
ESCB – and the same holds true for the Eurosystem, as well – is to be
understood as shorthand meaning ‘the ECB and the (euro-area) NCBs’.
Hence, for present purposes, whether any actor is empowered to imple-
ment TARGET2-Securities is to be discussed solely with respect to the
ECB and the euro-area NCBs.

B. Statutory power of the ECB/euro-area NCBs over

TARGET2-Securities
Before embarking on a detailed analysis of whether the EC Treaty and/
or the ESCB/ECB Statute confer the legal authority to set up and oper-
ate TARGET2-Securities on the ECB and the euro-area NCBs, it seems
worthwhile to briefly point out that the settlement of securities trans-
actions is a not uncommon function of central banks. Currently, for
example, the central banks of the United States, Japan, Belgium, Greece
and Portugal are active in this field.51 In addition, in the last twenty
years the central banks of France, the UK, Spain, 52 Italy, Ireland, the
Netherlands and Finland (as major shareholders) were involved in
securities settlement but gave up their involvement in the context of the
de-mutualization and privatization of their securities exchanges dur-
ing the 1990s.
51
G. Tumpel-Gugerell, ‘Speech at the EU Commission’s Conference on The EU’s new
Regime for Clearing and Settlement in Europe’, 30 November 2006, Brussels, www.ecb.
int/press/key/date/2006/html/sp061130_1.en.html.
52
Godeff roy, ‘Ten frequently asked Questions about TARGET2-Securities’, (note 5,
above).
 Statutory author it y ov er TA RGET-Secu r ities 509

Admittedly, the involvement of other central banks in the settle-

ment of securities does not predicate anything about whether any of
the actors just mentioned is empowered to execute such actions given
the current legal regime. However, it illustrates by way of example that
this field of activity is not alien to the operation of a central bank (some
of which are in fact euro-area NCBs). Indeed, in comparison with
TARGET2-Securites, most of these central banks assert a much more
substantive role in securities settlement, e.g. the US Fedwire System
also acts as CSD. 53

1. Principle of limited transfer of powers to the

ECB/euro-area NCBs
The starting point for an analysis of whether the EC Treaty and/or
the ESCB/ECB Statute confer the authority to implement TARGET2-
Securities on the euro-area CBs, i.e. the ECB and the euro-area NCBs is
the principle of limited transfer of powers.
The EC does not possess comprehensive jurisdiction, but can only act
insofar as sovereign rights have been transferred by Member States in
accordance with the principle of limited transfer of powers from Member
States to the EC (‘compétence d’attribution’). The principle of limited
transfer is not only applicable as far as the regulatory power of the
EC is concerned (Article 5 (1) EC Treaty), but also with respect to the EC
institutions (‘Organe’) (Article 7 (1) EC Treaty). Thus, each institution
can only act insofar as it has been assigned authority.54
The ECB is arguably not an institution of the EC (see Article 7, Article
8 EC Treaty) since it was established and given a legal personality of
its own by Article 107 (2) EC Treaty.55 Its exact legal nature is contro-
versial.56 However, since its powers are formed on a similar basis to an
institution of the EC,57 any action by the ECB requires a basis of authori-
zation, i.e. a legal basis. This applies for any kind of action – lawmaking
as well as other forms of acting. From this it follows that for the ECB

53
E.M. Jaskulla, ‘Zukünftige Regelung des Clearing und Settlement von Wertpapier- und
Derivategeschäften in der EU’, Zeitschrift für europarechtliche Studien, (2004), 497, at 509.
54
R. Geiger, Vertrag über die Europäische Union und Vertrag zur Gründung der Europäischen
Gemeinschaft, commentary, 4th edn (Munich: Beck, 2004), Art. 7 EC Treaty, No. 15.
55
Case C-11/00: Commission v. ECB (‘OLAF’) [2003] ECR I-7215, para. 92.
56
Cf. amongst several others U. Häde, ‘Zur rechtlichen Stellung der Europäischen
Zentralbank’, Wertpapiermitteilungen (2006), 1605 et seq.
57
C. Schütz, ‘Die Legitimation der Europäischen Zentralbank zur Rechtsetzung’,
Europarecht (2001), 291–2; A. Decker, Die Organe der Europäischen Gemeinschaft’,
Juristische Schulung (1995), 883–4.
510 Perspectiv es in fina ncia l r egu l ation

to be empowered to set up and operate TARGET2-Securities requires a

provision that goes beyond empowering the EC in general by vesting the
ECB in particular with the authority to undertake such a project.
Moreover, since the euro-area NCBs are an integral part of the ESCB
and, as such, act in accordance with the guidelines and instructions
of the ECB to carry out the tasks entrusted to the ESCB/Eurosystem
(Article 14.3 ESCB/ECB Statute) the principle of limited transfer of pow-
ers applies to the euro-area NCBs, when acting as an integral part of the
ESCB/Eurosystem, too.

2. Criteria for the choice of a legal basis

The legal basis is to be chosen according to objective, legally verifiable
circumstances, especially the purpose and content of the legally rele-
vant act.58 Given the features of TARGET2-Securities described above,
any legal provision that may serve as a legal basis for the euro-area CB’s
authority for TARGET2-Securities has to empower the ECB/euro-area
NCBs to carry out payments for securities transactions and to book
securities held by CSDs from one account into another in order to settle
securities transactions.
Since the Statute of the ECB, as part of the ESCB/ECB Statute, forms
a part of primary Community law,59 one or several Articles of the
Statute may empower the ECB/euro-area NCBs to establish and operate
TARGET2-Securities.

3. Provisions in the EC Treaty?

Neither Articles 56 et seq. EC Treaty nor Articles 94 et seq. EC Treaty
supply a legal basis for any action on the part of the ECB in general, or
for the setting up of TARGET2-Securities in particular.
In contrast, Article 105 (2) EC Treaty has been invoked as a legal basis.
Indeed, as just mentioned, Article 105 (2), fourth indent, of the EC Treaty
and Article 3.1, fourth indent, of the ESCB/ECB Statute attribute to the
ESCB the basic task inter alia of ‘promot[ing] the smooth operation of
payment systems’. However, these provisions only defi ne the framework
of the ESCB’s activities.60 The specific operations that the ESCB and –
since the ECB and the NCBs form part of and may carry out functions

58
Case 45/86, Commission v. Council APS [1987] ECR-1493, para. 11.
59
Supra IV.A.2. at note 50, above.
60
R. Smits, The European Central Bank, Institutional Aspects (The Hague: Kluwer Law
International, 1997), 179.
 Statutory author it y ov er TA RGET-Secu r ities 511

of the ESCB – the ECB and the euro-area NCB’s respectively are empowered
to pursue tasks as regulated in the ESCB/ECB Statute.61 These detailed
provisions would be circumvented, if Article 105 (2) EC-Treaty on its
own could serve as a legal basis for TARGET2-Securities.

4. Article 18.2 ESCB/ECB Statute?

Pursuant to Article 18.2 ESCB/ECB Statute, the ECB is to establish gen-
eral principles for open market operations and credit operations carried
out by itself or the NCBs.
For obvious reasons, this provision on its own does not authorize
the ESCB to set up TARGET2-Securities: general principles within the
meaning of Article 18.2 are legally non-binding rules i.e. rules that do not
bind third parties (except euro-area NCBs),62 not a technical platform.
The general principles referred to in this provision include inter alia the
preconditions which market participants willing to enter into transac-
tions with the ECB or euro-area NCBs have to fulfi l in order to qualify as
an eligible counterparty63 and set out the criteria under which the ECB
and euro-area NCBs enter into binding relationships and execute trans-
actions with such eligible counterparties. Thus, establishing these prin-
ciples, on the one hand, provides important information to the market
and, on the other hand, serves to limit the power of the ECB/euro-area
NCBs to discriminate among market participants in selecting counter-
parties to operations pursuant to Article 18.2. It also provides for the
binding framework under which the ECB and euro-area NCBs conduct
transactions, including the eligible ways of settling such transactions, for
instance, regarding the cross-border settlement of collateralized credit.64

5. Article 18.1 in conjunction with

Article 17 ESCB/ECB Statute?
According to Article 18.1 second indent ESCB/ECB Statute, the ECB and
euro-area NCBs may conduct credit operations with market participants,

61
Kempen, ‘Article 105 EC-Treaty’, in Streinz (note 50, above), Art.107 EC-Treaty’, No.
8, 15; Smits, ‘Article 105 EC-Treaty’, in von der Groeben and Schwarze (eds.) (note 50,
above), No. 4, 5; Smits, The European Central Bank, (note 60, above), 179.
62
Smits, The European Central Bank (note 60, above), 274; cf. also the examples given
in Weenink, ‘Art. 18 ESCB Statute’, in von der Groeben and Schwarze (eds.) (note 49,
above), No. 41 et seq.
63
Weenink in von der Groeben and Schwarze (eds.) (note 50, above), No. 41.
64
See e.g. Chapters 3 and 6 of the General Documentation on the Eurosystem monetary
policy instruments and procedures, September 2006 (Annex 1 to Guideline ECB/2000/7
as amended) (available at www.ecb.int/pub/pdf/other/gendoc2006en.pdf).
512 Perspectiv es in fina ncia l r egu l ation

with lending being based on adequate collateral. By way of clarifica-

tion, Article 17 ESCB/ECB Statute authorizes the ECB and NCBs to
‘accept assets, including book-entry securities, as collateral’.65 The term
‘assets’ is rather wide, and thus covers any legal method of transferring
securities,66 including inter alia the pledging of securities, the fiduciary
transfer of claims on third parties and the institution of a lien.67
Even read in conjunction, Articles 18.1 and 17 do not provide for a
legal basis for TARGET2-Securities in its entirety. As a purely techni-
cal platform, the system will not alter the existing securities accounts
structure. CSDs will still hold accounts with each other, whereas other
market participants will hold accounts with a CSD. As a consequence,
the ECB under TARGET2-Securities acts on behalf of the CSDs even if,
in a purely technical sense, holders of a securities account with a CSD
could send their settlement orders directly to the settlement platform.
In contrast, the ECB and NCBs, when carrying out the tasks entrusted
to the ECB by conducting lending operations based on accepting ade-
quate collateral with market participants, act for themselves when tak-
ing book-entry securities. From this it follows that Articles 18.1 and 17
cannot serve as a legal basis for the TARGET2-Securities project insofar
as the establishment and operation of a securities settlement platform
on behalf of market participants, i.e. CSDs, are concerned.
Arguably, the situation is somewhat different as far as the lending by
the ECB and euro-area NCBs based on collateral in the form of book-
entry securities is concerned (which is required for all central bank
credit operations). Admittedly, Articles 18.1 and 17 do not explicitly
state whether the ECB/euro-area NCBs are empowered to establish and
operate technical facilities aimed at facilitating the secure and effi-
cient settlement of lending against collateral transactions. However,
the Eurosystem does have a vital interest in the efficient and secure func-
tioning of securities settlement systems since, otherwise, its ability to
pursue monetary policies by lending against collateral transactions will
be severely hampered. Therefore, one may indeed interpret Article 18.1
in conjunction with Article 17 to the effect that a fortiori the ECB/

65
It has been argued that the legal basis for the cash leg of the system or the collaterali-
zation of central bank credit by securities could be found in Article 17. However, this
approach disregards the complex structure of TARGET2-Securities. In any case, it does
not supply a legal basis for the entire project.
66
Weenink, ‘Art. 17 ESCB Statute’, in von der Groeben and Schwarze (eds.) (note 50,
above), No. 11.
67
Smits, The European Central Bank, (note 60, above), 263.
 Statutory author it y ov er TA RGET-Secu r ities 513

euro-area NCBs are empowered to set up the technical (IT) infrastruc-

ture required for the purpose of effectively operating lending against
collateral transactions. Put differently, the establishment and operation
of a platform providing services conducive to the more effective conduct
of the Eurosystem’s credit operations falls within the mandate of the
ECB and the NCBs (notwithstanding the fact that such operations are
currently conducted without such a platform having been established,
albeit in a less effective and less secure manner). On the other hand, this
interpretation only holds true for those book-entry securities which the
ECB and the euro-area NCB’s are willing to accept as collateral, at least
in principle.

6. Article 23 ESCB/ECB Statute?

Article 23 ESCB/ECB Statute empowers the ECB and euro-area NCB’s to
acquire and sell spot and forward all types of foreign exchange assets –
including securities as clarified by the regulation itself – as well as to
hold and manage the assets and conduct all types of banking transac-
tions in relations with third countries.
It has been argued that the provision furnishes a legal basis for
TARGET2-Securities, because the ECB and the euro-area NCB’s have
been granted such a wide scope of operations in the external field
and therefore authority cannot be denied to the ECB/euro-area NCBs
domestically. Admittedly, the ECJ has developed external powers of the
EC by drawing a parallel to its internal powers as an example of implied
powers.68 According to this ruling, the EC is not only entitled to con-
clude international treaties if the EC Treaty explicitly stipulates a regu-
latory power to do so, but also if the EC has the corresponding inner
authority.69 However, as regards the ECB and the euro-area NCBs, their
internal powers are regulated in Articles 17–22 ESCB/ECB Statute and
thus implied powers can only be derived from these detailed regula-
tions. Article 23 only refers to external operations as its headline and its
content expressively state.
Still, it would be inconsistent if the regulation granted external pow-
ers to the ECB/euro-area NCBs to a much greater extent than internal

68
A. Haratsch, C. Koenig and M. Pechstein (eds.), Europarecht, 5th edn (Tübingen: Mohr-
Siebeck, 2006), 430.
69
Case 22/70: Commission v. Council (AETR) [1971] ECR 263, para. 72 et seq.; Joined Cases
3, 4 and 6/76: Kramer [1976] ECR 1279, para. 30, 33.
514 Perspectiv es in fina ncia l r egu l ation

powers.70 Therefore, Article 23 ESCB/ECB Statute indicates that the pro-

visions dealing with the internal powers, i.e., Articles 17–22 ESCB/ECB
Statute are to be construed extensively.

7. Article 22 ESCB/ECB Statute

Pursuant to Article 22 ESCB/ECB Statute, (i) ‘[the] ECB and national
central banks may provide facilities’,71 and (ii) ‘the ECB may make reg-
ulations, to ensure efficient and sound clearing and payment systems
within the Community and with other countries’. With respect to ‘facil-
ities’, the provision empowers the ECB as well as the euro-area NCBs.

a. Providing facilities for a securities settlement system on the basis

of Article 22? According to the ECB, the term ‘clearing and payment
systems’ in Article 22 also refers to securities settlement systems because
of the following arguments:72
• the inclusion of the term ‘clearing system’ would not have been neces-
sary if Article 22 referred only to payment systems;
• the potential for a major disturbance in a CSD’s operation, that could
spill over to payment systems and endanger their smooth function-
ing, is likely to have increased in recent years because of the increased
importance of secured lending as money market instruments, the
increased use of securities collateral to control risks and increase
liquidity in payment systems through collateralized intraday credit
lines, and the rapid growth of securities settlement volumes’:73

70
Smits and Gruber, ‘Art. 23 ESCB Statute’, in von der Groeben and Schwarze (eds.) (note
50, above), No. 24; Smits, The European Central Bank, (note 60, above), 312.
71
According to some commentators, the euro-area NCBs are empowered with respect to
payment systems operating within their country, whereas the ECB is empowered with
respect to payment systems operating cross-border within some or even all Member
States of the ESCB (cf. Smits and Gruber, ‘Art. 22 ESCB Statute’, in von der Groeben and
Schwarze (eds.) (note 50, above), No. 21). However, neither the EC Treaty nor the ESCB/
ECB Statute explicitly stipulate that there is a geographic limitation to the powers of
NCBs, if they act on behalf of the Eurosystem.
72
For most of the following arguments see ECB, ‘The role of the Eurosystem in payment
and clearing Systems’, ECB Monthly Bulletin (April 2002), 52, www.ecb.int/pub/pdf/
mobu/mb200204en.pdf.
73
See Bank for International Settlements, Cross-border Securities Settlement (Basle, 1995),
6. Also, in the Introduction of the CPSS/IOSCO Recommendations for securities set-
tlement systems it is pointed out that ‘securities settlement systems (SSSs) are a crucial
component of the fi nancial markets’ and that ‘weaknesses in SSSs can be a source of sys-
temic disturbances to securities markets and to other payment and settlement systems’.
 Statutory author it y ov er TA RGET-Secu r ities 515

• real-time cross-system DVP in central bank money can only be

achieved in a single integrated set-up and nobody but the Eurosystem
as the sole statutory provider of euro central bank money is able to
provide this service;
• the application of the term ‘system’ for payment systems as well as
securities settlement systems in the Settlement Finality Directive.74
However, none of these arguments is convincing.75 To begin with,
‘clearing’ is understood as a mechanism for transferring value in a
particular way, usually by way of ‘netting’. Strictly speaking, ‘clear-
ing’ excludes the settlement phase as well as systems where no clearing
is used, such as ‘gross’ settlement systems where value is transferred
immediately via accounts held with the settlement agent. In addition,
a large variety of clearing systems exist in the fi nancial market infra-
structure, but they are also used in many other (non-fi nancial) areas
of the economy. Put more generally, ‘clearing’ is not a specific feature
of securities transfer systems. Second, even granting that Article 22
vests the ECB with the power to make Regulations in the Community
law sense of the word,76 the (purported) necessity for a uniform legal
treatment of delivery versus payment systems cannot override the
lack of a pertinent legal basis, but simply prevents the realization of
a system which – and this is crucial in this context – is not mandated
by the ESCB/ECB Statute. In addition, TARGET2-Securities has no
bearing on the legal framework, i.e. the set of legal rules governing
cross-border securities transactions. Th ird, the use of a word in sec-
ondary and (!) subsequent EU legislation does not allow any inference
as to the meaning of the same word used in preceding primary EU law.
Moreover, Article 22 explicitly qualifies the systems meant by adding
the word ‘payment’.
In order to refute these arguments, it is sometimes said that, because
of the close functional relationship between payment systems and securi-
ties clearing and settlement systems, the ECB/euro-area NCBs will only
be able to carry out the ESCB’s task of contributing to the stability of the
financial system (Article 3.3 ESCB/ECB Statute) to perfection if they have
74
Directive 98/26/EC (note 9, above).
75
As to the following, in the same sense, see C. Keller, Regulation of Payment Systems’,
Euredia (2002), 455, 460–3.
76
Some authors even argue that the term ‘clearing’ in Art. 22 is not specific enough to grant
any authority for taking measures to promote the operation of ‘securities settlement and
payment systems’; cf. A. von Bogdandy and J. Bast, ‘Scope and Limits of ECB Powers in
the Field of Securities Settlement’, Euredia (2006), 365, 382.
516 Perspectiv es in fina ncia l r egu l ation

also powers with respect to securities systems.77 However, this argument

neglects the distinction enshrined in Article 3 ESCB/ECB Statute between
the ESCB’s basic task of promoting the smooth operation of payments
systems (Art. 3.1 fourth indent) and its more limited role of contributing
to the stability of the financial systems (Article 3.3). Article 22 empowers
the ECB and the euro-area NCBs ‘to ensure efficient and sound clearing
and payment systems’, i.e. attributes authority only in regard of its basic
task to promote the smooth operation of payment systems.
Finally, to clutch at straws, one may want to point to Article 2 (1)
of the German statute implementing The Headquarters Agreement
between the Government of the Federal Republic of Germany and the
European Central Bank concerning the seat of the European Central
Bank.78 According to this provision, the ECB participates as the central
depository for securities in the commercial intercourse of the CSDs.
However, the agreement is not a binding interpretation of the EC Treaty
or the ESCB/ECB Statute respectively. The regulation just shows that the
Member State, Germany, acted on the assumption of an ECB authority
for the settlement of securities transactions.

b. Designing TARGET2-Securities as a (facility for a) payment

system Since Article 22 does not cover securities settlement systems
as such, the ECB/euro-area NCBs would only be empowered to establish
TARGET2-Securities if, at least given a certain design, the system would
qualify as a facility for a payment system.
(i) The meaning of ‘payment systems’ in Article 22 is hardly ever spelled
out in any detail. The ECB provides the following useful definition:
‘a set of instruments, banking procedures and, typically, interbank
funds transfer systems which facilitate the circulation of money’.79 Put
differently, payments systems combine legal regulations, technical
norms and standards, and hardware for the primary goal of facilitat-
ing the transfer of money.80

77
Smits and Gruber, ‘Art. 22 ESCB Statute’, in von der Groeben and Schwarze (eds.) (note
50, above), No. 21.
78
Gesetz zu dem Abkommen vom 18 September 1998 zwischen der Regierung der
Bundesrepublik Deutschland und der Europäischen Zentralbank über den Sitz der
Europäischen Zentralbank, 19 December 1998, BGBl. II 1998, 2995.
79
ECB, ‘The role of the Eurosystem in payment and clearing Systems’, ECB Monthly
Bulletin, (April 2002), (note 72, above), 47.
80
The term ‘payment’ contained in Art. 22 is thus not limited to its meaning in Art. 56 (2)
EC, where payments constitute the consideration within the context of an underlying
 Statutory author it y ov er TA RGET-Secu r ities 517

(ii) Article 22 does not limit the power of the ECB/euro-area NCBs
to provide facilities for payment systems of a particular design.
Indeed, the wording to ‘provide facilities’ in order ‘to ensure effi-
cient and sound clearing and payment systems …’ does not even
require that the facility has to be part of a payment system.
Admittedly, existing payment systems, e.g. TARGET, do not inter-
link the transfer of payments and the corresponding transfer of secu-
rities. However, payment systems could also be designed to provide
for ‘contingent’ payment messages by participants, i.e. messages to
effectuate the cash transfer only on condition that the correspond-
ing book entries in the participants’ securities accounts have already
been made or will, at least, be made simultaneously. The operator of
such a payment system could even choose whether to allow orders to
the effect that a payment is only to be made provided that the trans-
fer of title with respect to the securities in question has taken effect
or, less demanding on the operator, whether just to allow orders
subject to the condition that the respective book entries have been
made, regardless of their effect with respect to the ownership of the
securities.
Regardless of the fi nal design, for the ECB/euro-area NCBs to
provide (facilities for) such a payment system would fall within
the scope of Article 22. Clearly, such a system would contribute to
the smooth operation of payments systems, at least with respect to
linked payments/(cross-border/cross-CSD)securities transactions.
(iii) TARGET2-Securities lends itself to be designed as such a second-
generation payment system81 for at least two reasons. First, while
CSDs would continue to serve as such and would still hold securi-
ties settlement accounts with one another, the ECB would not act
as a CSD but would operate the technical platform for the clearing
and settlement of the securities transactions taking place, includ-
ing those between the CSDs. Second, the booking on a single tech-
nical platform would facilitate the interlinking of the settlement
of the cash leg and the securities leg of a transaction. The design
of TARGET2-Securities according to the increasingly common

transaction, but it also includes money transfers forming part of the ‘movement of capi-
tal’ in the sense of Art. 56 (2) EC; see von Bogdandy and Bast, ‘Scope and Limits of ECB
Powers in the Field of Securities Settlement’, (note 76, above), 371.
81
Likewise, the Legal Committee of the Eurosystem (Legal Feasibility Study (note 40,
above), 2 (dating from 20 December 2006) states that ‘T2S is conceived as a feature that
supplements the operation of TARGET2,’ i.e. a payment system.
518 Perspectiv es in fina ncia l r egu l ation

model82 for securities settlement systems – DVP, i.e. booking is

only carried out after payment has been made – does not constitute
a restriction, because what is envisaged is delivery-versus-payment
model 1, which means settlement in real time of the cash leg of a
securities transaction in central bank money alongside simulta-
neous settlement of the securities leg (a novelty for cross-system
transfers which can only be provided through the active involve-
ment of central banks as the sole supplier of central bank money).
Thus, the delivery of securities takes place simultaneously with the
payment and is – as a consequence – compatible with the model of
a ‘contingent’ payment.83
(iv) It has been argued that Article 22 ESCB/ECB Statute can only serve
as a legal basis for TARGET2-Securities if current securities set-
tlement systems are either inefficient or unsound, but neither the
wording of the regulation nor its intention justify such a restric-
tive interpretation. Both also cover actions by the ECB/euro-area
NCBs destined to improve even further the workings of an already
largely sound and efficient clearing and payment system as well as
actions intended to prevent currently sound and efficient systems
from becoming inefficient or unsound. However, even those who
postulate this additional requirement come to the conclusion that it
is met, due to the inefficiency of the current systems.
(v) The final question of whether Article 22 even empowers the ECB/
euro-area NCBs to establish and operate the particular part of an IT
platform where the booking of the securities is carried out can also
be answered in the affirmative. Th is follows from the fact that the
easiest, most effective and most secure way to promote the smooth
operation of an Eurosystem payment system which allows for con-
tingent payment orders, i.e. for the payment orders of CSDs to be
executed on condition that the corresponding securities transaction
has taken place or takes place simultaneously, is for the ECB/euro-
area NCBs to operate a technical platform which allows the ECB/

82
See Standard No. 7 of the ECB-CESR Standards for Securities Clearing and Settlement
in the European Union (note 22, above).
83
It could even be argued that a payment system permits payment messages on the condi-
tion that the corresponding book entries in the securities account will be made in the
future. However, this confl icts with the principle of settlement fi nality since future can-
cellations of payments could be necessary.
 Statutory author it y ov er TA RGET-Secu r ities 519

euro-area NCBs to effectuate the book entries in the CSDs’ securi-

ties accounts as well – exactly the gist of TARGET2-Securities.84
The upshot is that a legal basis for TARGET2-Securities can be derived
from the term ‘payment system’ in Article 22 ESCB/ECB Statute having
regard to the euro-area CBs’ role as defi ned by Articles 105 (5) EC Treaty,
Article 3.3 ESCB/ECB Statute.

8. Principle of subsidiarity pursuant to Article 5 (2) EC Treaty

Since Article 22 is a concurrent competence,85 Article 5 (2) EC Treaty
applies. Due to the regulation’s transnational character, this require-
ment is not problematic.

9. Principle of competential proportionality pursuant to

Article 5 (3) EC Treaty
According to the ECJ, the principle of competential proportionality is
only violated by manifestly inapt measures, apparently erroneous evalu-
ations or if it is obvious that a less encumbering measure proposed by
the persons involved is equally effective,86 which is not the case in this
context.

V. Conclusion
The question whether the euro-area CBs, i.e., the ECB and the euro-area
NCBs, have authority to develop TARGET2-Securities can be answered
in the affirmative. The legal basis, which is required according to the
principle of a limited transfer of powers from EU Member States to the
ECB/euro-area NCBs, is furnished by Article 22 ESCB/ECB Statute hav-
ing regard to the ECB’s role, as defined by Articles 105 (5) EC Treaty,
Article 3.3 ESCB/ECB Statute.
However, because of the limited competence of the Eurosystem under
Art 22 ESCB/ECB Statute (referring only to facilities for payment and
clearing systems) TARGET2-Securities should not constitute a facility

84
However, as it has been argued correctly, this does not include the legal authority that
would permit the ECB to constrain CSDs to use exclusively TARGET2-Securities.
85
C. Eser, Die Außenkompetenz Europäischen Zentralbank im Spannungsfeld zur
Europäischen Gemeinschaft in der Endstufe der Wirtschafts- und Währungsunion
(Regensburg:, 2005), 134; Smits and Gruber, ‘Art. 22 ESCB Statute’, in von der Groeben
and Schwarze (eds.) (note 50, above), No. 17.
86
Case 280/93: Germany v. Council (‘Bananenmarktordnung’) ECR [1994] I-5039, para. 90
et seq.
520 Perspectiv es in fina ncia l r egu l ation

for a securities settlement system, but should qualify as a variation or a

feature ancillary to the operation of a payment system. This should be
possible, because Article 22 ESCB/ECB Statute does not limit the euro-
area CBs’ power to provide facilities for payment systems of a particular
design. Although existing payment systems do not interlink the transfer
of payments and the corresponding transfer of securities, payment sys-
tems could also be designed to provide for ‘contingent’ payment mes-
sages by participants, i.e. messages to effectuate the cash transfer only on
condition that the corresponding book entries in the participants’ secu-
rities accounts have already been made or will be made simultaneously.
Thus, the initial design of TARGET2-Securities as a mechanism ena-
bling the delivery-versus-payment model 1, i.e. settlement in real time of
the cash leg of a securities transaction in central bank money alongside
simultaneous settlement of the securities leg, would fall within the ambit
of Article 22 ESCB/ECB Statute. Alterations of and additions to the ini-
tial model are of no relevance as long as TARGET2-Securities will be a
functionality that is ancillary and subordinate to the main operation of
the Eurosystem, i.e. to the running of its payment system TARGET2.
However, if TARGET2-Securities were to provide a comprehensive serv-
ice to CSDs comprising the full post-trade production chain (similar to
a ‘Single Settlement Engine’ as conceived by other market participants)
this might be considered tantamount to a circumvention of Art 22 ESCB/
ECB Statute. Given that, TARGET2-Securities should limit itself to a
technical module allowing the coordination of book entries by the CSD
and by the Eurosystem to ensure delivery versus payment (DvP). As a
minimum, this would require TARGET2-Securities to take recourse to
TARGET2 for the settlement of the cash legs. Otherwise, the required
supportive character of TARGET2-Securities vis-à-vis TARGET2 would
be in doubt.
 SEC T ION 2

Transatlantic perspectives
 28

Learning from Eddy: a meditation upon

organizational reform of financial
supervision in Europe
Howell E. Jackson

With the March 2008 release of the US Treasury Department’s Blueprint

for a Modernized Financial Regulatory Structure, the reorganization of
financial regulation in the United States is, once again, an issue of pub-
lic debate in American policy circles. Fortunately, this is also a subject
which Eddy Wymeersch recently addressed in The Structure of Financial
Supervision in Europe: About Single Financial Supervisors, Twin Peaks
and Multiple Financial Supervisors. Like much of Professor Wymeersch’s
academic writing, this article offers American readers a unique and
illuminating view into European regulatory practice, combining the
theoretical sophistication of an accomplished academic with the prag-
matic insights of a senior regulatory official. My goal in this chapter is
to meditate upon Professor Wymeersch’s description of the evolving
supervisory practices in Europe and draw out potentially useful impli-
cations for policy issues raised in the Treasury Department’s Blueprint
and how regulatory reform might be implemented in the United States.
At the outset I should acknowledge the envy with which I regard my
academic and regulatory counterparts working in other jurisdictions.
While the United States prides itself in having a dynamic economy that
fosters innovation and invention, the country’s capacity to reform the
structure of its regulatory institutions pales in comparison to the ability
of member states of the European Union – or other developed coun-
tries such as Japan and Australia – to modernize their regulatory bodies.
As has often been noted, the American system of financial regulation
is a product of nearly two centuries of bureaucratic accretions, dating
back to the free banking statutes of the 1830s. Over the generations,
numerous oversight bodies have been added and few eliminated with
the resulting maze of supervisory bodies incomprehensible to those

523
524 Perspectiv es in fina ncia l r egu l ation

familiar with the supervisory systems of other leading economies and a

source of extraordinary cost and unnecessary complexity for regulated
firms and practicing attorneys in the United States.
With effort and patience, one can come to understand how and why the
American regulatory structure has evolved in the way it has and a large
portion of any academic course on financial regulation in the United
States is typically dedicated to unpacking the mysteries of regulatory
jurisdiction in this country.1 A national taste for federalism explains why
we have overlapping systems of state oversight in banking and securities.
Anachronistic and long-abandoned interpretations of the Commerce
Clause of the US Constitution allowed insurance regulation to develop
exclusively at the state level in the late nineteenth and early twentieth
centuries. An aversion to concentrated sources of governmental power
has led American politicians to retain sectoral division of supervisory
agencies – that is, separate regulatory bodies for banking, insurance and
securities – and also our even more fragmented oversight of depository
institutions (Federal Deposit Insurance Corporation (FDIC), Comptroller
of the Currency (OCC), Office of Thrift Supervision (OTS), and Federal
Reserve Board), securities/futures (Securities and Exchange Commission
(SEC) plus the Commodities Future Trading Commission (CFTC)), and
insurance (distinguishing freestanding insurance companies regulated
at the state level from employer-provided pensions and health insurance
covered by the Employee Retirement Income Security Act of 1974 at the
federal level). On top of these latent political preferences and historical
accidents, the political impediments inherent in our divided and increas-
ingly partisan political system make it difficult to effect financial reform,
at least as compared to the parliamentary systems of government found
in most other developed nations. Finally, add in a national predilection to
review any idiosyncratic aspect of governmental structure as a manifes-
tation of American exceptionalism, and one can develop a relatively rich
though not always inspiring explanation of why the American system
of financial regulation has strayed so far from the models of supervisory
oversight upon which the rest of the world is converging.
But whatever the explanation of the Rube Goldberg complexity of
regulatory oversight in the United States, there is still much to learn from
the experience of other countries in reforming their own supervisory
1
H.E. Jackson and E.L. Symons, The Regulation of Financial Institutions: Cases and
Materials (West Publications, 1999).
 fina ncia l superv ision in eu rope 525

systems. My purpose in reflecting upon Professor Wymeersch’s article is

to consider how the regulatory reforms with European members states
over the past decade might inform our understanding of the Treasury
Department’s recent proposal and, more specifically, to consider how
that experience can help us evaluate the many conflicting arguments
that have been made for and against more radical proposals to consoli-
date financial regulation in this country.

I.
In modern debates over regulatory reform, the issue is typically
framed in terms of a question of the degree to which and the manner
in which traditional sectoral agencies should be consolidated into a
smaller number of regulatory bodies. There are two basic approaches
to consolidation. The fi rst and simpler approach is to combine two or
more sectors of the fi nancial services industry under a consolidated
regulatory body, such as the British Financial Services Authority.2
Alternatively, existing agencies can be reconstituted into new and spe-
cialized organizational units designed to advance specific regulatory
objectives, like ensuring the fairness and transparency of interactions
between fi nancial fi rms and their customers (sometimes called market
conduct) or safeguarding the safety and soundness of fi nancial institu-
tions (often denominated prudential supervision). Adopting terminol-
ogy coined by Michael Taylor, this second approach is often labelled a
‘twin peak’ or ‘multi-peaked’ model, depending on how many different
regulatory objectives are specified and assigned to separate agencies.3
The Treasury Department’s recent Blueprint contains elements of both
approaches. In terms of combinations, the Department recommends
in the relatively near future the merger of the SEC and CFTC as well
as the consolidation of banking supervisory bodies, including its pro-
posed merger of the Office of Th rift Supervision with the Comptroller
of the Currency and also its more obliquely recommended combina-
tion of the currently divided FDIC and Federal Reserve oversight of

2
H.E. Jackson, ‘An American Perspective on the FSA: Politics, Goals & Regulatory
Intensity’, in L. J Cho and J. Y. Kim (eds.), Regulatory Reforms in the Age of Financial
Consolidation: The Emerging Market Economy and Advanced Countries (Korean
Development Institute, 2006), 39–71 (avail. at www.kdi.re.kr/kdi_eng/database/report_
read05.jsp?1=1&pub_no=00009931).
3
M.W. Taylor, Twin Peaks: A Regulatory Structure for the New Century (London: Centre
for the Study of Financial Innovation, 1995).
526 Perspectiv es in fina ncia l r egu l ation

state banks.4 Over the longer run, the proposal envisions the creation of
multi-peaked objective-oriented agencies, focusing on prudential reg-
ulation, market conduct and market stability, an objective centred on
minimizing systemic risks. As the Treasury also envisions the creation
of two smaller regulatory units – one for oversight of corporate issuers
and the other to contain government guarantee funds – the Blueprint’s
long-term recommendations might best be labelled a ‘three peak, two
foothill’ model of regulation.5
Within policy circles, the debates over the reform of financial
regulatory systems have been well-rehearsed at this point, and the
basic trade-offs are fairly well understood.6 The combination of single-
sector agencies offers the promise of greater efficiency and efficacy, as
consolidated agencies enjoy economies of both scale and scope. The
advantages are, it is argued, capable of simultaneously improving the
quality and lowering the cost of financial supervision, while also ben-
efitting regulated firms by offering a single point of supervisory contact
and eliminating sources of regulatory duplication and inconsistency.
The on-going consolidation of the financial services industry is often
cited as further justification for the combination of supervisory func-
tions, as an integrated regulatory supervisor is said to be better equipped
to oversee conglomerates that offer a full spectrum of financial products
4
United States Department of the Treasury, Blueprint for a Modernized Financial
Regulatory Structure (Mar. 2008), 89–100 (avail. online at www.treas.gov/press/releases/
reports/Blueprint.pdf).
5
United States Department of the Treasury, Blueprint for a Modernized Financial
Regulatory Structure (note 4, above), 137–80.
6
For more extensive treatments of the subject, see R.J. Herring and J. Carmassi, ‘The
Structure of Cross-Sector Financial Supervision’, Financial Markets, Institutions &
Instruments, 17 (2008), 51–76; United States Government Accountability Office, ‘Financial
Regulation: Industry Trends Continue to Challenge the Federal Regulatory Structure’,
GAO-08–32 (Oct. 2008); E.F. Brown, ‘E Pluribus Unum – Out of Many, One: Why the
United States Needs a Single Financial Services Agency’, University of Miami Business Law
Review, 14 (2005), 1–101; L.T. Llewellyn, ‘Institutional Structure of Financial Regulation
and Supervision’, in J. Carmichael, A. Flemming, and L.T. Llewellyn (eds.), Aligning
Financial Supervisory Structures with Country Needs (World Bank Institute, 2004), 17–92;
D. Masciandraro and A. Porta, ‘Single Authority in Financial Markets Supervision:
Lessons for EU Enlargement’, in D. Masciandaro (ed.), Financial Intermediation in the
New Europe (2004), 284–320; C. Briault, ‘Revisiting the Rational for a Single National
Financial Services Regulator’, FSA Occasional Paper Series No. 16 (Feb. 2002);
T. Di Giorgio and C. Di Noia, ‘Financial Regulation and Supervision in the Euro Area:
A Four-Peak Proposal’, Wharton Financial Institutions Center Working Paper 01–02
(Jan. 2001); R.K. Abrams and M.W. Taylor, ‘Issues in the Unification of Financial Sector
Supervision’, IMF Working Paper WP/00/213 (Dec. 2002); H.M. Schooner, ‘Regulating
Risk Not Function’, University of Cincinnati Law Review, 66 (1998), 441–88.
 fina ncia l superv ision in eu rope 527

and manage their own risks on an organization-wide basis. The growing

dominance of financial conglomerates in global markets also raises the
costs of single-sector supervision, as consolidated firms are thought to be
more capable of exploiting opportunities for regulatory arbitrage – that
is, instances in which different regulators establish different substantive
rules to deal with functionally similar products or activities – which sin-
gle-sector agencies have difficulty identifying and correcting. Relatedly,
consolidated agencies are thought to be better equipped to identifying
regulatory gaps, that is, pockets of economic activity that fall outside the
remit of traditional financial sectors, with hedge funds and perhaps sub-
prime mortgage lending activities and securitization activities being
prominent examples in recent times.
The case against regulatory consolidation is also multi-faceted. To
begin with, there is the absence of irrefutable evidence that consolidated
agencies are any more efficient than their single-sector predecessors, at
least in terms of total regulatory costs.7 More substantively, critics of con-
solidated supervisory functions argue that the goals of supervision differ
across industry sectors and that a combination of regulatory functions
may actually dilute the quality of supervision by imposing a standard-
ized model of oversight on all sectors of the industry. Combined over-
sight may also diminish market discipline as government guarantees
traditionally limited to certain sectors, like banking, may be assumed
to extend more broadly in a country where all sectors have a common
supervisory agency. In addition, there is concern that regulatory con-
solidation produces a governmental monopoly, less likely to respond to
changing market conditions and potentially more prone to wholesale
regulatory capture or at least a supervisory posture tilted in favour of
large conglomerates at the expense of smaller more specialized firms.
Regulation by objective, the third multi-peaked model of regulatory
organization, is a bit of a hybrid approach and thus shares some of the
advantages and disadvantages of the two other models.8 By reducing the
number of supervisory units, regulation by objective offers potential effi-
ciency advantages over traditional sectoral regulation, and it also addresses

7
See M. Ćihák and R. Podpiera, ‘Is One Watchdog Better than Th ree? International
Experience with Integrated Financial Sector Supervision’, IMF Working Paper
06/57 (Mar. 2006) (fi nding evidence of quality improvements not cost savings from
consolidated supervision).
8
J.J.M. Kremers, D. Schoenmaker and P.J. Wierts, ‘Cross-Sector Supervision: Which
Model’, in R. Herring and R.E. Litan (eds.), Brookings-Wharton Papers on Financial
Services (2003), 225–43.
528 Perspectiv es in fina ncia l r egu l ation

concerns of regulatory arbitrage as functionally similar products and serv-

ices are under the jurisdiction of the same supervisory body. But, like fully
consolidated oversight, regulation by objective risks imposing one-size-fits-
everyone rules, which discount unique characteristics of traditional sectors
and subsectors. Moreover, multi-peaked models generate new problems of
coordination, duplication and gaps, as the lines between functions such as
market conduct, prudential regulation and market stability are not clear, and
many regulatory structures, like disclosure or even capital requirements,
advance all three objectives. With regard to concerns over governmental
monopolies and supervisory rigidity, multi-peaked models again constitute
an intermediate case, less centralized than fully consolidated operations but
less attuned to sectoral differences than traditional sectoral oversight.
Another much discussed dimension of regulatory consolidation is
the appropriate supervisory role of central banks. Oftentimes, reorgani-
zation entails the movement of bank supervision away from the central
bank, as happened in the United Kingdom when the supervisory powers
of the Bank of England were transferred to the new Financial Services
Authority in the late 1990s. Less frequently, but occasionally, the cen-
tral bank itself becomes the consolidated regulatory, thereby expanding
its jurisdiction as a result of reorganization. Finally, in certain multi-
peaked models, including perhaps the Treasury Department’s Blueprint,
the central bank may itself be designated the ‘peak’ responsible for mar-
ket stability. The often-voiced concern about this aspect of regulatory
reorganization is the possibility that moving direct supervisory over-
sight out of a central bank diminishes the bank’s ability to effect appro-
priate monetary policy and maintain fi nancial stability.
Like many important issues of public policy, the debates over regula-
tory reorganization rest on numerous, confl icting claims regarding the
consequences of various kinds of reforms. Seldom do policy analysts
have unambiguous empirical evidence to validate their intuitions. But,
in the case of the financial regulation, we do have the benefit of looking
to the experiences of the dozens of European jurisdictions which have
engaged in regulatory reorganizations over the past two decades, as well
as Professor Wymeersch’s very helpful synthesis of what we might learn.

II.
In many respects, Professor Wymeersch’s portrayal of European regu-
latory consolidation covers familiar arguments for and against regula-
tory consolidation, with the growth of financial conglomerates pushing
 fina ncia l superv ision in eu rope 529

supervisors towards sectoral consolidation and the creation of amalga-

mated agencies posing concerns over the homogenization and dilution
of supervisory oversight. But where Professor Wymeersch’s analysis
covers new territory is in its explication of how the process of finan-
cial consolidation has actually occurred in the twenty-five EU Member
States his article surveys.

A.
Consider, for example, Professor Wymeersch’s description of modern
regulation within the traditional sectors. Typically, one discusses
sectoral oversight in terms of the regulatory structure applicable to the
core lines of business: banking, securities and insurance. But a recur-
ring theme of Professor Wymeersch’s article is the accretion of numer-
ous cross-sectoral regulatory regimes that are already in place in most
industrialized countries – money-laundering rules, privacy require-
ments, anti-terrorism measures, and measures to police tax avoidance.9
As is true in the United States, regulations addressing these over-arching
issues of public policy tend to be imposed uniformly across the fi nancial
services industry – that is, on a consolidated basis – and then imple-
mented on a sector by sector basis. Thus, in even the most fragmented of
modern supervisory systems (that is, in the United States), we observe
many elements of consolidated regulation, albeit implemented in a
haphazard, diff use and likely inefficient manner.
Another theme of Professor Wymeersch’s description of European
practices is the incremental and variegated manners in which member
states have transitioned to consolidated financial services oversight. While
foreign observers tend to focus on the fact that a substantial majority of
EU Member States now maintain consolidated supervisors, Professor
Wymeersch’s front line reporting reveals that many countries have made
the transition only haltingly and often have only gone partway down the
path. Moreover, if one looks closely at the organizational structure within
the regulatory apparatus of different EU member states, one can often
observe that old sectoral models of oversight have not disappeared even
within jurisdictions that maintain a single financial services agency.

9
E. Wymeersch, ‘The Structure of Financial Supervision in Europe: About Single
Financial Supervisors, Twin Peaks and Multiple Financial Supervisors’, European
Business Organization Law Review, 8 (2007), 245–6.
530 Perspectiv es in fina ncia l r egu l ation

Consider first the initial stages of financial reform. In many

jurisdictions, reform has often been a gradual process. The front end of
regulatory consolidation is sometimes accompanied by ad hoc efforts
to coordinate sectoral bodies, such as the creation of a coordinating
council in the Netherlands and several other jurisdictions or the use of
memoranda of understanding to coordinate existing bodies in Germany
and the United Kingdom.10 While Professor Wymeersch reports that
these preliminary efforts typically lack sufficient strength to effect sig-
nificant changes in regulatory practices, they often serve as the first step
in a complex supervisory quadrille that ultimately results in legislated
reforms enacted through parliamentary procedures. If true, then per-
haps the much-publicized memorandum of understanding between the
SEC and CFTC in the spring of 2008 will someday come to be marked as
the opening movement of this process in the United States as would be
subsequent efforts to achieve written agreements between the SEC and
Federal Reserve Board
Also of potential interest to US observers is Professor Wymeersch’s dis-
cussion of the role of industry conglomeration in regulatory consolidation.
Within the United States, the merger of banking and securities firms –
facilitated by the passage of the Gramm–Leach–Bliley Act in 1999 – has
long been recognized as a reason to develop better coordination between
banking and securities regulators. And the decision of the Federal
Reserve Board to extend credit to Bear Stearns and subsequent actions
with respect to AIG have only reinforced the need for this coordination.
Within parts of the EU, one sees similar developments, particularly in
the London markets, where the lines between major banks and securi-
ties firms have long been blurred. But what is interesting about Professor
Wymeersch’s account of industry consolidation is his emphasis on the
combination of banks and insurance companies in many continental
European jurisdictions and his assertion that the regulatory objectives
in these two areas are actually quite closely aligned, focused as they are
on prudential oversight and thus highly likely to benefit from integrated
supervision. For American financial analysts, less attuned to insurance
regulation which is largely regulated to state bodies, the notion that there
are serious benefits to be gained from combining banking and insurance
regulation is eye-opening, but upon reflection not wholly implausible.
Perhaps the greatest lesson to be learned from Professor Wymeersch’s
survey of regulatory practices in Europe is the array of organizational

10
Ibid., 262.
 fina ncia l superv ision in eu rope 531

arrangements currently in place within the EU. Putting aside the sev-
eral countries that have not yet combined all three core sectors into one
body, one still sees ample variation in approaches. On the one hand,
many jurisdictions maintain separate sectoral divisions for front line
oversight within integrated regulatory structures. This practice is quite
common in the Nordic states but exists elsewhere around the world,
most notably in Japan. In contrast, other consolidated agencies, such
as the British FSA, organized their chief supervisory units into retail
and wholesale markets (a sort of mini-twin-peaks approach within inte-
grated agencies) but also have something of a sectoral matrix approach
that maintains expertise along traditional lines but with a special unit for
complex organizations. Perhaps not surprisingly, integrated supervision
does not in practice consist of an undifferentiated blob of civil servants
loosed upon the financial service industry. Rather, in many jurisdic-
tions, operations are divided into supervisory units that would be read-
ily intelligible to one versed only in traditional sectoral oversight.

B.
A commonly cited, but as yet not well-documented virtue of consolidated
financial oversight is cost savings in government payrolls. Although
Professor Wymeersch alludes to these fi nancial savings, as well as even
greater savings accruing to regulated firms that need only deal with one
supervising body,11 his emphasis is on the qualitative improvements
that consolidated supervisory agencies provide – an aspect of integrated
supervision that has been explored elsewhere but not with nearly as
much institutional detail as Professor Wymeersch is able to offer.12
To begin with the most mundane, many administrative functions are
common to all regulatory bodies: personnel offices, information tech-
nology departments, various support personnel at all levels, and even top
positions such as the executive director or governing board.13 Aside from
the elimination of redundant offices, consolidated departments have
inherently larger mandates, which are apt to attract more experienced
and senior personnel. Oftentimes, expanded scope will afford increased

11
Wymeersch, ‘The Structure of Financial Supervision in Europe’, (note 9, above), 263.
12
For supporting views, see M. W. Taylor and A. Fleming, ‘Integrated Supervision: Lessons
of Northern European Experience’, Finance and Development, 36 (1999), 18; Ćihák and
Podpiera, ‘Is One Watchdog Better than Th ree?’, (note 7, above).
13
Wymeersch, ‘The Structure of Financial Supervision in Europe’, (note 9, above), 260.
532 Perspectiv es in fina ncia l r egu l ation

flexibility, allowing examiners or enforcement staff to be transferred

from one sector to another depending on changing conditions.
In terms of substantive expertise, there are to begin with the mount-
ing number of topics – money laundering, tax avoiding, privacy, and
fi nancial education – that in many jurisdictions apply to all sectors
of the fi nancial services industry and must be staffed repeatedly and
inefficiently under traditional sectoral regulation.14 With integrated
agencies, policy making can be combined and streamlined. But if one
looks inside the substance of traditional sectoral regulation, there are
many more instances of highly comparable matters of substantive
expertise: fitness qualifications for new owners or controlling share-
holders; suitability standards for investment products (and exemp-
tions for qualified parties); limitations on transactions with affi liated
parties; diversification requirements; disclosure obligations of various
sorts; and licensing procedures for new fi rms.15 Most modern systems
of fi nancial regulation share these same core elements. While the tech-
nical requirements (and even terminology) often differ from sector to
sector, the differences are often more the product of historical happen-
stance than major distinctions in substantive policy. Attorneys, econo-
mists and other policy analysts trained up to deal with these matters in
one sector could quite easily apply their expertise in other sectors. Very
plausibly, they would do their jobs better and make life substantially
easier for regulated parties if they had the broader remit afforded under
a consolidated supervisor.16
An excellent example of the benefits of a cross-sectoral purview
is capital requirements. Much attention has focused on the reform
of bank capital requirements under the Basel II process, which has
attracted the attention of some of the world’s most talented fi nan-
cial economists and been supported by literally hundreds of working
papers and dozens and dozens of academic conferences and symposia.
Many of the issues that have been explored in the Basel II process –
value-at-risk models, internal ratings, back-testing procedures – are
potentially applicable to other types of fi nancial institutions, such as
securities fi rms and insurance companies. Within the more integrated
European system, these connections are more easily drawn. In fact,
securities fi rms in Europe are subject to the Basel II capital require-
ments (and not the different SEC net capital rules applicable to broker

14
Ibid., 245–56, 248–9.
15 16
Ibid., 270–1. Ibid., 275.
 fina ncia l superv ision in eu rope 533

dealers in the United States). As Professor Wymeersch explains, even

the new insurance Solvency II directive is heavily informed by the
Basel II capital rules.17 Thus the oversight of insurance companies in
Europe indirectly draws on the expertise of the Basel process in a way
that would be difficult to imagine in the United States, where insurance
capital rules fall within the bailiwick of the NAIC and state insurance
commissions, which have few formal connections to banking regula-
tors and the large number of highly trained economists housed in the
Federal Reserve regional banks.

C.
Another insight available in Professor Wymeersch’s account concerns
the persistence of jurisdictional and substantive conflicts within consol-
idated regulatory frameworks and the manner in which those conflicts
are resolved. Regulatory reorganizations within the financial services
industry do not so much eliminate the existence of conflicts, as they
alter the dimension on which conflicts arise and change the locus of
their resolutions.
Take the case of the classic form of twin-peak regulation, where market
conduct is delegated to one agency and prudential oversight is given to
another. While this division of authority works well in theory, in practice it
entails considerable potential overlap in regulatory design. To begin with,
market conduct rules can have prudential implications, as, for example,
improper lending practices can give rise to private claims and enforcement
actions, which in the extreme can threaten institutional solvency. On the
other hand, ample capital reserves – the core of prudential regulation – can
have market conduct implications, as well-capitalized concerns are more
likely to police their own business activities in order to prevent reputational
losses and diminution of franchise value. For these reasons, prudential
regulators may have different views on market conduct issues that conflict
with the views of the market conduct regulator and vice versa. Sometimes,
a policy that advances market conduct regulation – say enhanced dis-
closure of financial weakness – can actually conflict with prudential
considerations or even market stability. Thus one regulatory body may
oppose additional disclosures whereas another opposes it, and the issue of
the proper hierarchy of regulatory functions is called into question.18

17 18
Ibid., 269. Ibid., 245, 249.
534 Perspectiv es in fina ncia l r egu l ation

In the early years of twin-peak regulation in Australia, there were many

examples of regulatory conflicts of this sort and it took a number of years
(and several memoranda of understanding) to devise a practical system
for implementing this form of divided regulatory authority. Professor
Wymeersch suggests that similar problems have arisen in multi-peaked
regulatory structures in the European context.19
With a fully consolidated regulatory structure, similar conflicts arise.
If the agency is organized around traditional sectoral divisions, then
the same inter-sectoral confl icts arise across divisions. For consolidated
agencies organized around functional divisions – that is, replicated mul-
ti-peak models within a single agency – the same overlaps and potentially
divergent views described above will arise in this context too. What is
different about the consolidated agency, as Professor Wymeersch notes,
is where these inevitable conflicts will be resolved, and that is within the
agency itself, presumably at the highest level.20 Conflict resolution in the
United States and in other jurisdictions where regulatory jurisdictions
is divided across numerous regulatory bodies is more complex. In some
instances, cross-agency compromises, typically in the form of memo-
randa of understanding, can be used to reconcile disagreements. But, as
Professor Wymeersch notes, these are complicated to negotiate and tend
to leave important issues unresolved or unforeseen.21 The alternative is
resolution in courts or through legislative intervention.22 But these solu-
tions – as exemplified in the United States – tend to be time-consuming
and unreliable, with many inter-jurisdictional conflicts allowed to drag
on for years.23
In this light, one of the less well understood virtues of consolidated
regulatory structures is their built-in ability to resolve through internal
mechanisms the inevitable conflicts that arise across industry sectors
and regulatory functions. Of course, this advantage carries with it an
amplification of one of the greatest potential problems with consolida-
tion: the centralization of excessive governmental authority within a
single administrative body, a topic to which I now turn.

19
Ibid., 247, 267.
20
Ibid., 243; R. M. Kushmeider, ‘Restructuring US Financial Regulation’, Contemporary
Economic Policy, 25 (2007), 337.
21
Ibid., 267–8.
22
Ibid., 281–2.
23
H.E. Jackson, ‘Regulation of a Multisectored Financial Services Industry: An Exploratory
Essay’, Washington University Law Quarterly, 77 (1999), 319–97.
 fina ncia l superv ision in eu rope 535

D.
Perhaps the most vexing questions surrounding the consolidation of
financial regulatory functions concern issues of accountability and main-
tenance of appropriate regulatory focus. Especially in the United States,
where concerns over aggregation of governmental authority have a spe-
cial and historic salience, regulatory consolidation is often portrayed as
almost un-American on the grounds that divided government is inher-
ently better than centralized authority, at least in this hemisphere. On
a more instrumental dimension, the benefits of regulatory competition
among diverse and overlapping regulatory agencies are thought to pre-
vent governmental stasis, to combat regulatory capture, and to ensure
appropriate regulatory reforms in light of market and technological
developments. European experience with consolidated supervision, as
Professor Wymeersch recounts, offers a somewhat different perspective
on all of these lines of argument.24
To begin with, a number of European jurisdictions have attempted
to hardwire political accountability into the enabling statutes for their
consolidated regulatory bodies. The best example of this is the British
FSA, for which Parliament set forth a clear set of regulatory goals and
principles of good regulation to which the agency is expected to abide.25
To ensure fidelity to these statutory guidelines, the FSA prepares annual
reports, holds annual meetings, works with a larger number of advisory
groups populated with different public constituencies, and – for at least
its first decade of existence – seems to have honed fairly tightly to the
guidelines that the British legislative process established. According to
Professor Wymeersch’s account, similar mechanisms of accountability
are found in other European statutes.26
Another lesson of Professor Wymeersch’s analysis is that domestic
regulatory competition of the sort illustrated by SEC versus CFTC
conflicts is not the sole source of competitive pressure on regula-
tory agencies. Within an increasingly globalized economy, regulatory

24
Wymeersch, ‘The Structure of Financial Supervision in Europe’, (note 9, above),
277–86.
25
For a more detailed discussion, see M. W. Taylor, ‘Accountability and Objectives in the
FSA’, in M.C. Blair et al. (eds.), Blackstone’s Guide to the Financial Services and Markets
Act 2000 (Blackstone Press, 2001), 17–36. See also E. Hüpkes, M. Quintyn and M.W.
Taylor, ‘The Accountability of Financial Sector Supervisors – Principles and Practice’,
European Business Law Review, (2005) 1575–620; Briault, ‘Revisiting the Rational for a
Single National Financial Services Regulator’, (note 6, above).
26
Wymeersch, ‘The Structure of Financial Supervision in Europe’, (note 9, above), 277–9, 281.
536 Perspectiv es in fina ncia l r egu l ation

competition across international boundaries offers a quite plausible sub-

stitute for the kind of regulatory competition that once only existed within
nation states. (Indeed, within the quite permeable national boundaries
of the European Union, Professor Wymeersch seems to see an excessive
amount of regulatory competition.) But the key point for policy analysts
fearful of the aggregation of regulatory functions within a single national
regulatory body is that cross-border regulatory competition is now an
important dynamic, which will put a natural constraint on the ability of
a domestic consolidated regulator to fall behind in regulatory innova-
tions.27 And, of course, in most jurisdictions, not all regulatory functions
are moved into consolidated agencies, with central banks and Ministries
of Finance (such as the US Treasury) usually also retaining some market
oversight role and offering a source of domestic checks on consolidated
agencies.
Another and somewhat surprising insight from Professor Wymeersch’s
survey is the reportedly diminished role of regulatory capture with con-
solidated regulatory bodies. Among US academics, one of the principal
failings of administrative agencies is their tendency to fall under the influ-
ence of the firms they oversee.28 A potential concern about consolidated
supervision is that the dangers of regulatory capture could be multiplied as
the jurisdiction of the regulatory agency is expanded. But what Professor
Wymeersch reports from Europe is that the relative power of any sector of
the financial services industry is diminished with respect to consolidated
agencies and so the ability of any single sector to capture the agency is
diminished.29 To be sure, this portrayal does not ensure that a coordinated
effort on the part of the entire financial services industry would not be suc-
cessful in having undue influence on regulatory authorities. But it does
suggest that in at least some instances consolidated agencies may be more
resistant to regulatory capture than their single-sector predecessors.

E.
A final insight to be drawn from Professor Wymeersch’s description of
current EU practices concerns the distinction between regulation – that

27
In a similar vein, interaction with multilateral organizations, such as ISOCO or the Basel
Committee on Banking Supervision, provides further checks on any single countries
regulator getting too far out of line of evolving international standards.
28
J.R. Macey, ‘Administrative Agency Obsolescence and Interest Group Formation: A
Case Study of the SEC at Sixty’, Cardozo Law Review, 15 (1994), 909–49.
29
Wymeersch, ‘The Structure of Financial Supervision in Europe’, (note 9, above), 265,
278–9.
 fina ncia l superv ision in eu rope 537

is, the articulation of regulatory requirements – and supervision – the

application of those legal requirements to various sectors of the fi nan-
cial services industry through oversight, examination and inspection,
and both formal and informal enforcement activity. While financial
supervision in Europe is increasingly implemented through consoli-
dated agencies, financial regulation in the region is often still effected
along traditional sectoral lines. The EU directives governing the fi nan-
cial sector are the best example of this phenomenon, structured as they
are around securities sector (e.g. the prospectus directive, the transpar-
ency directive or MiFID), the banking sector (e.g. the capital adequacy
directive and the second banking directive), and insurance sector (the
solvency directive).30 31 As Professor Wymeersch explains, this frag-
mented lawmaking process produces many of the problems common in
the United States. Functionally similar insurance and securities prod-
ucts are subject to different conduct of business rules, creating regula-
tory anomalies and opportunities for regulatory arbitrage.32 Thus, while
much attention has been focused on the supervisory consolidation
within many EU Member States, many of the benefits of this consoli-
dation are not fully realized as long as regulatory standards are largely
set on a sectoral basis. Here seems to be an area where Brussels needs to
catch up with the Member States.
Another idiosyncrasy of the EU regulatory structure is the disper-
sion of supervisory authority across member states, whether to consoli-
dated regulatory units of the sort found in the United Kingdom or to
more traditional sectoral bodies of France and Spain. This phenomenon
raises serious questions as to whether regulatory policy established at
the community level is being implemented and enforced consistently
across the region, issues which the Lampfalussy process was designed
to address, but which still has not been fully resolved, at least judging
from Professor Wymeersch’s account.33 Perhaps ironically, the principal
organizational mechanism being employed to monitor and correct une-
ven implementation or enforcement is sectoral-based coordinating coun-
cils, such as the Committee of European Securities Regulators (CESR),
which Professor Wymeersch has chaired. Thus, the fully consolidated
regulatory agencies, such as the British FSA or Professor Wymeersch’s

30
The fi nancial conglomerate directive would be a counterexample (ibid., 260), as would
the privacy directive.
31
Ibid., 244.
32
Ibid., 254 and n. 37.
33
Ibid., 288.
538 Perspectiv es in fina ncia l r egu l ation

own Belgium Banking, Finance and Insurance Commission (CBFA),

find themselves operating under sectoral directives established at the
EU level and then coordinating with the authorities of other member
states through sectoral counsels such as CESR. It is apparently the fate of
consolidated supervisors to have to operate, at least initially, in a world
built upon sectoral structures.
While the institutional details of European regulatory organiza-
tion reflect many conditions peculiar to the evolution of the European
Union and larger issues of constitutional structure, certain aspects of
European practice do, perhaps, have lessons for the United States and
other jurisdictions. The distinction between regulation and supervision
is an important one. Within the United States there is intense politi-
cal resistance toward consolidation of traditional supervisory units,
whether across sectoral lines, such as banking or securities, or even
among depository institutions (such as banks, thrifts and credit units) or
functionally similar products such as securities or futures. But European
practice reveals that it is possible to distinguish regulatory consolida-
tion from supervisory consolidation. The United States might possibly
proceed with regulatory consolidation – establishing uniform national
standards across sectoral boundaries – and still retain supervision and
enforcement within our traditional sectoral-based oversight units, at
least for a transitional period. In many areas, such as money laundering,
privacy safeguards and truth in lending, this is already the state of affairs
although these rule-making functions are currently located in differ-
ent administrative units. Recent initiatives to broadening the Federal
Reserve Board’s authority over issues of market stability could be seen
as a continuation of this process. As I explore in greater detail elsewhere,
one could easily imagine the creation of another industry-wide regula-
tory unit – perhaps built upon the current President’s Working Group
for Financial Markets – to develop consistent American regulation and
associated policy-making functions for other areas of financial regula-
tion, including consumer protection, the mechanical aspects of regulation
such as fitness standards or affi liated party transactions, and other rules
common to all sectors of the fi nancial services industry. In this way, the
United States could begin to achieve many of the benefits of consoli-
dated supervision, but without disrupting our traditional supervisory
structure and taking on all of the quite formidable political challenges
that consolidation of those units would entail.
If the United States were to head down this path, it would become
the converse of the current European model. Whereas the EU system
 fina ncia l superv ision in eu rope 539

now largely depends on sectoral regulation at the EU directive level

with mostly consolidated supervision and enforcement among member
states, the path toward consolidation that I imagine for the United States
would consist of moving towards consolidated regulation through con-
gressional legislation as well as a newly devised regulatory agency to
articulate most forms of financial regulation and perhaps the Federal
Reserve Board for issues related to market stability, but could retain for
some years sectoral supervision and enforcement along current lines.
The United States and the European Union could then engage in a quite
interesting form of regulatory competition over which form of financial
regulatory consolidation works best.34

* * * * *
For many years, financial regulation was a national affair, and regula-
tory structures evolved in response to national conditions and domes-
tic constituencies, with little attention to developments beyond national
borders. Today, however, financial regulation is inherently a global under-
taking, with an ever-increasing volume of cross-border transactions and
an ever-escalating mobility of financial firms. Nowhere in the world can
financial regulators proceed without attention to evolving supervisory
practices in other jurisdictions. For a number of decades now, American
legal academics have had the great good fortune to be able to look to the
work of Professor Wymeersch for a lucid and insightful window into the
European regulatory perspectives. All of us very much look forward to
many more years of this most important and illuminating work.

34
One of the challenges of devising a more integrated form of fi nancial regulation in the
United States is dealing with the fact that the scale of the US economy and its regulatory
operations is so much greater than that of other jurisdictions, (Jackson, ‘An American
Perspective on the FSA’, (note 2, above), 39–71). For an argument that scale factors should
not inhibit full consolidation of financial regulatory functions in the United States, see
Brown, ‘E Pluribus Unum – Out of Many’, (note 6, above), 1–101.
 29

The SEC embraces mutual recognition

Roberta S. K ar mel

I. Introduction
The traditional approach of the United States Securities and Exchange
Commission (SEC) toward foreign (non-US) issuers, financial interme-
diaries and markets has been national treatment rather than mutual
recognition. In the view of the SEC, mutual recognition was appropriate
only when there was harmonized securities regulation between the US
and a foreign jurisdiction. Accordingly, although the SEC made accom-
modations to foreign issuers, it rarely engaged in mutual recognition,
the one important exception being the multi-jurisdictional disclosure
(MJDS) regime with Canada. Th is exception actually proved the rule
because the Canadians amended their securities laws to harmonize
their securities regulations with US law, and to the extent that this was
not the case, with regard to generally accepted accounting principles
(GAAP), Canadian issuers were required to reconcile Canadian GAAP
to US GAAP.
More recently, however, the SEC has been taking a new look at
mutual recognition, and in the case of international fi nancial report-
ing standards (IFRS) it now allows foreign issuers to use IFRS rather
than US GAAP based on a theory of convergence rather than a require-
ment of harmonization. Furthermore, with regard to the prospect of
foreign exchange and broker-dealer access to the US capital markets,
the SEC is contemplating mutual recognition based on a theory of regu-
latory equivalence rather than a requirement of harmonization. On 1
February 2008, SEC Chairman Christopher Cox and European Union
Commissioner for the Internal Market and Services Charlie McCreevy
met in Washington, DC and agreed to a goal of an EU–US mutual rec-
ognition arrangement for securities regulation, declaring that ‘mutual
recognition offers significant promise as a means of better protecting

540
 The SEC embr aces mutua l r ecogn ition 541

investors, fostering capital formation and maintaining fair, orderly, and

efficient transatlantic securities markets’.1
This chapter will discuss the differences between mutual recognition
based on securities law harmonization, securities law convergence and
securities law equivalence, and suggest that changes in the international
capital markets are forcing the SEC to reconsider its long-standing
insistence on harmonization as a predicate for mutual recognition. By
accepting IFRS from foreign issuers, the SEC based its rule-making on
convergence between US GAAP and IFRS, rather than insisting on full
harmonization. In considering allowing foreign trading screens into the
US, the SEC may base new rules on regulatory equivalence. In order to
remain a leading securities regulator, the SEC is engaging in discussions
with foreign regulators to achieve regulatory comparability, whether
called harmonization, convergence or equivalence, and the promise of
mutual recognition may well act as an incentive to realizing high inter-
national standards for investor protection.

II. National treatment

A. Public companies
Generally, the most common approaches to regulating foreign issu-
ers which sell securities to domestic investors are: requiring them to
comply with host country laws (national treatment);2 creating special
host country rules for them;3 developing harmonized international
standards;4 and accepting compliance with home country standards
(mutual recognition).5 The US historically approached this problem
through national treatment, with some special rules to ameliorate the
problems of compliance for foreign issuers. By contrast, the EU has a

1
SEC Press Release 2008–9, ‘Statement of the European Commission and the US Securities
and Exchange Commission on Mutual Recognition in Securities Markets’, www.sec.
gov/news/press/2008/2008–9.htm, at 2 (last accessed 1 February 2008).
2
See R.C. Campos, ‘Speech by SEC Commissioner: Embracing International Business
in the Post-Enron Era’, speech at the Centre for European Policy Studies in Brussels
(Belgium), www.sec.gov/news/speech/spch061103rcc.htm (last accessed 11 June
2003).
3
Ibid. Th is has been the SEC’s approach to some extent.
4
See M.G. Warren III, ‘Global Harmonization of Securities Laws: The Achievement of the
European Communities’, Harvard International Law Journal, 31 (1990), 191.
5
Ibid.
542 Perspectiv es in fina ncia l r egu l ation

regime of mutual recognition, at least within the EU.6 While there is no

international securities regulator with the ability to impose a disclosure
or other regulatory regime on all issuers worldwide, the International
Organization of Securities Commissions (IOSCO) has developed a tem-
plate for basic disclosure standards and the International Accounting
Standards Board (IASB) has developed international accounting stan-
dards (formerly known as IAS and now known as international financial
reporting standards or IFRS).7
When the Securities Act of 1933 (‘Securities Act’) was passed, Congress
contemplated that foreign issuers might make offerings into the United
States, and provided a special disclosure regime for sovereign debt.8 Further,
the jurisdictional reach of the law extended to interstate and foreign com-
merce.9 The US courts have given the SEC authority to impose its disclosure
obligations on any foreign company that sells shares to US nationals.10 Under
the federal securities laws, any foreign issuer which makes a public offering
into the US must then become an SEC registered and reporting company.
A company wishing to list its securities on a US exchange also must regis-
ter its listed securities with the SEC under the Securities Exchange Act of
1934 (‘Exchange Act’) and become subject to the SEC’s annual and periodic
reporting and disclosure requirements.11 Although the SEC could require
any foreign issuer with more than 500 shareholders worldwide, of which 300
are US investors, and which has $10 million in assets, to register its equity
securities pursuant to the Exchange Act,12 the SEC has not exerted its juris-
diction to this extent. Foreign issuers which would be required to file under
the Exchange Act because they have $10 million in assets and 300 out of 500
US shareholders can file for an exemption from such registration.13

6
See M.I. Steinberg and L.E. Michaels, ‘Disclosure in Global Securities Offerings: Analysis
of Jurisdictional Approaches, Commonality and Reciprocity’, Michigan Journal of
International Law, 20 (1999), 255–61.
7
See M.I. Steinberg, International Securities Law: A Contemporary and Comparative
Analysis, (Kluwer Law International, 1999), 27–38.
8
Securities Act, Schedule B, 15 U.S.C. § 77aa (2008).
9
Ibid. § 77b (7) (2008).
10
See Europe and Oversees Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d
118 (2d Cir. 1998), cert. denied, 525 U.S. 1139 (1999) (suggesting that the Securities Act
applies when both the offer and sale of a security are made in the United States); Consol.
Gold Fields PLC v. Minorco, S.A., 871 F.2d 252, modified, 890 F.2d 569 (2d Cir.), cert.
dismissed, 492 U.S. 939 (1989).
11
15 U.S.C. § 78a (2008), et seq.
12
See 15 U.S.C. ‘ 78l. The SEC has under consideration rule-making to make this exemption
more difficult to claim and maintain. See note 53, infra.
13
Exchange Act Rule 12g3–2 (b), 17 C.F.R. § 240.12g3–2 (b).
 The SEC embr aces mutua l r ecogn ition 543

The attitude of the SEC staff long was that if a foreign issuer was going
to tap the US capital markets then it should play by the SEC’s rules. In the
mid 1970s the SEC requested public comment on improving the disclos-
ure required by foreign issuers, noting that the registration forms used by
them required substantially less information than required of US domes-
tic issuers.14 The SEC then adopted Form 20-F as a combined registration
and annual reporting form,15 but, since corporate governance regula-
tion generally was left to the states under US law, it was similarly left to
the national law of foreign issuers. Among other things, foreign issu-
ers were exempted from SEC proxy solicitation regulations and short-
swing insider transaction reporting requirements.16 Further, in Form
20-F, the SEC bowed to some of the objections of foreign issuers and
deleted certain proposed disclosures relating to corporate governance.17
Additionally, following a policy of international cooperation during the
1980s and 1990s, the SEC fashioned special exemptions for foreign issu-
ers relating to private offerings to institutional investors,18 and amended
its foreign issuer disclosure forms to comply with disclosure standards
endorsed by IOSCO.19
In 1991 the SEC adopted the MJDS whereby qualified Canadian issu-
ers could issuer securities in the US based on their fi lings with Canadian
securities regulators.20 This regime was based on harmonization of
securities law requirements between the SEC and the Canadian secu-
rities regulators and was a mutual recognition system. Canadian issu-
ers could use the same prospectus for offerings in the US as they had
14
Means of Improving Disclosure by Certain Foreign Private Issuers, Exchange Act
Release No.13,056, 41 Fed. Reg. 55,012, at 55,013 (16 December 1976).
15
17 C.F.R. § 249.220 (f). Th is continues to be the primary reporting form for foreign
issuers.
16
17 C.F.R. § 240.3a12–3.
17
Specifically, the disclosure of the business experience and background of officers and
directors, the identification of the three highest paid officers and directors and the aggre-
gate amount paid to them; and conditioned a material transactions disclosure to the
requirements of applicable foreign law. Rules, Registration and Annual Report Form for
Foreign Private Issuers, Exchange Act Release No. 16,371, 44 Fed. Reg. 70,132, at 70,133
(6 December 1979). See also Adoption of Foreign Issuer Integrated Disclosure System,
Securities Act Release No. 6437, 47 Fed. Reg. 54,764 (6 December 1982).
18
See Regulation S, 17 C.F.R. §230.901–905; Rule 144A, 17 C.F.R. §230.144A; Rule 12g3-2
(b), 17 C.F.R. §240.12g3-2(b).
19
International Disclosure Standards, Securities Act Release No. 7745, 64 Fed. Reg. 53900
(5 October 1999).
20
Multijurisdictional Disclosure and Modifications to the Current Registration and
Reporting System for Canadian Issuers Securities Act Rule 29354, 56 Fed Reg 30096
(1 July 1991).
544 Perspectiv es in fina ncia l r egu l ation

used in Canada, except that they were required to reconcile their finan-
cial statements to US GAAP.21 After the MJDS was put into effect, the
SEC considered establishing a mutual recognition regime with other
jurisdictions, in particular, the United Kingdom, but this effort was
abandoned. Among other reasons, the British authorities were advised
that the SEC could not establish a mutual recognition regime with only
one and not other EU countries.
Another area in which the SEC established a mutual recognition
regime was with respect to tender offers and rights offers.22 Because
of complaints from US investors holding foreign securities who were
deprived of the opportunity to participate in foreign issuer takeover
and rights offerings by reason of SEC protections they did not desire,
the SEC established a principle of mutual recognition for these types
of cross-border offerings. These rules were adopted at about the same
time that the SEC revised its disclosure standards for foreign private
issuers based upon the international disclosure standards endorsed by
IOSCO. The SEC was also going forward at this time on a program to
harmonize US and international accounting standards through the
IASB. Unfortunately, this spirit of international cooperation between
the SEC and foreign regulators was undermined by the enactment of the
Sarbanes–Oxley Act of 2002 (‘Sarbanes–Oxley’).23
Although foreign issuers had become used to a regime under
which US corporate governance standards did not apply to them,
Sarbanes–Oxley did not exempt foreign issuers from its new corpo-
rate governance requirements. Foreign issuers viewed the context for
Sarbanes–Oxley to be US fi nancial scandals and failures, and argued
that the SEC should not be imposing corporate governance regulations
on corporations that functioned in very different corporate fi nance
systems and with very different structures than US fi rms. 24 Congress
and the SEC retreated to the view that if foreign issuers wish to tap the
US capital markets, they needed to play by US rules. Financial scandals
in Europe, including the Royal Ahold, Parmalat and Vivendi cases, 25
21
Ibid. at 30101.
22
Cross-Border Tender and Exchange Offers, Business Combinations and Rights Offerings,
Securities Act Release No. 7759, 64 Fed Reg. 61382 (10 November 1999).
23
Sarbanes-Oxley Act of 2002, Pub. L. No. 107–204, 116 Stat. 745 (2002) (codified in
scattered sections of 11, 15, 18, 28 and 29 U.S.C.).
24
See K.S. Lehman, ‘Recent Development: Executive Compensation Following the
Sarbanes–Oxley Act of 2002’, North Carolina Law Review, 81 (2003), 2132–33.
25
See L. Enriques, ‘Bad Apples, Bad Oranges: A Comment From Old Europe on Post-Enron
Corporate Governance Reforms’, Wake Forest Law Review, 38 (2003), 911; E. Mossos,
 The SEC embr aces mutua l r ecogn ition 545

strengthened this view and made the SEC unwilling to craft exemp-
tions for foreign issuers. Although the SEC did exempt foreign issuers
from the requirement that their audit committees have independent
directors if their governance structures achieved the same goals as the
Sarbanes–Oxley audit committee provisions, 26 the SEC required for-
eign issuers to comply with other provisions such as the CEO-CFO
certification requirements27 and the internal control provisions of
Section 404 of Sarbanes–Oxley.28 After some difficult negotiations,
the SEC and foreign regulators came to an accommodation regarding
regulation of audit fi rms. 29

B. Foreign exchanges and broker-dealers

Pressure from the EU on US policy makers to allow foreign trading
screens in the US has been ongoing for some time.30 A response to this
pressure was expressed by SEC Commissioner Roel C. Campos, who
explained that the SEC ‘imposes significant regulatory requirements on
exchanges, as well as on issuers who list on those exchanges, whether
foreign or domestic. The exemptions being requested by some foreign

‘Sarbanes-Oxley Goes to Europe: A Comparative Analysis of United States and European

Union Corporate Reforms After Enron’, Currents: International Trade Law Journal, 13
(2004), 9; C. Storelli, ‘Corporate Governance Failures – Is Parmalat Europe’s Enron?’,
Columbia Business Law Review, 3 (2005), 765.
26
Final Rule: Standards Relating to Listed Company Audit Committees, Securities Act
Release No. 8220, 68 Fed. Reg. 18788 (16 April 2003).
27
Sarbanes-Oxley, §§ 302, 906.
28
15 U.S.C. § 7262 (2008).
29
Sarbanes–Oxley, which created the Public Company Accounting Oversight Board
(PCAOB), directed public accounting firms that participate in audits of SEC report-
ing companies to register with the PCAOB and become subject to PCAOB audit rules
and inspection (§§ 102–104, 15 U.S.C. § 7212 (2004)). These provisions applied on their
face to foreign auditors, a situation which created confl ict between the SEC and foreign
regulators. In order to ameliorate these problems, the PCAOB stated its intention to
cooperate with non-US regulators in accomplishing the goals of the statute without sub-
jecting non-US public accounting forms to unnecessary burdens or confl icting require-
ments. See Final Rules Relating to the Oversight of Non-US Public Accounting Firms,
PCAOB Release No. 2004–005, www.pcaobus.org/Rules/Docket_013/2004–06–09_
Release_2004–005.pdf, at 2–3 (last accessed 9 June 2004).
30
See F. Bolkestein, ‘Towards an Integrated European Capital Market’, Keynote Address
at Federation of European Securities Exchange Convention, London’, (13 June 2003);
F. Bolkestein, ‘Press Conference with EU Internal Market and Taxation Commissioner
Frits Bolkestein, Washington, D.C.’,
http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/03/297&format= H
TML&aged=1&language=EN&guiLanguage=en (last accessed 29 May 2002).
546 Perspectiv es in fina ncia l r egu l ation

exchanges would create access to US investors on different terms than

those available to US Exchanges. This, in turn, puts considerable stress
on our system of regulation, disrupting the level playing field we have
created for all market participants.’31
There are two problems with regard to giving foreign securities
exchanges access to the United States. One is how to fit such exchanges
into national market system (NMS) regulation. Domestic electronic com-
munications networks (ECNs) or alternative trading systems (ATSs) have
been brought into the NMS regulatory framework through the adoption
of Regulation ATS and a revised definition of the term ‘exchange’ under
the Exchange Act.32 In its Concept Release proposing that ATSs should
either register as exchanges or undertake new responsibilities as broker-
dealers, the SEC addressed the problem of foreign exchanges wishing to
access the US capital markets.33 Since then, the SEC and the EU have put
in place comprehensive and probably incompatible regulations governing
trading on regulated markets.34 The second major problem preventing
foreign stock exchange access is that thousands of foreign securities that
are not registered with the SEC and whose issuers do not meet SEC dis-
closure and accounting standards, would become tradeable in the US.35
The SEC has suggested several possible solutions to this problem. First,
the SEC could subject foreign exchanges to registration as ‘exchanges’
under the Exchange Act and prevent them from trading any securities
not registered with the SEC under the Exchange Act.36 Second, the SEC
could limit cross-border trading by ECNs, ATSs or foreign exchanges
seeking US investors to operate through an access provider which would
be a US broker-dealer or ECN.37 Third, the SEC could limit trading in
foreign securities by foreign exchanges to transactions with sophisticated
US investors so that some exemption from Securities Act registration

31
R.C. Campos, ‘Speech by SEC Commissioner: Embracing International Business in the
Post-Enron Era’, speech at the Centre for European Policy Studies, Brussels, www.sec.
gov/news/speech/spch061103rcc.htm (last accessed 11 June 2003).
32
See Exchange Act Rule 3b-16, 17 C.F.R. § 240.3b-16 (2000).
33
Concept Release, Regulation of Exchanges, Exchange Act Release No. 38672, 62 Fed.
Reg. 30485 (4 June 1997) [hereinafter ‘ATS Concept Release’].
34
See R.S. Karmel, ‘The Once and Future New York Stock Exchange, The Regulation of
Global Exchanges’, Brooklyn Journal of Corporate, Financial and Commercial Law, 1
(2007), 370–79.
35
See ATS Concept Release, supra note 33, at 30529.
36
Ibid. at 30488.
37
Ibid. at 30488.
 The SEC embr aces mutua l r ecogn ition 547

might be available.38 Fourth, the SEC could limit trading to world-class

foreign issuers.39

C. Marketplace changes
Marketplace developments in recent years have made a US listing less
attractive for foreign issuers. The European markets have matured to a
point where capital can be raised there to meet the needs of most compa-
nies.40 Foreign, and even some US companies, engaging in IPOs or stock
exchange listings have done so in Europe, rather than in the US. In 1999
and 2000, foreign IPOs on US exchanges exceeded $80 billion, ten times
the amount raised in London, but in 2005 London exchanges raised over
$10.3 billion in foreign IPOs compared to $6 billion on US exchanges.41
In 2004, only three out of the twenty-five largest IPOs were listed on US
exchanges, in 2005 none of the twenty-five largest IPOs were listed on US
exchanges, and during the first half of 2006, only two of the largest twenty-
five international IPOs were listed on US exchanges. By contrast, in 2000,
eleven of the twenty-five largest IPOs were listed on US exchanges.42
Another possible factor in the SECs new attitude toward mutual
recognition probably was the merger of the New York Stock Exchange,
Inc. with Euronext, NV in 2007.43 In order for this merger to be accom-
plished, it was necessary for the SEC to assure European regulators that
the SEC would not attempt to impose provisions of Sarbanes-Oxley
upon companies listed on Euronext.44 In addition, it was necessary for

38
Ibid. In 2003 the staff of the Ontario Securities Commission recommended a new
approach to the recognition of securities in foreign based stock exchange indexes based
on mutual recognition. See Regulatory Approach for Foreign-Based Stock Exchanges,
www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part2/sn_21–702_for.
39
J.W. White, ‘Speech by SEC Staff: “Corporation Finance in 2008 – International
Initiatives”, Remarks Before PLI’s Seventh Annual Institute on Securities Regulation in
Europe’, www.sec.gov/news/speech/2008/spch011408jww.htm, at 15–16 (last accessed
14 January 2008).
40
See K. Betz, ‘Former SEC Official Sees New Realities For Foreign Issuers Seeking to Raise
Capital’, 38 Sec. Reg. & L. Rep. (BNA), (15 May 2006), at 852.
41
See S. Fidler, ‘How the Square Mile Defeated Prophets of Doom’, Financial Times
(London), (10 December 2005), at 11.
42
See A. Lucchetti, ‘NYSE, Via Euronext, Aims to Regain Its Appeal for International
Listings’, Wall Street Journal, 30 June 2006, at C1.
43
See NYSE Euronext At-a-Glance, www.nyse.com/pdfs/NY7_3_p44_45InSide.pdf.
44
C. Cox, ‘Speech by SEC Chairman: Remarks on Acceptance of the Atlantic Leadership
Award from the European-American Business Council’, www.sec.gov/news/speech/
2008/spch020108cc.htm, at 3 (last accessed 1 February 2008).
548 Perspectiv es in fina ncia l r egu l ation

the SEC to be assured of regulatory cooperation by European regulators.

In order to facilitate this merger, the SEC and the College of Euronext
Regulators therefore negotiated a comprehensive arrangement to facili-
tate cooperation in market oversight.45

III. The converge concept and the IFRS roadmap

At the end of last year, the SEC determined to allow foreign issuers to
report their fi nancial statements in IFRS, rather than US GAAP, without
a US GAAP reconciliation.46 Th is step was a significant breakthrough
in a step toward mutual recognition by the SEC in circumstances where
regulatory standards are sufficiently converged (although not com-
pletely harmonized) to protect investors. Of equal importance to the
decision by the SEC to accept IFRS in fi lings by foreign issuers, the SEC
proposed to allow US issuers to report their financial statements in
IFRS.47
The recognition of IFRS has been a long time in coming. In 1988, the
SEC explicitly supported the establishment of international accounting
standards to reduce regulatory impediments resulting from disparate
national accounting standards.48 Nevertheless, the SEC determined not
to adopt a process-oriented approach to IASB standards, recognizing
them as ‘authoritative’ and therefore comparable to US GAAP standards
promulgated by the Financial Accounting Standards Board. Rather, it
intended to assess each IASB standard after its completion, and then rec-
ognize acceptable standards. In 1991 and 1993, it did so with respect to
IASB standards on cash flow statements, business combinations and the

45
SEC Press Release 2007–8, SEC, Euronext Regulators Sign Regulatory Cooperation
Arrangement, www.sec.gov/news/press/2007/2007–8.htm (last accessed 25 January
2007).
46
Acceptance from Foreign Private Issuers of Financial Statements Prepared in
Accordance with International Financial Reporting Standards Without Reconciliation
to US GAAP, Securities Act Release No. 8879, 73 Fed. Reg. 986 ( 4 January 2008) [herein-
after ‘Acceptance of IFRS Final Release’].
47
Concept Release on Allowing US Issuers to Prepare Financial Statements in Accordance
with International Financial Reporting Standards, Securities Act Release No. 8831, 72
Fed. Reg. 45599 (14 August 2007), corrected 72 Fed. Reg. 53509 (19 September 2007).
48
C.W. Hewitt and J.W. White, Testimony Concerning Globally Accepted Accounting
Standards, Before the Subcomm. On Securities, Insurance, and Investment of the Sen.
Comm. On Banking Housing and Urban Affairs, www.sec.gov/news/testimony/2007/
ts102407cwh-jww.htm, at 2–3 [hereinafter ‘Hewitt Testimony’] (last accessed 24 October
2007).
 The SEC embr aces mutua l r ecogn ition 549

effects of changes in foreign exchange rates.49 But the SEC then suspended
this approach of recognizing one standard at a time and decided instead
to consider all IASB standards after the IASB completed its core stan-
dards work program.50 This program was completed in March 2000, and
the SEC then issued a Concept Release as part of the assessment process
possibly leading to the SEC’s acceptance of IFRS. IOSCO, as well as the
SEC and others, were working on financial disclosure harmonization,
and by May 2000, IOSCO had assessed all thirty core standards in the
IASB work program and recommended to its members that multi-na-
tional issuers use the core standards, supplemented by reconciliation,
disclosure interpretation where necessary.51 But in its 2000 Concept
Release on accounting disclosure for foreign companies, the SEC con-
tinued to reject a mutual recognition approach except for the MJDS with
Canada.
At this time, the SEC was not concerned about particular IFRS stand-
ards, with a few exceptions, but it questioned whether these standards
could be rigorously interpreted and applied.52 In particular, the SEC had
criticized the structure and financing of the IASB and took a heavy hand
in restructuring this organization. A new constitution was adopted in
May 2000, which established this body as an independent organiza-
tion with two main bodies, the Trustees and the Board, as well as the
Standing Interpretations Committee and Standards Advisory Council.53
The Trustees appoint the Board Members, exercise oversight and raise
the funds needed, whereas the Board has sole responsibility for setting
accounting standards. The founding Chairman of the Board of Trustees
for the restructured IASB was Paul A. Volker, Former Chairman of the
US Federal Reserve Board.54 It appeared that, despite SEC staff reserva-
tions about IFRS, a momentum for mutual recognition of accounting
standards, based on convergence, if not harmonization, was moving
along. But the spirit of cooperation that had been established between

49
International Accounting Standards Concept Release, Securities Act Release No. 7801,
65 Fed. Reg. 8896 (23 February 2000), at 8903, n.33 [hereinafter ‘IAS Release’].
50
Ibid. at 8899.
51
See Press Release, IOSCO, IASC Standards, http://iosco.org/news/pdf/IOSCONEWS26.
pdf (last accessed 17 May 2000).
52
See IAS Release, (supra note 49), at 8901–02.
53
See Acceptance From Foreign Private Issuers of Financial Statements Prepared in
Accordance With International Financial Reporting Standards Without Reconciliation
to US GAAP, Securities Act Release No. 8818, 72 Fed. Reg. 37962, (11 July 2007) [herein-
after ‘Acceptance of IFRS Proposing Release’], at 37964.
54
Hewitt Testimony, (supra note 48), at 5.
550 Perspectiv es in fina ncia l r egu l ation

the SEC, the EU and the IASB was unfortunately overtaken by the stock
market collapse of 2000–1 and the enactment of Sarbanes–Oxley.
The EU was then able to seize the initiative with respect to interna-
tional accounting standards by turning those European issuers which
had been considering reporting in US GAAP rather than their home
country GAAP, to IFRS, by mandating that all listed companies report
in IFRS as of the year end 2005 and threatening to make US EU-listed
companies also report in IFRS. Moreover, Asian and other issuers also
began looking at IFRS, rather than US GAAP, as an alternative to report-
ing in their national GAAPs for offerings in the international capital
markets.55 As the markets in Europe and Asia strengthened, relative to
the US markets, New York was no longer the only place where multi-
national corporations could raise capital and the SEC was no longer a
regulator which could force its regulations on foreign issuers.
In April 2005, the Chief Accountant of the SEC set forth a road-
map for eliminating the need for non-US companies to reconcile to US
GAAP financial statements prepared according to IFRS.56 This road-
map was explicitly affirmed by SEC Chairman William Donaldson in a
meeting with EU Internal Market Commissioner Charlie McCreevy in
April 2005,57 and then reaffirmed by SEC Chairman Christopher Cox in
February 2006.58 On 6 March 2007, the SEC held a Roundtable on IFRS
as a prelude to issuing a proposed rule on 2 July 2007 to accept from
foreign private issuers financial statements prepared in accordance with
IFRS.59
In that release, the SEC pointed out that almost a hundred countries,
including the twenty-seven EU Member States, were using IFRS, with
more countries considering adopting IFRS.60 The SEC made two argu-
ments in favour of allowing foreign issuers to report in IFRS, a somewhat

55
D. Tweedie and T.R. Seidenstein, ‘Setting a Global Standard: The Case for Accounting
Convergence’, Northwestern Journal of International Law and Business, 25 (2005), 593.
56
D.T. Nicolaisen, ‘Statement by SEC Staff: A Securities Regulator Looks at Convergence’,
www.sec.gov/news/speech/spch040605dtn.htm (last accessed April 2005).
57
SEC Press Release 2005–62, Chairman Donaldson Meets with EU Internal Market
Commissioner McCreevy, www.sec.gov/news/press/2005–62.htm (last accessed
21 April 2005).
58
SEC Press Release No. 2006–17, Accounting Standards: SEC Chairman Cox and
EU Commissioner McCreevy Affirm Commitment to Elimination of the need for
Reconciliation Requirements, www.sec.gov/news/press/2006–17.htm (last accessed 8
February 2006).
59
Acceptance of IFRS Proposing Release, (supra note 53).
60
Ibid. at 37965.
 The SEC embr aces mutua l r ecogn ition 551

remarkable turnabout from its prior resistance to the use of any foreign
GAAP in SEC fi lings. First, the SEC asserted that it had long advocated
reducing disparity between US accounting and disclosure regula-
tions and other countries as a means to facilitate cross-border capital
formation; second, the SEC asserted that an international accounting
standard may be adequate for investor protection even if it is not the
same as the US standard.61 Therefore, based on increasing convergence
between US GAAP and IFRS, and cooperation between the SEC, IOSCO
and the Committee of European Securities Regulators (CESR), the SEC
proposed amendments to its rules that would allow a foreign private
issuer to fi le fi nancial statements without reconciliation to US GAAP, if
those financial statements are in full compliance with the English lan-
guage version of IFRS as published by the IASB.62 The SEC adopted final
rules on permitting foreign issuers to report in IFRS, substantially as
proposed, based primarily on the progress of the IASB and the FASB
toward convergence, their expressed intention to work toward further
convergence in the future and a finding that IFRS are high-quality stand-
ards.63 Yet, significant differences between IFRS and US GAAP continue
to exist, and questions remain about the funding and independence of
the IASB, as well as how IFRS will be interpreted and the lack of conver-
gence on auditing standards between US and EU regulation.
Nevertheless, the SEC’s decision to end the requirement that foreign
issuers reconcile financial statements to US GAAP was extraordi-
narily important from a philosophical and political standpoint, and
showed the rest of the world the US was serious about global accounting
standards.64

IV. Equivalence as a predicate for mutual recognition

A serious change in the tone and content of the SEC–EU dialogue on
foreign exchange access was marked by the publication in 2007 of an
article by Ethiopis Tafara, Director of the SEC’s Office of International
Affairs suggesting ‘substituted compliance’ as a basis for permitting for-
eign stock exchanges to place their screens in the United States and also

61
Ibid. at 37965–66.
62
Ibid. at 37970.
63
Acceptance of IFRS Final Release, (supra note 46).
64
S. Marcy, ‘End of Reconciliation Requirement Big Step to Common Accounting, IASB
Member Says’, 39 Sec. Reg. & L. Rep. (BNA), (10 December 2007), at 1915.
552 Perspectiv es in fina ncia l r egu l ation

for permitting foreign broker-dealers to solicit US customers without

being registered with the SEC.65 Although the SEC as a matter of policy
disclaims responsibility for statements by an SEC staffer, this article
nevertheless was a trial balloon of a new approach to a policy of mutual
recognition. Tafara’s proposal was a system of bilateral substituted
compliance for foreign screens and foreign financial service providers
based upon four steps: (1) a petition from a foreign entity to the SEC
seeking an exemption from registration; (2) a discussion between the
SEC and the entity’s home regulator to determine the degree to which
the trading rules, prudential requirements, examinations, review proc-
esses for corporate fi lings and other securities regulatory requirements
are comparable; (3) a dialogue between the entity and the SEC which
would include an agreement to submit to SEC jurisdiction and service
of process with regard to the anti-fraud laws; and (4) public notice and
an opportunity for comment on the petition.66 An important part of this
proposal was collaboration between the SEC and an entity’s home juris-
diction, including a memorandum of understanding (MOU) between
the two regulators and their ability to share inspections reports, con-
duct joint inspections and therefore enable them to share enforcement-
related information.67 In this connection, it should be noted that the SEC
has MOUs with the EU, CESR and a number of individual European
securities regulators.68
Following the publication of the Tafara article and favourable com-
ments upon it,69 the SEC held a Roundtable on Mutual Recognition.70
65
E. Tafara and R.J. Peterson, ‘A Blueprint for Cross-Border Access to US Investors: A New
International Framework’, Harvard International Law Journal, 48 (2007), 31.
66
Ibid. at 58–9.
67
Ibid.
68
See US Securities and Exchange Commission, International Enforcement Assistance,
www.sec.gov/about/offices/oia/oia_crossborder.htm#bilateral; US Securities and
Exchange Commission, Cooperative Arrangements with Foreign Regulators, www.sec.
gov/about/officies/oia/oia_cooparrangments.htm#enforce.
69
See E.F. Greene, ‘Beyond Borders: Time to Tear Down the Barriers to Global Investing’,
Harvard International Law Journal, 48 (2007), 85; E.F. Greene, ‘Beyond Borders Part II:
A New Approach to the Regulation of Global Securities Offerings’, www.corporateac-
countability2007.com/02.pdf (last accessed 2007); H. E. Jackson, ‘A System of Selective
Substitute Compliance’, Harvard International Law Journal, 48 (2007), 105. But see
G.W. Madison and S. P. Greene, ‘TIAA-Cref Response to A Blueprint for Cross-Border
Access to US Investors: A New International Framework’, Harvard International Law
Journal, 48 (2007), 99.
70
See SEC Press Release No. 2007–105, SEC Announces Roundtable Discussion Regarding
Mutual Recognition, www.sec.gov/news/press/2007/2007-105.htm (last accessed 24 May
2007).
 The SEC embr aces mutua l r ecogn ition 553

The purpose of the Roundtable was to discuss selective mutual recogni-

tion, described as ‘the SEC permitting certain types of foreign financial
intermediaries to provide services to US investors under an abbreviated
registration system, provided those entities are supervised in a foreign
jurisdiction with a securities regulatory regime substantially compara-
ble (but not necessarily identical) to that of the United States’.71 Mutual
recognition of foreign markets and broker-dealers was also promoted in
speeches by the SEC Director of the Division of Market Regulation.72
The SEC Director of the Division of Corporation Finance also has
embraced mutual recognition based on mutual recognition of foreign
securities regulatory regimes as a means to permit foreign fi nancial
intermediaries and broker-dealers to access US markets based on equiv-
alent regulatory standards.73 He made clear, however, that in his view,
such a regime should apply to trading of world-class securities, not to
capital raising by foreign companies. Furthermore, he suggested that
with regard to foreign issuers with a significant US shareholder follow-
ing, the SEC might alter its long-standing exemption for foreign issuers
from the reporting requirements of the Exchange Act.74

V. The way forward

On 1 February 2008, SEC Chairman Cox and EU Commissioner
McCreevy met in Washington and agreed to implement a mutual
recognition regime in order to better protect investors, foster capital for-
mation and maintain fair, orderly and efficient transatlantic securities
markets. They jointly declared that since the US and EU comprise 70%
of the world’s capital markets, they had a common interest in developing
a cooperative approach to securities regulation.75

71
Ibid.
72
See E.R. Sirri, ‘Speech by SEC Staff: A Global View: Examining Cross-Border Financial
Services’, http://sec.gov/news/speech/2007/spch081807ers.htm (last accessed 18 August
2007); E.R. Sirri, ‘Speech by SEC Staff: Trading Foreign Shares’, www.sec.gov/news/
speech/2007/spch030107ers.htm (last accessed 1 March 2007).
73
J.W. White, ‘Speech by SEC Staff: “Corporation Finance in 2008 – International
Initiatives” Remarks Before PLI’s Seventh Annual Institute on Securities Regulation
in Europe’, www.sec.gov/news/speech/2008/spch011408jww.htm, at 16 (last accessed
14 January 2008).
74
Ibid.
75
SEC Press Release 2008–9, Statement of the European Commission and the US Securities
and Exchange Commission on Mutual Recognition in Securities Markets, www.sec.gov/
news/press/2008/2008–9.htm (last accessed 1 February 2008).
554 Perspectiv es in fina ncia l r egu l ation

Hopefully, future cooperation between the SEC, the EU and CESR

will lead to improved investor protection regimes that can form the
basis for mutual recognition initiatives based either on convergence or
substantial equivalence, thus reducing compliance costs for issuers and
financial intermediaries, and making capital formation more efficient.
Both the SEC and the EU are facing regulatory competition from other
securities regulatory regimes around the world. Working together they
can continue to act as leaders in the field of financial regulation and
attract both investors and issuers into their markets.
 30

Steps toward the Europeanization of US securities

regulation, with thoughts on the evolution and design
of a multinational securities regulator
Donald C. Langevoort

I. Introduction
The United States currently faces a set of regulatory issues that are
profoundly important to the future of its form of securities regulation
and hence its place in the global capital marketplace. Calls for exten-
sive reform have come from a well-publicized set of studies that question
the ability of the US to be competitive worldwide because of excessive
regulation and an overdeveloped litigation culture.1
One of the principal moves being considered takes the form of mutual
recognition.2 The likely first stage of this would be the invitation to for-
eign stock exchanges and securities firms to have a presence in the US
without registration with the SEC as a domestic exchange or broker-dealer
firm, upon the determination that adequate home country regulation
exists and can be relied upon as a substitute for direct SEC oversight.
As part of this, however, would be some attention to a bigger project:
the potential for mutual recognition of issuer disclosure and governance
rules. Foreign trading screens and foreign broker-dealer presence in the
US is meaningful largely as a means of making foreign securities more
readily available to US investors, and the potential for increased compe-
tition and lower costs will hardly follow if making such securities avail-
able means intense US regulation of the issuers of those securities. Some
mutual recognition of issuer disclosure standards is thus inevitable if

1
Committee on Capital Markets Regulation, Interim Report, 30 November 2006, www.
capmktsreg.org/research.html.
2
E. Pan, ‘The New Internationalization of US Securities Regulation: Improving the
Prospects for an Trans-Atlantic Marketplace’, European Company Law, 5 (2008), 1; E.
Tafara and R. Peterson, ‘A Blueprint for Cross-Border Access to US Investors: A New
International Framework’, Harvard International Law Journal, 48 (2007), 31–68.
555
556 Perspectiv es in fina ncia l r egu l ation

the project is to succeed, and the SEC has already taken steps in this
direction with the recent determination that foreign issuers do not have
to reconcile their financial reporting to US generally accepted account-
ing principles.3 Because financial reporting is at the heart of issuer dis-
closure, toleration of different sets of rules would presumably signal a
willingness to do the same with respect to other aspects of disclosure.
Of course, we do not yet know that this willingness to experiment in
mutual recognition will continue. There have been Republican chair-
men of the SEC for the last eight years, and a shift in political control
of the chairmanship and majority of the Commission might lead to a
pull-back. Nor do we yet know the details of what might emerge even
under the current administration. Quite possibly the eventual steps in
the direction of mutual recognition will be small and disappointing to
its adherents.
Because of this political uncertainty, my aim in this essay is not to
explore mutual recognition in depth. Rather, it is to connect this and
a number of other issues to what I regard as a deeper shift in the style
and substance of US securities regulation that is likely to continue no
matter who exercises political control. That shift comes as a result of the
increasing institutionalization of both holdings and trading in stocks of
widely-followed companies, or what Brian Cartwright, the SEC’s gen-
eral counsel, recently termed the resulting ‘deretailization’ of the US
securities markets.4
Mutual recognition and the issues arising out of ‘deretailization’ have
much in common. What makes them particularly appropriate to con-
sider in this volume of essays in tribute to Eddy Wymeersch’s masterful
contributions both as regulator and scholar is that they both represent
ways in which the US is increasingly open to a more European style of
securities regulation, where institutionalization has long been domi-
nant and mutual recognition a long-standing project within the EU.5
I am not suggesting a perfect analogy, of course. Europe has determined
that greater retailization of its capital marketplace is a worthwhile goal,6
3
J. White, ‘Corporation Finance in 2008 – International Initiatives,’ London, England,
2008, www.sec.gov/news/speech/2008/spch011408jww/htm.
4
B. Cartwright, ‘The Future of Securities Regulation’, University of Pennsylvania,
Philadelphia, Pennsylvania, 24 October 2007, www.sec.gov/news/speech/2007/spch
102407bgc.html.
5
E. Ferran, Building an EU Securities Market (Cambridge University Press, 2004).
6
N. Moloney, ‘Building a Retail Investment Culture Th rough Law: The 2004 Markets in
Financial Instruments Directive’, European Business Organization Law Review, 6 (2005),
341–421.
 Eu ropea n ization of US Secu r ities R egu lation 557

so that what we may be seeing is movement toward a more mixed inves-

tor demography on both continents. And mutual recognition as it is
developing in the US, at least, may actually be a form of deregulation
aimed mainly at the more sophisticated, wealthy end of the market, not
something that makes significant changes for the average American
household.
But it does seem clear that US securities regulation is today willing to
concede that for well-known issuers, the market is truly institutional,
and that forms of regulation of these issuers (and their trading markets)
that exceeds what institutional investors want or need does risk driving
some business away to the detriment of the securities industry and its
ancillary service providers such as lawyers and accountants. The fear in
the US is that Europe’s ability to focus on market building without the
heavy baggage of historically large-scale retail participation is a com-
petitive advantage in this respect.
Thus, I want first to think about how US securities regulation might
change so as to become more European in style – that is, more consonant
with institutional investor demands and preferences – with respect to the
securities of larger issuers. (To be clear, I am not suggesting that Europe
has built its markets and regulatory regime at the behest of institutional
investors; rather, it has built its markets and regulatory regime in an envi-
ronment where there has not been a strong, competing political voice by
retail investors). It is important to emphasize that ‘deretailization’ does
not imply a drop in the percentage of US households who hold securi-
ties, but just that more of those households have interests in securities
held by institutional intermediaries. The political fact that still makes
the US different from most of Europe is that far more US households see
themselves as active investors, and hence the beneficiaries of relatively
intense securities regulation. Thus the political demand for strong secu-
rities regulation will not change. What will change is the focus. There
will still be emphasis on those segments of the market (e.g. microcap
stocks) that remain largely retail, and – of course – greater emphasis
on the need for protection of investors who participate in institutional
portfolios of various sorts. The SEC will still have plenty of work to do in
the name of retail investors. But where the interests of retail participants
are relatively well aligned with those managing the institutional portfo-
lios, the SEC is likely to defer increasingly to the professional investors’
articulation of how they would like to see the law structured.
There is one additional form of Europeanization of US securities reg-
ulation that also strikes me as at least a strong possibility. It is probably
558 Perspectiv es in fina ncia l r egu l ation

still a fair assessment that Europe treats the public responsibilities of

large corporations more seriously than the US does as a matter of cor-
porate governance. There is more emphasis on disclosure of labour and
environmental practices, and more strings that European governments
can pull to rein in the private, competitive impulses of larger fi rms
located within their jurisdictions. I have written elsewhere that even
though the norm of shareholder primacy still officially holds in the US,
there have been reforms in both securities law and corporate govern-
ance that hint strongly of greater public-regarding expectations with
respect to the process of corporate decision making, which strikes me
as a bit more like the European model. Sarbanes-Oxley is a good illus-
tration, insofar as it introduces more transparency, accountability and
public voice into the boardroom in order to check both excessive risk
taking and private aggrandizement.7 The effects of many of these rules
(i.e. strong internal controls) are at best ambiguous in terms of value to
investors, but that does not appear to be the test – the value to society
in general from more open corporate decision making seems to be the
point. Although its effects will not always dominate the political land-
scape, this increasing ‘publicization’ of the US corporation will persist.
Such political demand is independent of any trend toward deretailiza-
tion, and – at least through the voices of public pension funds, the most
vocal of institutional investors – may actually be enhanced by it.
In the following pages, then, I want to look at a number of conceptual
issues in securities regulation to see how a more European approach to
US law might play out. The list of issues is not meant to be exhaustive of
the important possibilities, but simply illustrative.

II. Jurisdiction and mutual recognition

The mutual recognition discussion that is on-going in the US is really the
continuation of a much longer-running debate over the subject-matter
jurisdiction of US securities law as applied to cross-border activity. In
principle – and assuming a relatively high degree of market efficiency – it
is easy to imagine a regime of issuer choice, where the issuer commits to a
particular regulatory regime by some state or country.8 It would then be

7
D. Langevoort, ‘The Social Construction of Sarbanes-Oxley’, Michigan Law Review, 105
(2007), 1817–55.
8
S. Choi and A. Guzman, ‘Portable Reciprocity: Rethinking the International Reach of
Securities Regulation’, Southern California Law Review, 71 (1998), 903–52.
 Eu ropea n ization of US Secu r ities R egu lation 559

able to offer securities or trade in the capital markets in any other country
based on its adherence to its ‘home country’ law. Sophisticated inves-
tors would assess the risks, costs and benefits associated with the chosen
regulation and the markets would price the securities accordingly.
This, however, is not the European way. Though committed to a pass-
port system of mutual recognition, the EU has insisted that Member
States adhere to certain fairly demanding standards of regulation so
that what is exported has a high degree of regulatory credibility. Many
of the institutions of contemporary EU securities law are meant to
force Member States into a stronger and more uniform commitment
to regulation and enforcement so as to support a safer form of mutual
recognition.9
The US does not have the same institutional tools to work with, and so
mutual recognition would take a somewhat different form. Apparently,
what would happen is that the US would set its own minimum standards
for the quality of ‘home country law’ that would have to be satisfied before
the SEC would allow the foreign exchange, securities fi rm or issuer to
enter the US without the full application of US law. Importantly, there
would be no deference to home country law with respect to instances of
securities fraud that occur or have significant effects in the US.
Let us assume, as is likely, that this form of mutual recognition is
limited to securities or services where the institutional presence domi-
nates. It seems to me that institutional investors would have little reason
to oppose this kind of liberalization. It offers somewhat lower transac-
tion costs associated with doing business in foreign securities because of
enhanced competition and disintermediation. To be sure, institutions
that value the higher level of disclosure required by US law might pre-
fer that it be available, but the evidence is that many foreign issuers are
choosing to avoid listings in the US rather than submit to such require-
ments, and so that might not really be the choice.
The key to any workable system of mutual recognition is in assessing
both ex ante and on an on-going basis the quality of the home coun-
try’s securities regulation. Initially, it would seem, the EU would be the
place to start: countries that indeed adhere to the requirements in the
various Directives could be presumed to have acceptable regulation.
No doubt more work needs to be done (as Europe already recognizes)

9
N. Moloney, ‘Innovation and Risk in EC Financial Market Regulation: New Instruments
of Financial Market Intervention and the Committee of European Securities Regulators’,
European Law Review, 32 (2007), 627–63.
560 Perspectiv es in fina ncia l r egu l ation

to bring the enforcement capacity of Member States’ laws up to speed,

but this is already on the agenda. So long as US and European regulators
coordinate their demands appropriately, mutual recognition by the US
could be helpful in moving the European efforts along. And with this
experience as a guide, mutual recognition could be extended to other
major capital marketplace countries.
What may be more difficult is in addressing the specific issues that are
likely to arise after mutual recognition is granted. Suppose, for instance,
that a particular problem were to arise, with disagreement about the
home country’s willingness to be as aggressive in applying its laws as
the SEC would like. There is, of course, the possibility of withdrawal of
mutual recognition, but this seems unlikely except in the most extreme
circumstances. Instead, the likely response to a breakdown is that the US
would invoke its reserved authority over fraud to act unilaterally. In fact,
for a variety of reasons having to do with the way the federal securities
laws were originally drafted, the SEC and private plaintiffs have learned
numerous ways to turn virtually any form of misbehaviour into fraud.
If that happens frequently enough, however, it is unlikely that mutual
recognition will succeed, because foreign participants will foresee this
and fi nd little comfort in entering the US under home country law that
can so easily be displaced. For mutual recognition to succeed, then,
there must be some dispute resolution mechanism that helps medi-
ate these disputes before the US defects by unilaterally bringing fraud
claims. Here is another place where the European experience may be
a guide. The creation of CESR and other institutions of pan-European
cooperation in securities regulation have many justifications, but one
is their role as a dispute resolution mechanism where Member States
might disagree about what the basic Directives requirements mean.10
Mutual recognition on a global scale requires a dispute regulatory
authority on a comparable scale. Th is need not be a formal administra-
tive body, but does need to be a reliable mechanism whereby skilled
‘neutrals’ are able to pressure individual countries and their regula-
tors into either action or forbearance. One could imagine any number
of forums that could be so designated, including some growing out of
existing structures such as IOSCO. My prediction would be that the
success of mutual recognition – and the willingness of countries such as
the US to embrace broader versions of it, not simply limited to the insti-
tutional setting – is wholly dependent on this. To be sure, as is currently

10
Moloney, ‘Innovation and Risk in EC Financial Market Regulation’, (note 9, above), 646.
 Eu ropea n ization of US Secu r ities R egu lation 561

an issue in the EU, the emergence of any mediator would raise ques-
tions of legitimacy and accountability, but these are familiar problems
with respect to nearly all efforts at harmonization short of treaty-based
formal authority.
In turn, the creation of such a global administrative body, even if advi-
sory only, could become a platform for other tasks that are likely necessary
for mutual recognition to succeed. As I have written about elsewhere in a
volume that Eddy Wymeersch and Guido Ferrarini edited, cross-border
securities enforcement is likely to be problematic unless some institu-
tions of enforcement cooperation are created that overcome the ‘home
bias’ of domestic regulatory authority.11 Although the creation of a ‘global
SEC’ may be beyond the politically practicable, it is not beyond imagina-
tion that if a group of major capital marketplace countries could agree on
an informal dispute resolution mechanism authority, that that author-
ity could also be a place where professional staff could guide a team of
enforcement personnel from each of the participating countries in order
to launch joint investigations and enforcement proceedings that invoke
the existing laws of those countries in a coordinated fashion. To be work-
able, this would have to be limited to cases of fraud and manipulation
about which there is no substantive disagreement. But with the growth
of the dispute resolution process in the application of minimum global
standards, a consensus on enforcement is itself more likely to evolve.
Mutual recognition, if successful in its earliest stages, naturally raises the
question of how far it should extend. To what extent should it be extended
to retail investors, or more thinly capitalized foreign issuers? Obviously,
we can expect gradual extension insofar as there is strong confidence in
home country regulation in terms of its ability to respond to issues and
problems that arise. As a well-known and long-standing academic debate
in the US has considered, one could eventually take mutual recognition to
the point at which there is near-total ‘issuer choice’ – any issuer could sim-
ply choose its home jurisdiction, which would lead to competitive rewards
to countries whose regulation that is most attractive, and competitive
penalties to jurisdictions that either over- or under-regulate.
The vehicle through which mutual recognition would most likely
evolve in this direction is exchange-based listings. To the extent that the

11
D. Langevoort, ‘Structuring Securities Regulation in the European Union: Lessons
from the US Experience’, in Ferrarini and Wymeersch (eds.), Investor Protection in
Europe: Corporate Law Making, the MiFID and Beyond (Oxford University Press, 2006),
485–506.
562 Perspectiv es in fina ncia l r egu l ation

world is willing to accept that the appropriate securities regulator is the

jurisdiction of the exchange on which the issuer has voluntarily chosen
to list its securities for trading, then there will be a de facto regime of
issuer choice.12 Arguably, this is what is going on right now – New York
is losing its relative position as a favourable site for cross-listings, and
other jurisdictions are gaining. The call in the US is for relaxing the
intensity of its regulation as a response, which if successful would pre-
sumably reverse the trend. That is exactly as it should happen.
But before getting carried away with this as the vision for global securi-
ties regulation generally, it is important to remember that this vision is one
for cross-listings only, not listings generally. In fact, I am not convinced that
listings will continue to play a pivotal role in securities regulation at all. They
can to the extent that trading is centralized on a single exchange, which then
has the incentive to seek regulatory enforcement to bond the credibility of
the listing commitment. But if global securities trading instead moves in the
direction of fragmentation rather than consolidation – with many different
trading sites around the world sharing in the order flow – the incentive for
any one exchange or regulator to devote the necessary resources to enforce-
ment diminishes. In a fragmented trading environment, it is unlikely that
any single country has good reason to devote adequate resources to the
regulatory task, unless its own citizens are disproportionately at risk.
Whether or not there is continued fragmentation, however, there is
a second reason to doubt that listings can truly be the primary juris-
diction nexus. The test is to consider the extent to which a country like
the US would permit its own domestic issuers to migrate away from US
regulation simply by listing solely on a foreign stock exchange, as a few
have done. In fact, the issuer accomplishes relatively little by so doing.
To be sure, the burdens of the Securities Act and its regulation of the
public offering itself are removed, so long as the issuer submits to the
heavy lock-ups required by Regulation S. But registration under the
Securities Exchange Act – the on-going corporate disclosure obligations
and resulting litigation exposure – are triggered whenever a domestic
issuer comes to have 500 or more shareholders and more than $10 mil-
lion in assets. For domestic issuers, there is nothing comparable to the
reporting relief given to unlisted foreign issuers under Rule 12g3–2.
What we are observing, then, is an increasingly ‘territorial’ basis
to jurisdiction. That is, there are two levels in terms of the intensity of

12
C. Brummer, ‘Stock Exchanges and the New Market for Securities Law’, University of
Chicago Law Review 75 (2008), 1435.
 Eu ropea n ization of US Secu r ities R egu lation 563

securities regulation. For those issuers with a strong territorial nexus

with the US – essentially, domestic issuers – there is a high level of regu-
lation, and largely inescapable. For widely traded foreign issuers, there is
increasingly less regulation.
My sense is that this is a stable equilibrium, which will eventually
result in near-complete deregulation of such foreign issuers via a strong
regime of mutual recognition if they choose to list in the US. In a market-
place characterized by high institutional holdings, the pricing efficiency
and risk-absorbing feature of portfolio diversification make it reasonably
safe to defer to competent foreign regulatory regimes, especially if aided
by the kind of global inter-jurisdictional ‘mediator’ I described earlier.
What about the predilection of US retail investors to react to issuer
misbehaviour and demand reforms in the face of scandal? What, in
other words, will happen in the aftermath of the next large issuer melt-
down involving a well-known foreign company that triggers losses by
US investors? Mutual recognition is fairly well suited to weather foreign
issuer scandals without triggering a Sarbanes–Oxley kind of reaction.
First, the percentage of US investors affected by a foreign issuer scan-
dal is less than for a domestic one, and there is less political potency
for this reason alone. And those affected are more likely to be through
diversified portfolios, so that the effects are even more softened. But the
biggest difference – to me, explaining much about Sarbanes–Oxley and
US regulation generally – is that the spillover effects of the foreign issuer
scandal on other important constituencies, such as employees, company
pensioners, local communities and the like, are dramatically smaller.13
To the extent that these effects are what creates the political motivation
for dramatic regulatory responses, the motivation will almost always
be lacking when the main locus of the fraud is elsewhere. Conversely,
this also explains why a listings-driven (as opposed to cross-listings-
driven) regulatory regime would be unstable: the US will not give issuers
with so great an ability to harm multiple US constituencies an ability to
opt out from its preferences about the proper level of transparency and
accountability.
I do not want to make too much of the analogy with Europe here. The
EU, of course, has struggled with the right balance among sovereignty,
subsidiarity and the free flow of economic activity – the desire of certain
Member States, at least, to maintain ‘home country’ regulatory control

13
D. Langevoort, ‘The Social Construction of Sarbanes–Oxley’, Michigan Law Review, 105
(2007), 1828–9.
564 Perspectiv es in fina ncia l r egu l ation

over their domestic business entities is strong, presumably for reasons

similar to those in the US. My simple point is that the compromises
made in the US will increasingly resemble those made in Europe as the
investment marketplace in the US becomes more heavily institutional
and the institutional investor voice comes to dominate the retail voice in
important segments of the capital markets.

III. Institutionalization and the litigation culture

By all accounts, the most troubling difference in terms of competitive
appeal between the US and European approaches to securities regula-
tion comes in terms of enforcement and litigation. On the public enforce-
ment side, there are difficult questions regarding intensity: whether the
US overdoes both criminal prosecution and agency (SEC) enforcement.
This is another area where the relative degree of institutionalization
makes a difference. With respect to repeat players, knowledge sharing
among institutions and the need for regular access to the capital markets
makes reputation a more formidable check on misbehaviour compared
to retail markets in which new naïve investors regularly appear and old
ones too often forget. But even in institutional markets, reputation is an
imperfect check (last period problems, etc.) and so a reasonable degree
of ex post enforcement is needed. It is certainly possible that European
countries have found strategies, such as prudential oversight, that obvi-
ate the need for even this. But I am not aware that there has been any
well-grounded explanation for precisely what forces would be at work
that would lead to behaviours consistent with anything but the classical
economic calculus: that what works in deterrence is the balance between
the probability of detection and severity of sanction upon discovery.
Given the immense profits that can be made by cheating in the securities
markets, and the difficulties of detection, one is forced to believe that sig-
nificant enforcement intensity is required. I am open to the possibility
that other extra-legal influences (business culture, moral suasion, etc.)
have some power, and that the close-knit nature of certain European
money centres – the City of London being the most notable example –
may utilize these more effectively than is practicable in a more diff use
capital market such as the US. If this is an explanation, then the interest-
ing question becomes whether it is sustainable as these money centres
gain greater geographic and cultural reach, becoming world markets in
which it is harder for local elites to impose extra-legal discipline simply
by invoking locally established behavioural norms. My suspicion is that
 Eu ropea n ization of US Secu r ities R egu lation 565

Europe will gradually adjust by intensifying public enforcement, while

the US will more likely shift the focus of when and how public enforce-
ment occurs.
The much more interesting question has to do with private securi-
ties litigation, which operates in the US in ways simply not replicated
anywhere else in the world. The exercise, once again, is to think through
how US attitudes toward private litigation might change, based on a
shift to a more completely institutionalized market for the securities of
well-known issuers. Some imagination is necessary because the voices
of certain institutional investors are affected by conflicts of interest
that make it hard to disentangle the economic from the political. Public
pension funds have led aggressive litigation, but perhaps (though they
certainly deny it) for reasons having to do with the interests of those in
state governments. Conversely, the silence of mutual funds in the liti-
gation area may be explained by their role in administering employer-
sponsored retirement funds, which may be put at risk if they take on a
visible plaintiff-side litigation posture.
The economics of private securities litigation are complicated, and by
all accounts, differ depending on whether we are considering a lawsuit
against a company that has directly benefited from an alleged fraud (as is
the case in a public offering in which the company raises funds through
a false or misleading prospectus) or not (as in the case of a typical ‘fraud
on the market’ lawsuit). To be sure, the line between these two kinds of
cases is blurred, but we can assume that at least a substantial portion of
fraud was meant to enrich only the managers of the firm, not the firm
itself.
In the latter instance, there is good reason to suspect that well-
diversified institutional investors lose more than gain from litigation.14
There are two well-known points here. First, consider that – apart from
insider trading or other extractions of wealth by the wrongdoers – fraud
is close to a zero-sum game for investors. Those fortunate enough to
sell stock when the price is artificially inflated win, while those unlucky
enough to buy lose. Over time, for well-diversified active investors, one
would expect the gains and losses to even out – indeed, for active trad-
ers, we would expect some evening out because the investor both bought
and sold during the class period. Absent a theory about why any given
investor would expect systematically to be a loser over time (which is

14
J. Coffee, ‘Reforming the Securities Class Action: An Essay on Deterrence and its
Implementation’, Columbia Law Review, 106 (2006), 1534.
566 Perspectiv es in fina ncia l r egu l ation

especially difficult to imagine for a professionally managed portfolio),

it is not clear that institutions in general would demand much at all in
litigation rights if the gains and losses are internalized within the capital
markets. Certainly, they would not pay heavily for any such protection.
The second point is related. The vast majority of all payouts in pri-
vate securities litigation come from the issuer, either directly or (to a far
greater extent) insurance paid for by the issuer and for which the issuer
is the named beneficiary. In essence, then, payments in settlement or
judgment come largely from the pockets of some investors to the pockets
of others, which merely reallocates funds rather than transfers money
from the guilty to the innocent. Recent research has confirmed that the
insurer’s role in private securities regulation comes with little benefit in
terms of doing justice.15 Insurers do not vary their price much to reflect
the corporate governance risk, nor are they particularly sensitive to
the merits of the underlying claims. They settle when their customers
(company management) ask them to settle.
This system has some benefits, to be sure. Investors do receive some
compensation, which may be significant when the investor was insuffi-
ciently diversified or otherwise systematically or especially unlucky. It
also has a somewhat greater rationality from a deterrence perspective
when the fraud was intended to benefit the company as well as its manag-
ers, although even this is negated when the payments come entirely from
the insurers. The key point comes in the costs: the very high legal fees paid
to both plaintiffs’ and defendants’ law firms, plus the profits made by the
insurance companies for funding such a system of transfer payments.
The problem is a collective action one, once again. Even if investors
lose more than gain from the system in general, they will invoke what-
ever rights they are given in those circumstances when they are hurt
by fraud. In turn, the compensation recovered is tangible and visible,
whereas the costs paid over time are diff use and largely invisible. My
suspicion is that on an entirely rational calculus, institutional investors
have little reason to support such a litigation system, and that the politi-
cal support for it comes mainly from retail investors much more affected
by the differences in saliency between costs and benefits and inclined to
see litigation as an exercise in retribution.
If so, then this should be another area where the increasing voice of
the institutional investor should lead to a shift in regulatory attitude.

15
T. Baker and S. Griffith, ‘The Missing Monitor in Corporate Governance: The Director
and Officer’s Liability Insurer’, Georgetown Law Journal, 95 (2007), 795–845.
 Eu ropea n ization of US Secu r ities R egu lation 567

We know that private securities litigation is effectively limited to highly

institutionalized settings, both because courts require a showing of
high market efficiency to afford the class a presumption of reliance, and
because plaintiffs’ law firms tend only to target high-capitalization issu-
ers because that is the only setting where there is enough money to be
found. The so-called ‘Paulson Committee’ report recommends that issu-
ers be allowed to opt out of class action exposure by placing limitations
on the right to sue in a company’s charter or articles.16 The hypothesis is
that this will lead to forms of alternative dispute resolution, such as arbi-
tration, as an alternative. Whether this is plausible depends on whether
there are forums that can handle large-scale, fact-intensive inquiries;
the current models for arbitration in the securities area (e.g. customer-
broker disputes) are not suited for this. Nor is it clear that it would be
easy to design an incentive structure that would encourage good actions
to be brought, given the expenses associated with such actions. A rea-
sonable fear is that no adequate alternative system would emerge, and
that the opt-out would be in the direction of no significant deterrence
at all.
There are others changes that would be more investor-friendly.
Remember that an important objective from the standpoint of the
sophisticated investor is to recoup the fruits of fraud from insiders who
do capture the benefits. Some investors in the US are pushing revisions
in executive employment contracts that allow for clawbacks of incentive
compensation and trading profits after the discovery of significant cor-
porate misconduct. There are ways the law could be revised to encour-
age greater use of disgorgement and other equitable remedies that target
such insider gains, which institutional investors might well also find
appealing.
One of the most interesting lingering questions in the building of
a more institution-friendly litigation system has to do with public
offerings. If we think in terms of an initial public offering, the idea of
a lawsuit seems relatively efficient: the money raised in the fi rst stage
of public fi nancing is a transfer from public investors (including many
institutions) to the promoters, backers and other insiders of the start-up
fi rm. Recapturing this money in the event of fraud resembles the dis-
gorgement of insider gains from fraud-on-the-market, rather than
simple pocket-shift ing. Th is, however, becomes less so with respect to

16
Committee on Capital Markets Regulation, Interim Report, 30 November 2006, www.
capmktsreg.org/research.html.
568 Perspectiv es in fina ncia l r egu l ation

distributions by seasoned fi rms. Moreover, it is not clear that sophisti-

cated investors would necessarily want to base recovery on the current
standards in US law: strict liability for the issuer (assuming that the
stock price drop that triggers the lawsuit can be associated with discov-
ery of some material misrepresentation) or due diligence liability for
directors, underwriters and others who, especially with respect to some
kinds of fi nancing, have little practicable ability to discover the truth.
Th is liability arguably leads either to under-pricing of the deal or higher
fees charged by deal participants. Hence, this is another area where
reform might be supported by unconfl icted institutional investors.
The potential roadblock to reform here is that, thus far, it appears that
US retail investors see themselves as beneficiaries of the current litigation
system. In this sense, they are political allies with those – plaintiffs’ law
firms and public pension funds – who have staked the clearest claims to
the efficacy of strong private rights of action. Overcoming this requires
stronger empirical evidence that retail investors as a whole lose more
than they gain, and that the hidden costs associated with the meagre
recoveries that occasionally occur are significant. Politically, even if
institutional investors as a group were persuaded, selling this to broader
segments of market participants probably requires that there be evi-
dence that some alternative mechanisms will emerge to address the need
to target wrongdoers,17 and to gain compensation for those retail inves-
tors (e.g. pensioners with portfolios heavily weighted with the stock of a
single issuer) where the costs of issuer fraud are most vivid.

IV. Conclusion
My hypothesis is that US securities regulation as it relates to foreign
issuer disclosure, corporate governance and litigation will gradually
shift in the direction of policies that sophisticated institutional investors
find comfortable, which will mean significant shifts from the legacies
created during the times (from the 1930s through to the early 1980s)
when the US had a more thoroughly retail investment culture. It is inter-
esting to think of how many of the rules and procedures in US laws that
are currently under criticism – the structure of the two main securities
statutes and the fraud-on-the-market lawsuit, for instance – date from

17
D. Langevoort, ‘On Leaving Corporate Executives “Naked, Homeless and Without
Wheels”: Corporate Fraud, Equitable Remedies, and the Debate Over Entity Versus
Individual Liability’, Wake Forest Law Review, 42 (2007), 627–61.
 Eu ropea n ization of US Secu r ities R egu lation 569

this time period. Once again, however, I would emphasize that even a
strong institutional voice will not check the demand for regulation that
comes from domestic stakeholders when serious negative externalities
result from a US-based breakdown in corporate governance.
Mutual recognition is a healthy exercise through which to wean US
law away from these legacies in the settings in which the markets are suf-
ficiently institutional. In turn, as this occurs, those segments of the US
market will take on a more European character. To be sure, not all forms
of investing in the US are making this shift: there will always be a robust
retail presence in the markets for smaller stocks. And just as in Europe,
the retail nature of the markets for institutionalized investments will
continue to pose regulatory challenges and a demand for significant
protections. The more complicated the portfolio strategies of institu-
tional investors, the more opaque and potentially risky the individual
accounts.
My prediction, then, is that US securities regulation will significantly
reduce its intensity vis-à-vis foreign issuers, and partially reduce its
intensity vis-à-vis domestic issuers. The reduction will take place with
respect to litigation as to both domestic and foreign issuers so long as
some ‘safety-valve’ remains in place for disciplining and recouping
wealth from insiders who cause serious economic damages to investors
and other stakeholders. This would be a distinctly European turn. As to
retail investor interests, the shift will be towards seeing the ultimate prob-
lem in securities regulation as addressing the relationship between public
investors and those who manage large portfolios. I make no claim to see
Europeanization coming here – rather, regulators on both continents will
find this the common challenge in coming decades.
 31

The subprime crisis – does it ask for more

regulation?
Fr iedr ich Kübler 

I. Introduction
The creation and sale of asset-backed securities (ABS) is an established
practice of financial management. It offers benefits to all participants.
The original lender (originator) can sell the loans made to the original
borrowers although they are correctly qualified as ‘imperfectly market-
able assets’. In a normal sale the information asymmetry between the
selling bank, who knows the borrower, and the acquiring institution,
who does not know her that well, will result in a considerable discount
from the nominal value of the loan. Th is outcome is avoided by the secu-
ritization procedure. The claims (assets) are collected in a pool, held by
an independent and bankruptcy-remote ‘special purpose vehicle’ (SPV),
which is often organized in the form of a trust. The SPV issues debt
instruments – notes or commercial paper (CP) or bonds – to the public,
mostly to institutional investors. Their information problems as to the
credit or default risk affecting the pooled assets are greatly reduced by the
analysis and the evaluation of the pool by a credit rating agency (CRA).
In many transactions the rating is improved by the ‘credit enhancement’
(CE) provided by the arranger of the programme or by the arranger’s
bank; this is a guarantee that a set percentage of the losses generated by
defaulting assets will be borne by the arranger or the bank.
Such a transaction allows the original lender to transform its highly
illiquid assets into cash and to significantly reduce the amount of
required capital under the capital adequacy rules.2 The lender removes
risky assets from the balance sheet and thus reduces capital requirements.
1
The assistance of Justin Gross is gratefully acknowledged.
2
For a general description of the mechanism and the advantages it offers to participants,
see H. Scott, International Finance: Transactions, Policy and Regulation, 14th edn.
(New York, Foundation Press, 2007), 530 et seq.

570
 su bpr ime cr isis – does it ask for mor e r egu l ation? 571

At the same time the lender can use the cash to engage in more lending
transactions, and this again increases the availability of credit for bor-
rowers. The investors receive considerably higher returns from their CP
compared to bank deposits; at the same time they enjoy the liquidity of
a security traded on an organized market. And the arranger is benefited
by the fees derived from setting up the scheme, from providing credit
enhancement, and possibly from underwriting the securities issued by
the SPV.
The generation of mortgage-backed securities (MBS) follows very
much the same pattern. This practice is even older; it dates back to the
1960s, and the amounts outstanding appear to be considerably higher
than those for ABS. At a first glance MBS look like more stable instru-
ments compared to ABS. ABS are mostly based on pools of credit card
and car loan receivables; these assets are directly exposed to the consid-
erable risk of consumer insolvency. MBS appear to provide much more
safety as the pooled home owner loans are collateralized by mortgages.
Whenever the borrowing home owner fails, the creditor can look for sat-
isfaction from the mortgage which is backed by the value of real estate.
There appears to be ample evidence that this mechanism of securi-
tizing or restructuring debt has worked quite well until recently. The
amounts outstanding increased from year to year,3 and the contractual
instruments were refined by the joint efforts of banks and law firms.
Larger-scale problems were unknown.
The subprime crisis came obviously as a surprise. It appears that there
have been some market participants or observers who at an early stage
were concerned by some of the specific practices used more recently.
But the dimensions of the problems became evident only step by step;
and at the moment, when this contribution is written, it is generally
assumed that still more will come to the surface. But some facts are
uncontroversial. Very experienced fi nancial institutions like Merrill
Lynch, Citibank or UBS had to disclose losses from investments in ABS
amounting to volumes close to or even exceeding $20 billion.4 A number
of smaller institutions like Century in the US, Northern Rock in the UK
or Industriekreditbank (IKB) and Sächsische Landesbank in Germany
either failed or had to be rescued by merger or by huge capital injections
3
For Europe it is assumed that in 2006 the outstanding amount of European securitiza-
tion deals exceeded $1 trillion; see P. Aguesse, ‘Is Rating an Efficient Response to the
Challenge of the Structured Finance Market’, Autorité des Marchés Financiers (AMF),
Research Department, Risk and Trend Mapping, 2 (2007), 7.
4
New York Times, 1 February 2008, C 6.
572 Perspectiv es in fina ncia l r egu l ation

from controlling shareholders. This again has affected the stock markets
globally; and there appears to be a threat that the world economy will
sink into a recession.
In this situation lawyers interested in the regulation of financial mar-
kets and institutions have good reasons to ask not only what went wrong
but also whether there are regulatory responses which might prevent
similar outcomes in the future. Th is preliminary investigation is organ-
ized in five steps. The first question, discussed in Section II, is to what
extent the planned securitization of mortgage debt has influenced the
contracting process between the borrower and the lender which gener-
ates the securitized assets. In a next step, in Section III, it will be asked to
what extent the continued leveraging of MBS and CDO debt has contrib-
uted to the problem. In particular with regard to highly complex finan-
cial instruments, it can be asked to what extent the incentives provided
by the internal structure of financial institutions discourage or prevent
participants from applying adequate due diligence, this is discussed in
Section IV. In Section V, it has to be asked whether the observed prac-
tice of rating structured finance products is appropriate or should be
improved. Finally, some preliminary conclusions will summarize the
observations in Section VI.

II. Impact of securitization on the origination:

predatory lending and borrowing
One source of the problem appears to be the contracting process between
the borrower (mortgagor) and the lending bank (originator). It is cred-
ibly reported that in many cases the documentation as to the borrower
has been very weak.5 There is no documentation of the income and the
assets of the borrower; this makes it difficult to determine whether the
borrower honestly disclosed her situation to the lender. It is assumed
that this was not always true: that there have been cases of ‘liar loans’
and of predatory borrowing.
But there is evidence that in many cases the lending institution did
not care about the fi nancial situation of the borrower. Many of the bor-
rowers had weak FICO scores and little or no equity. Many of them had
faced bankruptcy in the last five years and/or foreclosure during the last
two years and/or two or more thirty-day delinquencies in the last twelve

5
R. Herring, ‘From Subprime Mortgages to ABS to CDO to SIVs and ABCP: The Darker
Side of Securitization’ (slides 2007, on fi le with author).
 su bpr ime cr isis – does it ask for mor e r egu l ation? 573

months.6 Many of the loans had very specific features. They provided the
borrower with a ‘five-year interest-only option’, during which time no
repayments of capital were due. For the first two or three years there was
a ‘teaser’ interest rate, lower than the interest rate for fi xed-rate mort-
gages. After this time nearly 90% of the loans became ‘adjustable rate’.
The interest rate was now determined by the market.7 For many of the
borrowers this structure entailed a continuing and very steep increase of
their mortgage costs over a period of only a few years.8 It could be that in
the beginning they had to use about 40% of their income to service the
mortgage, and that this ratio had climbed to 80% after five years. Under
these circumstances foreclosure appears to be inevitable. And there was
mostly less than 10% of equity or none at all; thus the loan would not be
fully repaid once real estate prices started to decline.
These are transactions implying a degree of default risk which would
under normal circumstances exclude them from being done by a finan-
cially rational and responsible bank. They were obviously acceptable
for no other reason than to sell them in securitized form to an anony-
mous market. This impression is confirmed by the procedures used for
making these loans.9 New Century Financial, a company which fi led
for bankruptcy protection on 2 April 2007, had established an auto-
mated internet-based loan submission and pre-approval system called
FastQual. Under this system, subprime lending by New Century grew
at an annual rate of 59% between 2000 and 2004; in 2006 the fi rm
originated $51.6 billion of mortgage loans.
These facts suggest that there are flaws in the securitization proc-
ess; this will be discussed later. They have also triggered requests for
additional regulation, e.g. for federal legislation which would prohibit
predatory lending. At this point it is much less than clear that this would
have any significant impact. The Truth in Lending Act (TILA) and other
(state) rules already address unsafe lending and borrowing practices.
They may be helpful where they address and sanction misrepresenta-
tions used to defraud the other party. But this is not the major problem
6
A. Ashcraft and T. Schuermann, ‘Understanding the Securitization of Subprime
Mortgage Credit’ (typescript 2007, on fi le with author), 19; IMF, Global Financial
Stability Report (October 2007), 7, note 7.
7
Ashcraft and Schuermann, ‘Understanding the Securitization of Subprime Mortgage
Credit’, (note 6, above), 20.
8
The offer of ‘affordable products’ expose borrowers to later payment shocks, See IMF,
Global Stability Report (April 2007), 6.
9
Ashcraft and Schuermann, ‘Understanding the Securitization of Subprime Mortgage
Credit’, (note 6, above), 18.
574 Perspectiv es in fina ncia l r egu l ation

here. The agents operating for the lending institutions must have been
aware that many of the loans were extremely risky. They did not care as
they were not affected by the likely defaults. It is to be assumed that they
were motivated by a compensation structure rewarding the conclusion
of the deals regardless of the consequences they would entail. Th is is a
more general problem affecting the way financial markets work, it will
be discussed in Section IV.

III. Leveraging
A second aspect of the present crisis is the amazing practice of leverag-
ing mortgage debt. In an MBS transaction the pool of the collected assets
is normally cut into several tranches.10 There is a senior tranche, mostly
rated AAA, which pools the mortgages presenting the lowest default risk.
This tranche would back bonds or commercial paper sold to institutional
investors. In addition there can be more junior ‘mezzanine’ tranches
pooling more risky mortgages and therefore backing lower-rated com-
mercial paper or notes designed for more sophisticated investors.11 At
the low end of the spectrum there are tranches which do not receive a
rating as they are backing highly risky debt or equity securities. This
separation and subordination presents a method of providing credit
enhancement to the most senior tranches. But it also raises the question
of what to do with the tranches at the lower end. The originating bank
could keep them: this would improve risk sharing as the bank would
continue to have an interest in keeping the lending operations within
the limits of sound banking practice.12
But this is not what has happened recently. To a large extent the first
loss pieces have been transferred to entities which would repackage
them into pools serving again as collateral for the issuance of securities,
mostly asset-backed commercial paper (ABCP).13 The first loss pieces
and junior tranches have been mostly repackaged into Collateralized
Debt Obligations (CDOs). They can have different features: they can be
10
See Herring, ‘From Subprime Mortgages to ABS to CDO to SIVs and ABCP’, (note 5,
above) and IMF, Global Stability Report (April 2007), 8.
11
G. Franke and J. P. Krahnen, ‘Default Risk Sharing Between Banks and Markets: The
Contribution of Collateralized Debt Obligations’ in M. Cary and F. Stulz, The Risk of
Financial Institutions (2007), 603–8.
12
Franke and Krahnen, ‘Default Risk Sharing Between Banks and Markets’, (note 11,
above), 625.
13
The face value of the debt instruments pooled in ABCP vehicles amounts to $1.4 trillion;
IMF, Global Financial Stability Report (October 2007), 19.
 su bpr ime cr isis – does it ask for mor e r egu l ation? 575

fully funded by the transfer of ABS or they can be ‘synthetic’; in this

latter case the bank retains the securities and buys a credit default swap
on behalf of the CDO vehicle.14
The CDO vehicles can and often did repeat the process of cutting its
pool into tranches which would represent different categories of risk and
therefore bear different rating grades. The most senior tranches were
sold to the market, the most junior ones securitized again. The vehicles
now could be CDOs again, or Structured Investment Vehicles (SIVs),
which would also receive and pool other assets, or Security Arbitrage
Conduits (SACs), which would collect preferably higher-rated ABS.15
And with their ABCP the process could be repeated again and again.
The rated securities were sold mostly to hedge funds and to banks.16
It is not too difficult to see how this process of leveraging increases
the risk for the holders of the ABCP. It is always the tranches containing
the most risky assets which are securitized again. When the new pool
is divided again and the best assets are put into a senior segment rated
AAA, this method of credit enhancement does not appear to reduce the
risk and to improve the quality of the original assets, which continue
to be needed to satisfy the claims of the holders of the ABCP. That is to
say, each new securitization of MBS products considerably increases the
default risk for the holders of the leveraged securities.
Again it is to be asked whether this practice of leveraging securitized
debt could and should be contained by new regulation. And again this is
difficult to determine. Leveraging can be a useful technique of risk allo-
cation. This is no less true where it is combined with asset securitization;
any ban or constraint of these transactions is not likely to improve the
efficiency of financial markets. What is striking, however, is the com-
plexity of the arrangements and the intransparency and opaqueness of
the process used to put together the CDOs, SIVs etc.17 In December 2004,
the Securities and Exchange Commission (SEC) adopted Regulation
AB providing for major changes to the disclosure regime for public
offerings of ABS.18 Regulation AB requires information explaining the

14
Franke and Krahnen, ‘Default Risk Sharing Between Banks and Markets’, (note 11,
above), 606.
15
IMF, Global Financial Stability Report (October 2007), 18.
16
Ibid., 15.
17
J. R. Mason and J. A. Rosner, ‘How Resilient are Mortgage Backed Securities to
Collateralized Debt Obligation Market Disruption?’, Working paper (2007), http://ssrn.
com/abstract=1027472.
18
Release No. 33–8518; 34–5095, (22 December 2004).
576 Perspectiv es in fina ncia l r egu l ation

characteristics of the pool, the background, experience, performance

and role of the parties, and the legal structure used for the SPV. But this
applies only to public offerings and not to private placements. Where
ABCP are exclusively sold to institutional investors like hedge funds or
banks the gathering and evaluation of the material facts is left to their
exercise of due diligence. This is to be further discussed in Section IV.
Another element of the existing regulatory framework to be taken into
consideration at this point are the rules on capital adequacy. The rules intro-
duced by Basle I certainly encouraged securitization. Whenever a bank
replaced a loan to a customer by sponsoring and enhancing an ABS project
originated by this customer the bank was able to considerably reduce the
amount of required capital.19 This would not be dramatically different
under Basle II. The new rules increase the amount of required capital for
banks pooling and securitizing their own receivables. The most interest-
ing change occurs with regard to banks investing into ABS originated and
sponsored by other institutions. Basle I provided for risk categories which
would normally imply a risk weight of 100%. Basle II – for the Standardized
Approach – refers to credit rating: for ABS in a senior tranche with an AAA
rating the risk weight factor would be reduced to 20%. Now we are faced
with the question: how good is the process of rating ABS or other struc-
tured credit products? This is to be discussed in Section V.

IV. Complexity and due diligence

Another aspect of the current crisis is that these highly leveraged ABCP
have been bought to an amazing extent by highly sophisticated fi nancial
institutions. For 2007 Merrill Lynch had to write down $24.5 billion,
Citigroup $22.1 billion, UBS $18.4 billion and HSBC $10.7 billion.20 This
may include some losses which are not connected to high-risk home
loans, but there is no doubt that the problems result primarily from the

19
Assume a bank lends $100 million to a car manufacturer who needs to finance loans made
to the buyers of the cars. The loan has a credit weight of 100%. The capital ratio man-
dated by Basle I is 8%. This means that the bank has to support this transaction by using
$8 million of its capital base. Providing credit enhancement of 5% to a $100 million pool
of car loan receivables generates a potential – and therefore off-balance-sheet – liability
of $5 million. As a standby type of guarantee it carries a conversion factor of 100% and
(again) a risk weight of 100%. In other words, the required capital amounts to 8% of
$5 million or $400,000. This is just 5% of the $8 million required for the loan to the car
manufacturer. Even if we assume a credit enhancement for 20% of the pool the required
capital is only one-fi ft h of what it would be for the loan.
20
New York Times, 1 February 2008, C 6.
 su bpr ime cr isis – does it ask for mor e r egu l ation? 577

collapse of the subprime mortgage market. Thus we are faced with the
question of why and how these and other fi nancial firms did accumulate
such enormous amounts of highly problematic securities. One answer
could be that they trusted favourable ratings. This certainly has to be
taken into account, but it does not fully explain the lack of in-house
analysis before making these huge investments.
There are other indications that the observance of due diligence has
declined.21 Clayton Holdings is a firm specialized in rendering due dili-
gence reports to investment banks with regard to residential mortgage
loans; it is the biggest provider of this service in the US. Clayton reported
that starting in 2005, it observed a significant deterioration of lending
standards, and that with the growing demand for the residential loans,
mortgage companies were in a strong enough position to stipulate that
investment banks have Clayton and other consultants look at fewer loans.
It appears that the lenders wanted due diligence to find fewer problem
loans which would be sold at a discount. Clayton reported in addition
that investment banks did not give the due diligence reports to the rating
agencies.22
This story suggests a somewhat paradoxical situation. On the one
hand, the instruments of structured finance have become inherently
less safe for investors, and the increasing risks were disguised by more
and more complex and opaque arrangements. On the other hand, due
diligence has been systematically reduced.
There are several ways to explain this phenomenon; they are not
mutually exclusive. Many of the players in the field are big institutions
characterized by complex organizational structures, a high degree of
specialization to perform very specific services, incentive compensa-
tion based on short-term results, and significant job mobility.23 Such an
arrangement generates incentives to increase volume regardless of the
medium- or long-term consequences: when the losses occur, the respon-
sible agents have cashed their bonuses and been moved to other functions.
Another explanation is ‘disaster myopia’, the often-observed tendency
to underestimate the probability and the consequences of low-frequency

21
Th is appears to be equally true for other functions in the process; see Ashcraft and
Schuermann, ‘Understanding the Securitization of Subprime Mortgage Credit’, (note 6,
above), 10.
22
J. Anderson and V. Bajaj, ‘Loan Reviewer Aiding Inquiry Into Big Banks’, New York
Times, 27 January 2008, 1 and 10.
23
R. Herring, ‘Credit Risk and Financial Stability’, Oxford Review of Economic Policy, 15
(1999), 63–73 et seq.
578 Perspectiv es in fina ncia l r egu l ation

shocks.24 And we may also see the consequences of ‘herding’ behaviour:

the fact that others have done exactly the same thing serves as a defence
against ex post recriminations.25 These phenomena are interconnected:
disaster myopia and herding behaviour can be supported and reinforced
by institutional arrangements.26
This experience raises the question of whether and to what extent top
management and possibly the board of fi nancial institutions should be
held responsible for inadequate organizational structures which discour-
age employees from observing adequate due diligence and risk assess-
ment practices. This would not be a completely new approach. Section
404 of the Sarbanes–Oxley Act requires management to establish and
maintain effective internal controls with regard to corporate govern-
ance. Bank supervisors could be allowed and encouraged to have a closer
look into the organizational implications of sound risk management.

V. Rating structured finance products

It is obvious that there have been considerable problems with the rating
of MBS, CDOs and other structured finance products. Top executives of
major rating agencies have conceded in public that significant mistakes
have been made.27 Changes in the methods of MBS and CDO rating28 led
to considerable downgrading of already-issued ABCP.29 This again has
negatively affected the reputation and credibility of rating agencies.30
It is less obvious why the rating process failed to such an extent. There
are several explanations (which are again not mutually exclusive):
1. There is some evidence that the rating agencies have not been fully
informed by the issuers and underwriters of ABCP.31 It is less obvious

24
R. Herring and S. Wachter, ‘Real Estate Booms and Banking Busts – An International
Perspective’, Group of Th irty, Occasional Paper, No. 58 (1999), 9 et seq.
25
R. Herring, ‘Credit Risk and Financial Stability’, (note 23, above), 73.
26
J. Guttentag and R. Herring, Disaster Myopia in International Banking, (Princeton
University International Finance Section, 1986), 5; R. Herring, ‘Credit Risk and Finan-
cial Stability’, (note 23, above), 73.
27
F. Norris, ‘Moody’s Official Concedes Failure in Some Ratings’, New York Times,
28 January 2008, C 13.
28
J. Mason and J. Rosner, ‘Where did the Risk Go? How Misapplied Bond Ratings
Cause MBS and CDO Market Disruption’, Working paper (2007), http://ssrn.com/
abstract=1027475, 21.
29
Ibid., 80 et seq.
30
C. W. Calomiris, ‘Not yet a ‘Minsky Moment’’ (typescript 2007, on fi le with author), 3.
31
Anderson and Bajaj, ‘Loan Reviewer Aiding Inquiry Into Big Banks’, (note 22, above), 15,
report that investment banks did not give their due diligence reports to the rating agencies.
 su bpr ime cr isis – does it ask for mor e r egu l ation? 579

why the agencies either did not find out this lack of disclosure or
abstained from sanctioning them. Traditionally rating agencies have
enforced disclosure by downgrading issuers who had proved to be
unwilling to come forward with all the required information.
2. Another aspect may be derived from the special relationship between
the rating agencies and the ABCP issuers (and their investment
banks and law firms). It is argued that the number of relevant issuers
has declined and that this form of concentration impairs the mar-
ket position of the rating agencies; they become more dependent on
specific issuers and therefore more inclined to accommodate to their
wishes.32 At the same time the revenues of rating agencies are increas-
ingly derived from evaluating structured finance products.33 And the
complexity of these products asks for closer cooperation between rat-
ing agencies and investment banks; this is plausibly viewed as a new
source of confl icts of interest.34
3. Another concern is the use of ratings by regulators.35 It is true that the
rating agencies are mostly compensated by the issuer. This does not
necessarily imply a conflict of interest as they are normally chosen
by the institutional investors who are or may be interested in acquir-
ing the securities. In these cases the rating agencies depend on the
goodwill they enjoy among institutional investors. Their reputation
and their success are closely linked to the accuracy and the reliability
of their evaluations and their forecasts, they are thus disciplined by
the market. This is not necessarily true with ratings for regulatory
purposes as regulators normally do not insist that the rating be made
by the agency of their choice. This can modify the incentives, such
that rating agencies may be more inclined to respect the wishes of the
issuers.
4. Finally it has been correctly observed that the rating of structured
finance products differs significantly from the rating of corporate
bonds.36 In assessing the default risks of corporate bonds the rating
agency evaluates the financial stability and the future cash flows of

32
Aguesse, ‘Is Rating an Efficient Response to the Challenge of the Structured Finance
Market’, (note 3, above), 8 et seq.
33
Mason and Rosner, ‘Where did the Risk Go?’, (note 28, above), 8.
34
Ibid., 31.
35
Calomiris, ‘Not yet a ‘Minsky Moment’’, (note 30, above), 18 et seq.
36
Ashcraft and Schuermann, ‘Understanding the Securitization of Subprime Mortgage
Credit’, (note 6, above), 48 et seq.; Mason and Rosner, ‘Where did the Risk Go?’, (note 28,
above), 36 et seq.
580 Perspectiv es in fina ncia l r egu l ation

the issuing firm. MBS and CDO ratings are different; they refer to
a static pool and not to a dynamic corporation; they rely on quan-
titative models and not on the judgement of analysts.37 In addition,
rating agencies have difficulties assessing the risk of whether a mort-
gage will be prepaid by the borrower.38 And these aberrations tend to
increase with every step of leveraging the original pool.39
Do these weaknesses and deficiencies in the process of rating structured
finance products present good reasons to ask for changes in existing regu-
lation? First of all, it has to be remembered that in the US, rating agencies
are regulated.40 Since 1975, the SEC has determined who is a ‘Nationally
Recognized Statistical Rating Organization’ (NRSRO).41 In 1997, the SEC
defined the formal criteria for becoming an NRSRO. The Credit Rating
Agency Reform Act from 200642 has officially confirmed the regula-
tory and supervisory powers of the SEC; the Act states that the SEC can
revoke NRSRO status of a rating agency for lack of financial or mana-
gerial resources.43 In December 2004, the International Organization
of Securities Commissions (IOSCO) released a code of conduct for the
rating agencies.44 And the Committee of European Banking Supervisors
(CEBS) has issued ‘Guidelines on the Recognition of External Credit
Assessment Institutions’,45 following largely the example of American
legislation. The promulgation of these rules obviously overlaps in time
with the emergence of the problems described in this contribution. For
all these reasons the push for new regulations at this moment should not
be supported; the effectiveness of the existing framework should be care-
fully assessed before additional rules are enacted.
A separate issue is the proposal to eliminate the use of ratings for the
purpose of regulation.46 Th is would affect and probably eliminate the

37
Ashcraft and Schuermann, ‘Understanding the Securitization of Subprime Mortgage
Credit’, (note 6, above), 48.
38
Mason and Rosner, ‘Where did the Risk Go?’, (note 28, above), 55.
39
Ibid., 66 et seq.
40
US regulation is essential since the most important rating agencies are located in the
US.
41
Ashcraft and Schuermann, ‘Understanding the Securitization of Subprime Mortgage
Credit’, (note 6, above), 43.
42
S. 3850, 109th Congress § 2 (E) (2006).
43
Mason and Rosner, ‘Where did the Risk Go?’, (note 28, above), 29.
44
IOSCO, Press Release, ‘IOSCO Releases Code of Conduct Fundamentals for Credit Rating
Agencies’, (23 December 2004).
45
Available at www.bundesbank.de/download/bankenausicht/pdf/cebs/GL07.pdf.
46
Calomiris, ‘Not yet a ‘Minsky Moment’’, (note 30, above), 18 et seq.
 su bpr ime cr isis – does it ask for mor e r egu l ation? 581

core element of the Basle II regime of capital adequacy which refi nes
the risk weighting of bank assets by the use of ratings. Before such
a revolutionary (or reactionary) step is taken it should be considered
whether there are less far-reaching options likely to improve the rat-
ing process. One possibility would be to distinguish between ratings
which have been asked for by investors and are in addition used for
risk weighting, and ratings which are exclusively used for regulatory
purposes. The fi rst category should be less of a problem as the selection
of the agency continues to be controlled by the market. In the other
case the choice should not be left to the issuer or the underwriter: the
decision should be made by the regulatory agency which is charged
with the supervision. Th is might eliminate or at least reduce the temp-
tation of the rating agency to pay too much attention to the interests of
the issuer.

VI. Preliminary conclusion

There can be no doubt that some of the consequences of the subprime
crisis are serious. They may justify measures taken for the protection of
individuals who are facing particularly harsh consequences like the loss
of their family home through foreclosure.47 But this cannot be achieved
by the hasty introduction of new regulation for the financial markets.
So far there is no evidence that any risk affecting the safety of the global
financial system cannot be addressed by existing tools like the provision
of liquidity by the central banks. It should also be remembered that we
cannot expect financial markets to move consistently on a path of regu-
lar and balanced growth; there appears to exist no reasonable method
to prevent business cycles by regulatory intervention. At the same time
we should acknowledge that individual behaviour on fi nancial markets
is not completely determined by rational motives; and this appears to be
true not only for small investors but also for the professionals who are
running major financial institutions like banks and insurance companies.
It is not likely that their performance will be improved by new regulation.
Yet there is evidence that some of the irregularities – disaster myopia, herd-
ing, and extreme short-termism – are at least partially due to the internal
structures and the compensation schemes of financial institutions. This

47
Th is is, however, far from uncontroversial; see e.g. the warnings by the (American)
Shadow Financial Regulatory Committee, ‘Treasury Department’s Mortgage Foreclosure
Program’, Statement No. 250 (10 December 2007).
582 Perspectiv es in fina ncia l r egu l ation

could and probably should be addressed by the supervision of these firms

within the existing regulatory framework. At the same time it should be
remembered that there are strong indications that financial markets are
already overregulated.48 New rules should not be enacted unless there is
at least some evidence that the benefits will outweigh the costs.
48
For the US, see Committee on Capital Markets Regulation, Interim Report (30 November
2006) and ‘The Competitive Position of the US Public Equity Market’, Report (4 December
2007).
 32

Juries and the political economy of legal origin

Mark J. Roe *

I. Introduction
Legal origin – common law versus civil law – is important to the past
decade’s finance theory. Peculiarly, the theory has not had traction in the
academic legal literature, which might be surprising given academic discip-
lines’ understandable tendency to see their own issues as central and deter-
minative. What legal academic commentary that the theory has provoked
has either been sceptical that the legal origins channels that the law and
finance literature promotes are really so important or sceptical that origin
could be as important as modern political economy considerations. That is,
while the legal literature hardly denigrates law’s importance, it has doubted
the importance of legal origin to financial development. Mahoney,1 although
sympathetic in part (particularly to the idea of a detrimental statist nature
of civil law), denigrates the idea that civil law codification can be as import-
ant as the legal origin theory had hypothesized, since so much of American
corporate and commercial law is codified. Coffee2 sees the propensity of
some countries to disrupt their stock markets, which would have provided
the needed investor protections regardless of underlying legal institutions, as
central. Roe indicates that while property rights and investor protection are
important, legal origin differences cannot explain the institutional differ-
ences, since common law countries use non-common-law institutions, such
as securities regulators, and not just common-law-oriented fiduciary duties:
modern political economy forces are likely to explain modern financial and
investor protection differences in wealthy nations better than legal origin.3

* Th is article was originally published in the Journal of Comparative Economics, 35 (2007),

294–308.
1
P.G. Mahoney, ‘The common law and economic growth: Hayek might be right’, Journal
of Legal Studies, 30 (2001), 503–25.
2
J.C. Coffee, ‘The rise of dispersed ownership’, Yale Law Journal, 111 (2001), 1–82.
3
M.J. Roe, ‘Political preconditions to separating ownership from corporate control’,
Stanford Law Review, 53 (2000), 539–606; M.J. Roe, ‘Legal origins, politics, and modern
stock markets’, Harvard Law Review, 120 (2006), 460–527.

583
584 Perspectiv es in fina ncia l r egu l ation

In Legal Origin? Klerman and Mahoney 4 investigate central elements

of Edward Glaeser and Andrei Shleifer’s5 analysis of how differences
between common and civil law emerged in the thirteenth century, criti-
quing a paper called, simply enough, ‘Legal Origins.’ There, Glaeser and
Shleifer said that the English judiciary was decentralized relative to the
French and that political differences between England and France at the
time best explained that relative decentralization. The relative power of
the king in each nation differed, the barons feared the king more than
one another in one nation (and one another in the other nation), and
each nation’s economic structure differed, with large contiguous land
holdings in France giving the thirteenth century French barons more
power and autonomy than the British barons.
I had much admired Glaeser and Shleifer’s investigation and explana-
tion, because it focuses on power and politics in the thirteenth century
as explaining legal structure outcomes; despite that I am not a fan of
the legal origins strand in the law and fi nance literature overall, as the
citations in the first paragraph of this note suggest. I am sceptical of
their big picture story because, first, it exaggerates the impact on finan-
cial outcomes of differences in legal style, when there are much more
important – and more modern – explanations for the differences than
legal origin. It also privileges corporate legal institutions in finance,
which while important, are usually less critical than whether the pol-
ity has an ongoing antagonism to, or affinity for, capital markets. If the
polity likes capital markets, then capital markets will tend to get the sup-
porting institutions that they need. While older legal institutions are
important, they are only part of the story and probably not the central
one. Equally important, the differences in institutions between the legal
origins are not so wide that either one is disabled or privileged in achiev-
ing the goals sought, such as investor protection primarily and property
protection more broadly. Indeed, common law countries use regulators,
such as the Securities and Exchange Commission, and codes, such as
the securities regulations and the uniform commercial code, to deal
with commercial disputes among investors and merchants. When we
use those kinds of institutions, we forgo whatever advantages common
law institutions, such as fiduciary duties, could have provided. Investor

4
Daniel M. Klerman and Paul G. Mahoney, ‘Legal Origin?’, Journal of Comparative
Economics, 35 (2007), 278–93.
5
E. Glaeser and A. Shleifer, ‘Legal origins’, Quarterly Journal of Economics, 117 (2002),
1193–1228.
 J u r ies a nd the politica l econom y of lega l or igin 585

protection can be achieved through institutions available to both legal

traditions. The big picture issue is more likely to lie in whether the pol-
ity is ready to accept and promote financial markets, not which institu-
tional forms it classically preferred.
But I admired the 2002 ‘Legal Origins’ piece because it convincingly
focused on the issues of power and politics in the thirteenth century,
cogently analysing how differing political configurations in England
and France then seemed to have yielded strong juries in England and
centralized judging in France. I also admired the 2002 piece as a sus-
tained effort to link legal origins institutions to outcomes in a tight way;
the legal origin literature displays many regressions but few extended
inquiries beyond the 2002 piece linking origins to outcomes theoreti-
cally and historically. So, it is disappointing to see that Klerman and
Mahoney view the history there as not fully accurate, with the actual
structures (English courts were quite centralized, they say, and under
the king’s thumb in the twelft h century and for centuries thereafter) the
opposite of what Glaeser and Shleifer described. Since both sides rely
on standard sources, perhaps there is an uncertain historical record.
It is also possible that some of Glaeser and Shleifer’s jury decentraliza-
tion story can be preserved if we move beyond their jury story, which
Klerman and Mahoney say is inaccurate, to a more general explanation
for thirteenth century English decentralization. I shall explain how
below.
Here I make three points about the interplay between the emergence
of the jury in thirteenth century England and modern finance. The first
is that legal origins proponents should have paused in their other work
in which they assert that legal origin has a major impact on financial
outcomes around the world, because the jury is not central to finan-
cial regulation in many important common law nations. Indeed, its
existence on the periphery of fi nance may be detrimental to financial
development. If it is the jury that needs to be explained to understand
differences in legal origin, but the jury is not important to finance (or is
in fact detrimental), then that suggests legal origin differences may be
less important to modern finance than the origins literature has it.
Second, for the jury story to resonate with the overall legal origin story,
Britain would have had to have generally transferred the jury system to
its colonies. As Glaeser and Shleifer state, in the thirteenth century:
France went in the direction of adjudication by royally controlled pro-
fessional judges, while England moved toward adjudication by relatively
independent juries. Over the subsequent millennium, the conditions in
586 Perspectiv es in fina ncia l r egu l ation

England and France reinforced the initial divergence in the legal systems.
Moreover, the transplantation of the two legal systems … may account for
some crucial differences in social and economic outcomes in countries
that are reported in empirical studies. 6

But did Britain uniformly transplant the jury to its colonies? While
the jury has had a long, deep and important role in the United States and
Britain, it seems that most British colonies did not usually use the jury
for civil trials and many, perhaps close to a majority, did not for criminal
trials. The jury clashed with British colonial policy: decentralization and
local empowerment was not something that the British sought, particu-
larly after its experience with the jury in Ireland. Britain’s wariness in
transferring the jury around the world exemplifies a general and deeper
point – it illustrates the bigger concept that legal origin institutions are
trumped, and perhaps trumped easily, by modern political economy
forces. Britain was in the business of running a colonial empire. If the
jury conflicted with its colonial strategy, then out it went.
Third, the structure of the legal origins jury argument is in tension
with the overall, bigger picture legal origins thesis. The overall legal ori-
gin thesis is that differences in French civil law and common law legal
origin determine (or strongly influence) differences in modern financial
markets. Why are there differences in institutions? The answer lies, the
theory has it, in important part in differences in the political economies
of thirteenth-century England and France: powerful barons with con-
tiguous land holdings in France, a strong king in England. Differing legal
institutions emerged then based on the differing political configurations
of the time – so far, so good, those institutional differences persisted,
and those persisting differences in institutions determine differences in
financial markets in the twentieth and twenty-first centuries.
It is the conclusion in that chain that the legal origins’ authors ought
to have been more wary of: if the political economy of the thirteenth
century explains thirteenth-century outcomes, why should we not
look as well to twentieth-century political economy explanations to
explain twentieth-century outcomes? Should we not look to historical
experiences more recent than the thirteenth century as well? If political
economy differences were important in the thirteenth century, might
political economy differences of the twentieth century also be impor-
tant, perhaps even dominant?
I explore some of these issues below.
6
Glaeser and Shleifer, ‘Legal origins’, (note 5, above), 1194.
 J u r ies a nd the politica l econom y of lega l or igin 587

II. Emergence of juries in the thirteenth century

A. Thirteenth-century political differences
between England and France
Medieval, thirteenth-century France was unstable, while England was
at peace. England’s king decentralized judicial decision making, while
the French king centralized it. A key piece of English decentralization
was the emergence of the jury, say Glaeser and Shleifer.
According to Glaeser and Shleifer, the relative power of the king in
Britain and France induced centralized French courts, because this was
the only way that the relatively weak French king could control proceed-
ings and because the rivalrous barons acceded to the king’s control since
they feared one another more than they feared the king. Meanwhile, the
more confident English monarch in the more peaceful realm could allow
for decentralized juries and courts that could counter the local barons.
Glaeser and Shleifer focus in particular on bullying, with the powerful
French barons more likely to bully local juries successfully than would
the weaker English barons.

B. The Klerman–Mahoney reconsideration

Klerman and Mahoney say this story just was not so: British courts were,
they report, centralized in the twelft h century and for centuries thereaf-
ter. Indeed, this is as one might expect (and indeed Glaeser and Shleifer
expected that the powerful English king would have centralized judi-
cial power and were surprised to conclude that he had not): the power-
ful monarch tries to, and succeeds in, centralizing authority, while the
weaker monarch cannot. Moreover, the doctrines and institutions that
emerged then that could have had later pro-investor effects seem to have
emerged from the most centralized, most ‘French-like’ features of the
English courts, say Klerman and Mahoney. If there is a true institutional
difference between the common law and the civil law, say Klerman and
Mahoney, it emerged centuries later.
Klerman and Mahoney point out that rather than dispersing
the English judiciary, the English kings, from Henry II onward, kept
the judges on a short leash. Physically the king kept them close at
Westminster, that is, close to the king. Typically when they travelled
through England, they did so with the king. And the English judges were
a small group that the king controlled more easily than he could have
controlled a larger group of judges. And, yes, the king’s judges sought
588 Perspectiv es in fina ncia l r egu l ation

to build a common law, but common in the sense of uniform through-

out the king’s lands. Moreover, they point out, doctrines and institutions
like fiduciary duties – useful to modern outside investors in enterprises –
emerged not in the law courts that practiced the common law, but in the
king’s chancery courts, which emerged in the fourteenth century as the
most centralized of the English courts, the most under the king’s control,
and the least tied to juries. Hence, they say, whatever differences there are
today between common and civil law emerged after the thirteenth century
and, hence, the thirteenth-century history does not give one the opportu-
nity to reject the basic idea that law and social/economic/political institu-
tions are largely determined simultaneously in favour of a legal origins
theory. Whatever emerged in the thirteenth century does not seem to have
determined later institutions, mostly because England was centralized in
the thirteenth century. Perhaps, they say, the divergence occurred later,
when British merchants obtained more political power in the seventeenth
century and then got the kind of court system they preferred. And, they
suggest, perhaps the later, continuing divergences had much to do with
the continuing ascendancy of the Whig commercial interests in England,
an ascendancy that presumably allowed the Whigs to get – and keep – a
legal system that was not antagonistic to their interests.

III. Legal origin theory’s bigger picture

Let us take a step back from Klerman and Mahoney’s critique. For the
moment, let us take Glaeser and Shleifer’s view of the thirteenth-century
differences as accurate, despite Klerman and Mahoney’s criticisms.
What impact should that analysis have on the legal origins bigger pic-
ture? The jury analysis in ‘Legal Origins’ does not fit well with the legal
origins big picture on several important margins.
First, the historical record does seem to be contestable here, since
both sides use standard sources. Not being a legal historian or even
someone who consults legal histories of the English thirteenth cen-
tury regularly, I am not well positioned to arbitrate. Moreover, even if
Glaeser and Shleifer’s sources are inaccurate, perhaps enough of their
basic thirteenth-century story could still be preserved to be useful. That
is, Glaeser and Shleifer interpret the Magna Carta’s judgment by one’s
peers as guaranteeing a jury trial. Klerman and Mahoney point out that
the jury trial was not so used, that ‘judgment’ required judging not jury-
ing. The Magna Carta did not guarantee jury trials, they argue using
standard historical sources. However, the core of Glaeser and Shleifer’s
 J u r ies a nd the politica l econom y of lega l or igin 589

specific argument here could be saved if they view the judgment of one’s
peers as a decentralizing move, one that reduced the king’s power, even
if King John never agreed to give the barons a true jury. Still, Klerman
and Mahoney say that the next phrase in the Magna Carta – or the law of
the land – reasserts the king’s authority. Here Glaeser and Shleifer might
argue that this still confined the king to avoid actions based on caprice,
requiring consistency with prior rulings.
So, let us consider the implications if Glaeser and Shleifer’s thirteenth-
century view is, on the whole or in important part, correct. How does it
fit with the bigger legal origins picture? It still fits awkwardly.

A. What is the bigger picture?

The bigger picture is straightforward: legal origin is important to modern
finance because common law nations protect outside investors in firms
better than do French civil law nations. Common law nations use fiduci-
ary duties to protect outside investors ex post, after transactions occur;
they also prefer transparency and property rights; and they are relatively
decentralized and non-statist. The emergence of the thirteenth-century
jury – in the version Glaeser and Shleifer promote – fits the bigger picture,
they say, because the jury decentralizes power, reflecting and promoting
the barons’ independence from the English king. The less-centralized
state allowed institutions that could protect property rights to emerge in
a way that a centralized state might not have allowed. They state:
Starting in the twelft h and thirteenth centuries, the relatively more peace-
ful England developed trials by independent juries, while the less peaceful
France relied on state-employed judges to resolve disputes. It may also
explain many differences between common and civil law traditions with
respect to both the structure of legal systems and the observed social and
economic outcomes.

English systems promote commerce, French systems promote state

power, and some important packet of those differences trace back to the
thirteenth century.

B. How important for modern commerce?

One can see how the jury could be important to commerce. With the
jury drawn from the populace, the state would find it harder to dominate
decisions left to the judiciary. Judicial decentralization would facilitate
590 Perspectiv es in fina ncia l r egu l ation

commerce. Property owners would be less fearful of state incursion. In

contrast, a system of state-appointed judges operating without juries
could promote state power at the expense of property interests in medi-
eval times and business interests generally in modern times.
On the surface, there’s something appealing in the idea. But some
facts cause problems, problems that should induce us to rethink the
idea and possibly reject it. First, the facts. The key on-the-ground
American lawmaking institutions that affect outside investors are
the Delaware Chancery Court and the Securities and Exchange
Commission. The SEC operates without a jury, of course. It is staffed
by government-appointed officials. But – and here is the problem for
this arm of the legal origins theory – so does the Delaware Chancery
Court. Yet the absence of the jury is regularly seen by legal commen-
tators to be an advantage of the Delaware courts over others.7 A lively
literature in legal academic circles has arisen on why American firms
incorporate away from their original place of business and what the
consequences of that movement are. It is quite plausible and consist-
ent with the range of that literature that American corporations are
incorporating into Delaware in part, perhaps in major part, to escape
the jury. 8
Moreover, English civil courts do not use juries, Klerman and
Mahoney point out. Hence, the jury idea could have induced legal origins
theorists to re-think whether the core common–civil law differences are
really important to finance. If the jury is a key characteristic of the com-
mon law, but if financial interests try to escape the jury and often prefer
(French-like) expert judges to juries, then it is open to question whether
the common law generally, or this feature of traditional American and
British law, is basic to finance.

C. Is the jury uniformly important

in common law nations?
For the jury story to resonate with the overall legal origin story, Britain
would have had to have generally transferred the jury system to its

7
M. Kahan and E. Kamar, ‘The myth of state competition in corporate law’, Stanford Law
Review, 55 (2002), 708–709.
8
To be sure here, other states’ corporate laws are often dealt with via jury trials and when
the SEC sues wrongdoers it usually needs to operate before a jury. Trials for securities
damages go to juries, but my understanding is that players consider the jury’s awards to
be erratic. And recall that Britain hardly uses the jury at all in non-criminal trials.
 J u r ies a nd the politica l econom y of lega l or igin 591

colonies. But did it? It is true that juries have had a long and storied
role in English and American jurisprudence. But it appears that many,
perhaps most, former British colonies do not use juries for civil trials
and perhaps a majority do not for criminal trials. For Britain, a colo-
nial jury clashed with British colonial policy: decentralization and local
empowerment was not something that the British sought, particularly
after their difficult experience with the jury in Ireland. This is not a sec-
ondary point – it fits with the bigger concept that political economy con-
siderations trump legal origin institutions.
American colonists used the power of the jury to subvert the author-
ity of royal governors and the Crown. Jury nullification resulted in the
acquittal of John Peter Zenger (tried for criminal libel against British
interests), smugglers prosecuted under the Navigation Acts, rioters
against the Stamp Act, and participants in the Boston Tea Party, as Vogler
retells.9 One royal governor complained that a ‘Customs House Officer
has no chance with a jury let his cause be what it will,’ Moore reports.10
Irish juries were reluctant to enforce the law, which they saw as a tool of
English domination. Their reluctance led to lower conviction rates for
all crimes in Ireland than in England and Wales, Johnson states,11 such
that Britain suspended Irish juries during periods of unrest.12 As a nine-
teenth-century colonial power, the British had reason from experience
not to deeply embed the jury in its new colonies. As Young concludes,
even if the French origin systems had more centralizing and less liti-
gious potential than the British:13
By the time of the British imperial occupation of African territory, the
dangers to colonial hegemony in indiscriminate transfer of British legal
practices was well recognized. Thus, there was no question of application
of the jury system of criminal law, which had so undermined the effective-
ness of the law as a vehicle for colonial control in Ireland and the North
American colonies.

9
R. Vogler, ‘The international development of the jury: The role of the British Empire’,
International Review of Penal Law, 72 (2001), 528.
10
L.E. Moore, The Jury: Tool of Kings, Palladium of Liberty, (Cincinnati: W.H. Anderson
Co., 1973), 110.
11
D. Johnson, ‘Trial by jury in Ireland, 1860–1914’, Journal of Legal History, 17 (1996),
273–277.
12
K. Quinn, ‘Jury trial in Republic of Ireland’, International Review of Penal Law, 72 (2001),
200.
13
C. Young, ‘The African colonial state and its political legacy’, in D. Rothchild and N.
Chazen (eds.), The Precarious Balance: State and Society in Africa, (Boulder, CO:
Westview Press, 1988).
592 Perspectiv es in fina ncia l r egu l ation

The British did introduce the jury trial to India, extended it haltingly,
but never fully embedded it throughout India. They used it in India to
convince Europeans to feel safe working and living there, because trial
by a jury (of one’s European peers) protected Europeans from answer-
ing for crimes against Indians;14 India abolished it after independence,15
presumably because Indians saw it as a tool of hegemonic power. African
encounters with the jury are parallel: Britain limited its use and, where
used, used it primarily to protect Europeans against native Africans.16
This illustrates the complexity of context: the jury might well have
been a decentralizing institution in thirteenth-century England. But, in
some colonies Britain used it to centralize power by freeing colonizing
Europeans from native justice.
To be specific here and current, several representative common law
countries do not seem to systematically use juries: Botswana, Kenya,
India, Nigeria, Pakistan, and South Africa. Others do, but usage is by
no means uniform. Hence, if the purpose of examining the jury’s emer-
gence in England is to find a foundation for jurisprudence and decen-
tralization in English legal origin countries, that showing has not been
made. And a preliminary look at the legal history suggests it would not
have been easy to find that jury foundation throughout the common law
world.

D. Rebuilding Glaeser and Shleifer’s

jury-decentralization view
Legal origins theorists might have re-thought the jury’s impact in the
following way: the current direct presence or absence of the jury in cor-
porate and commercial cases is not really so important (recanting some
of the implications of the 2002 article), they might concede. But, overall
the jury represents a decentralized system that protects property. It is an
example of decentralization but not intrinsic to it.
Here is how, they might say: for governments (or the powerful, such
as landowners in the thirteenth century and corporate insiders in the
twentieth) to take property from another, they needed to get courts to

14
A.G.P. Pullan, ‘Trial by jury in India’, Journal of Comparative Legislation and
International Law, 28 (1946), 109, 3d series.
15
Vogler, ‘The international development of the jury’, (note 9, above), 532.
16
R.K. Mawer, ‘Juries and assessors in criminal trials in some commonwealth countries:
A preliminary survey’, The International and Comparative Law Quarterly, 10 (1961),
892–8; Vogler, ‘The international development of the jury’, (note 9, above), 525–52.
 J u r ies a nd the politica l econom y of lega l or igin 593

approve or acquiesce. But, the argument would run, if property owners

are well distributed through the populace – or at least among those who
could be selected for jury service – property would be protected. If the
judge – appointed by the legislature, the king or those in authority – acted
alone, civil-law-like, the judge might run roughshod over property rights if
the judicial institution lacked a check from a property-sympathizing jury,
one composed typically of property owners. Hence, the ubiquity of com-
mon law jury trials protected property, with the operational tool being
that the jury would be chosen from a populace of property holders.17
Though plausible, that argument gets tied up in knots when we try
to tie it to the bigger legal origin theory. What makes that kind of jury
work is that property is well-enough distributed that property owners
dominate juries, or the rules for jury selection make property owner-
ship a likely characteristic of the median jury member. But the same
pro-property result would be reached if property owners dominate the
legislature (or, again, if the rules for legislative composition favoured
property owners). If property owners dominate the legislature, then
it will produce property-oriented legislation. It will set up rules for its
courts that protect property. But if so, then the judicial system derives
from the composition of society (or, better, from the composition of its
legislative commanders). Even if the polity had no jury, if the legislature
(or the electorate or the relevant decision-makers) were dominated by
property owners, then that society’s rules would protect property and
the composition of the jury would not matter, because even if there were
no jury, judges would have to respect property.
Hence, it is not whether a nation uses a jury that matters but whether
the nation’s political institutions support or denigrate property rights.
If the legislature supports property and the legislature is powerful,
then in the end even judges without juries will protect property. If they
would not protect property, the legislature (or the executive, or the
electorate) would not let them be appointed. If property-disrespecting
judges did somehow get appointed, the legislature would take away
their authority. Most likely, severe conflict would not arise, because
judges and legislators would come from the same milieu – the same
law schools, for example – and have similar world views. If property

17
Or, if they gave up their jury argument, Glaeser and Shleifer might say that the Magna
Carta, by providing for judgment by one’s peers, protected property owners enough in
the thirteenth century that the baronial property owners would invest in improving
their property.
594 Perspectiv es in fina ncia l r egu l ation

is not well distributed among the jury population (and if the jury did
thwart property rights), then the property-oriented legislature would
disband or control juries (so as to protect property). Or courts would
adapt to the legislative realities, in the way Spiller and Gely suggested.18
Perhaps through happenstance, this sequence occurred in the United
States: a property-oriented polity allowed a corporate law institution –
Delaware Chancery Court judges operating without a jury – to emerge
and become important because it would protect corporate property
better than a jury-based court would.
And the converse is true as well: if the legislature is antagonistic to
property, then, first, the composition of the jury pool probably would
not be property protecting and, second, even if it is, the rules and insti-
tutions would not last long against a property defi ling but powerful
legislature.
Thus, the common law jury argument standing on its own is a
dead-end.
This sequence parallels Klerman and Mahoney’s hypothesis that the
history of British property protection emanates not from the thirteenth
century jury but from the seventeenth-century legislature. Their conjec-
ture seems plausible, because that is when commercial interests asserted
themselves and came to dominate the British power structure. It also
parallels19 Roe’s20 arguments that twentieth-century politics could have
overturned prior property protection, and did in some nations. When
those in power were not interested in supporting financial markets,
financial markets did not develop. Nations’ legal traditions were less
important than their contemporaneous political economy features.
This is not just history. The process of legislative property protection
is happening here and now, in the United States. Consider the Kelo case,
which the United States Supreme Court decided in 2005.21 The court
said that state legislatures were free to define what the public purpose
was when they took property from property owners for economic devel-
opment. (There is more detail here for a law school property course, but

18
P.T. Spiller and R. Gely, ‘Congressional Control or Judicial Independence: The
Determinants of U.S. Supreme Court Labor-Relations Decisions, 1949–1988’, RAND
Journal of Economics, 23 (1992), 463–92.
19
Roe, ‘Political preconditions to separating ownership from corporate control’, (note 3,
above), 539–606.
20
M.J. Roe, ‘Delaware’s competition’, Harvard Law Review, 117 (2003), 588–646; Roe,
‘Legal origins, politics, and modern stock markets’, (note 3, above), 460–527.
21
United States Supreme Court, Kelo v. City of New London, 125 S. Ct. 2655 (2005).
 J u r ies a nd the politica l econom y of lega l or igin 595

we need not go into it.) This decision would not be a good one for a legal
origin theory that sees fundamental importance in common law judi-
cial property protection. But then the issue became a public one, going
on the ballot in eleven states, with nine of them confi ning their decision
makers from expanding the notion of property that could be taken.22
Today it is the American property-oriented polity, not the judges, that
restricts takings.

IV. Juries’ interaction with the

bigger picture
There’s another interaction between the Glaeser–Shleifer article and
the bigger picture of the legal origin analysis – and it may well be more
important. Let us pursue it here and see how it could lead us to higher
ground and better insights. That higher ground is the ascendancy of
political economy considerations in understanding the foundations for
financial markets.

A. Political economy foundations in

the thirteenth century
First, let us analyse the core legal origins perspective, step by step.
The central argument in this literature is that law that protects inves-
tors is important for financial markets. (Few would dispute this in its
ordinary form.) Law though is not primarily the creation of modern pol-
itical and economic forces, the legal origin theorists assert, but the result
(primarily, largely, in important measure) of long-standing legal tradi-
tions that date back centuries. Figure 1 illustrates the view that modern
property protection is rooted in medieval institutions.
What caused the common and civil law legal systems to diverge?
Well, political differences in the twelft h, thirteenth, and perhaps the
seventeenth centuries; political differences having to do with the rela-
tive power in England and France of the king and of the complementary
relative power of the barons in each nation. I illustrate with Figure 2.
With these two sequences in mind, we can, in the legal origins theory,
understand much of modern finance.

22
Castle Coalition, www.castlecoalition.org/legislation/ballot-measures/index.html (2006);
C. Cooper, ‘Court’s eminent-domain edict is a flashpoint on state ballots’, Wall Street
Journal, August 7 (2006), A4.
596 Perspectiv es in fina ncia l r egu l ation

Legal Tradition/ Modern Stock 20th (and 21st) Century

Institution Market and Legal Market Results
Institutions
Common Law
a) Juries Strong markets
b) Protecting market
against state Developed stock
c) Open-ended judging markets
Strong stock market
Ownership
institutions/law
separation

Civil Law
a) Weak judiciary Weak markets
b) Strong state
Weak stock
c) Over-regulation
markets
d) Formalistic judging Weak stock market
Concentrated
institutions/law
ownership

Figure 1 From medieval legal origin to modern fi nancial markets

Origin of the Legal Tradition/ Modern Stock 20th (and 21st) Century
Legal Tradition Institution Market and Legal Market Results
Institutions
Politics: 13th Common Law
Century a) Juries
Strong markets
b) Protecting market
against state Developed stock
Politics: 17th c) Open-ended judging markets
Century Strong stock market
Ownership
institutions/law
separation

Politics: 13th Civil Law

Century a) Weak judiciary Weak markets
b) Strong state
Weak stock
c) Over-regulation
Politics: 18th markets
d) Formalistic judging Weak stock market
Century Concentrated
institutions/law
ownership

Figure 2 From medieval political foundations to legal origins differences

B. Political economy foundations in the twentieth century?

So in the legal origins theory, politics is indeed important, but its import-
ance is in how it induced institutional differences to arise in the twelft h,
 J u r ies a nd the politica l econom y of lega l or igin 597

thirteenth, and maybe the seventeenth centuries. Modern politics in the

theory is relatively unimportant. For example, in one legal origins piece,
Botero et al.23 argue that left–right power and the relative importance of
labour interests are not as important to European labour legislation in
the past few decades as legal origin. One might – dropping the theory’s
transmission institution of legal origin – call the thesis one of the medi-
eval origins of modern financial markets. I illustrate with Figure 3 the
legal origin advocates’ rejection of modern politics as a key determinant
of financial markets. (Surely the authors would not deny that modern
politics has some effect, but their idea would be that its effect is smaller
than legal origin, or interacts so closely with legal origin that it is really
origin that determines the lion’s share of the political economy configu-
rations and the financial outcomes.)
An alternative view, one that I illustrate with Figure 4, is that modern
politics is quite important to modern financial markets. Some polities
favour capital markets; others are hostile to financial markets. The first
will build supporting institutions; the second will not. And even if the
second does build those institutions at times – or does allow them to
emerge privately – they will not do much good in developing deep fi nan-
cial markets because capital owners are wary of letting go of their capi-
tal in a hostile (or indifferent) political environment. Roe develops this
theory.24
The point here is not to deny that institutions, particularly legal
institutions, are sticky. They are. And their stickiness can persist for
years, even decades, impeding some changes.25 But stickiness does not
mean that, once constructed, they are impervious to subsequent influ-
ences. If history had ended in the thirteenth or seventeenth centuries
in Europe, then it is plausible that the institutional objects, having been
set in motion, would persist. And if those institutional differences were
central to financial differences (a view disputed in part by Klerman and
Mahoney here and Mahoney26 and Roe elsewhere – because both sets of
institutions can achieve the same investor protection ends if the political
23
J. Botero, S. Djankov, R. La Porta, F. Lopez-de-Silanes and A. Shleifer, ‘The regulation of
labor’, Quarterly Journal of Economics, 119 (2004), 1339–1382.
24
Roe, ‘Political preconditions to separating ownership from corporate control’, (note 3,
above), 539–606; Roe, ‘Delaware’s competition’, (note 20, above), 588–646; Roe, ‘Legal
origins, politics, and modern stock markets’, (note 3, above), 460–527.
25
M.J. Roe, ‘Chaos and evolution in law and economics’, Harvard Law Review, 109 (1996),
641–68; L.A. Bebchuk and M.J. Roe, ‘A theory of path dependence in corporate owner-
ship and governance’, Stanford Law Review, 52 (1999), 127–69.
26
Mahoney, ‘The common law and economic growth’, (note 1, above), 503–25.
598 Perspectiv es in fina ncia l r egu l ation

Origin of the Legal Tradition/ Modern Stock 20th (and 21st) Century
Legal Tradition Institution Market and Legal Market Results
Institutions
Politics: 13th Common Law
Century a) Juries Strong markets
b) Protecting market
against state Developed stock
Politics: 17th c) Open-ended judging markets
Century Strong stock market
Ownership
institutions/law
Politics: 20th separation
Century

Politics: 13th Civil Law

Century a) Weak judiciary Weak markets
b) Strong state
Weak stock
c) Over-regulation
Politics: 18th markets
d) Formalistic judging Weak stock market
Century Concentrated
institutions/law
ownership
Politics: 20th
Century

Figure 3 Medieval legal origins and the unimportance of modern politics to

modern financial markets

Origin of the Legal Tradition/ Modern Stock 20th (and 21st) Century
Legal Tradition Institution Market and Legal Market Results
Institutions
Politics: 13th Common Law
Century a) Juries Strong markets
b) Protecting market (weak)
against state Developed stock
Politics: 17th c) Open-ended judging markets
Century Strong stock market
Ownership
institutions/law
Politics: 20th separation
Century (stronger)

Politics: 13th Civil Law

Century a) Weak judiciary Weak markets
(weak)
b) Strong state
Weak stock
c) Over-regulation
Politics: 18th markets
d) Formalistic judging
Century Weak stock market Concentrated
institutions/law ownership
Politics: 20th
Century (stronger)

Figure 4 The importance of modern politics to modern fi nancial markets

will is there), then modern finance could well have been determined by
centuries-old institutions. More plausibly, other institutional differences
arose in the interim, replacing, strengthening and changing earlier ones.
The residue of events from the thirteenth century was certainly an input,
 J u r ies a nd the politica l econom y of lega l or igin 599

but only one and probably not the determinative one. Certainly the
English Civil War and the Glorious Revolution were central to English
history, substantially influenced the English economy in the seventeenth
century, and had continuing influence into the eighteenth century and
beyond. Certainly the welfare state’s rise in the twentieth century and its
intensity in continental Europe could have affected finance and property.
The point is not that institutions are not sticky, but that the events that
influence them occur more frequently than once every seven centuries.

C. Differences due to wars and insecurity

A parallel analysis of the legal origins argument can be made – parallel
in the sense that the influence of thirteenth century (or seventeenth cen-
tury) institutional differences has strong modern parallels, forcing us to
wonder whether it’s the medieval influence or the modern one that is the
stronger one. Starting in the twelft h and thirteenth centuries, Glaeser
and Shleifer state (at 1194):
France went in the direction of adjudication by royally controlled pro-
fessional judges, while England moved toward adjudication by relatively
independent juries. Over the subsequent millennium, the conditions in
England and France reinforced the initial divergence in the legal systems.
Moreover, the transplantation of the two legal systems … may account for
some crucial differences in social and economic outcomes [around the
world].

Glaeser and Shleifer say that this happened because the French situ-
ation in the thirteenth century was unstable, while the English enjoyed
(relative) tranquillity. Th is – relative order and tranquillity in England –
induced differential institutional development. As Glaeser and Shleifer
plausibly state (at 1208):
We estimate that between 1100 and 1800, France had a war on its soil dur-
ing 22 per cent of the years, whereas England only 6 per cent (one can also
argue that the wars on English soil were relatively bloodless). The constant
war on the French soil meant that weapons and warriors were readily
available to anyone who wanted to subvert justice.

Glaeser and Shleifer focus on the stability of the jury system:

It is not entirely surprising…that tight state control of adjudication has
often been introduced as part of national liberation or unification, often
in the aftermath of national liberation or civil war and other disorder.
600 Perspectiv es in fina ncia l r egu l ation

Without internal peace to begin with, a system of juries may simply not
work. 27

Again, the jury system might not be so central to modern finance,

for the reasons I gave a few pages ago, and may not have been trans-
planted around the common law world, but one could stick with the
basic elements of the Glaeser–Shleifer argument by substituting the con-
sequence as being one of a decentralized state, one amenable to local,
property interests (for which the jury could have been a manifestation,
but not a necessary one) and which internal and external disorder would
weaken.
Some of this relative order arose, I shall add to give some texture to
Glaeser and Shleifer’s argument, from the differences of geography: the
open areas of the European continent put differing, often hostile, pop-
ulations next to one another. The English had the advantage of being
separated by a channel of water, with the Scots and Welsh as the only
immediate hostile neighbours. (Invasions of England, like the Norman
one in 1066 and what could be characterized as the Dutch one of 1688,
were difficult to pull off.) The contrasting geography of the thirteenth
century gave a geographic impetus to a powerful prince in Europe in gen-
eral and France in particular, one who could fend off hostile neighbours.
The English had an easier time thinking of suppressing a standing army
and decentralizing power than would most states on the continent.
From these differences in internal and external order, in the Glaeser
and Shleifer perspective, it is plausible that a centralized civil law system
emerged on the continent in France, perhaps as early as the thirteenth
century, and a less centralized one emerged in England. Centuries later,
these contrasts affected finance, with the English courts better equipped
institutionally to protect property, shareholding and creditor interests
than the centralized, statist civil law systems, as Figure 5 illustrates.
But the problem is that this kind of continental European disorder did
not end once and for all in the thirteenth century, or even in the seven-
teenth century. This contrast persisted up to 1945 and the end of World
War II, or perhaps until 1989 and the collapse of traditional communism
and the Berlin Wall. Figure 6 illustrates. Proponents of the legal origin
story may simply be seeing in medieval legal origins the back reflections
of more modern – and more important – political economy differences
of the twentieth century, differences arising in large measure from the

27
Glaeser and Shleifer, ‘Legal origins’, (note 5, above), 1211.
 J u r ies a nd the politica l econom y of lega l or igin 601

European Medieval disorder Strong 20th Weak

Continent and invasion Century State market

Middle Ages’ Civil

strong state Law

Britain,
USA, No standing Weak 20th Strong
Canada, army Century State market
Australia
Middle Ages’ Common
weak state Law

Figure 5 Medieval disorder and stability

contrasting levels of twentieth-century disorder and destruction, and

their political consequences. And that, I suspect, is where, for modern
financial outcomes, the real political economy story begins in earnest.

V. Conclusion
Legal origin has been brought forward as a key influence on modern
finance, with the perspective being advanced that common law institu-
tions are intrinsically better adapted to protect investors than civil law
institutions. Glaeser and Shleifer offer a creative inquiry into the early
emergence of the jury in common law nations and its relative unimport-
ance in civil law nations.28 They offer it as one of the significant con-
tinuing differences between common and civil law, one dependent on
the differences in relative power between the English monarch and the
French one in the thirteenth century, with the powerful British monarch
able to forgo centralization, while the weaker French monarch needed
to assert control over localities via a more powerful judiciary. Daniel
Klerman and Paul Mahoney provide an excellent analysis of the diffi-
culties of doing this kind of historical work, as it turns out that much
evidence indicates that the powerful British monarch in fact centralized
judicial authority.29 If differences emerged, say Klerman and Mahoney,
they emerged later on. Moreover, they say that one cannot yet reject the
possibility that law is determined simultaneously with social, political

28
Glaeser and Shleifer, ‘Legal origins’, (note 5, above), 1193–228.
29
Klerman and Mahoney, ‘Legal Origin?’, (note 4, above).
602 Perspectiv es in fina ncia l r egu l ation

20th Century
Wars

European Medieval and Strong 20th Weak

Continent modern disorder Century State market

Middle Ages’ Civil

strong state Law

Britain,
USA, Weak 20th Strong
No standing army
Canada, Century State market
Australia

Middle Ages’ Common

weak state Law

Figure 6 Modern disorder and stability

and economic facts, as the thirteenth century structures did not seem
to predetermine the later ones. If by simultaneous, we mean over the
course of decades, with multiple feedback effects, their thesis is one I’d
sympathize with and indeed put forward.30
And the basic investigation here of the jury should give pause to those
promoting the overall legal origin thesis. The fi rst reason to hesitate is
that the jury is not central to protecting outside investors in common
law nations. Indeed America’s premier corporate court – the Delaware
Chancery court – sits without a jury and the usual view in legal circles
is that the jury’s absence (which results in decision making by expert
judges, not juries) is a strength of the court, not a weakness. The sec-
ond reason is that Britain often did not transfer the jury to its colonies.
The transplantation assumption in the legal origin literature is weaker,
maybe much weaker, than the law and fi nance literature has it. The
third reason is that the analysis for the jury differences between civil
and common law nations depends on political economy differences of
centuries ago. But if political economy differences determined institu-
tional differences in the earlier centuries, it is plausible that political

30
Roe, ‘Political preconditions to separating ownership from corporate control’, (note 3,
above), 539–606; Roe, ‘Delaware’s competition’, (note 20, above), 588–646; Roe, ‘Legal
origins, politics, and modern stock markets’, (note 3, above), 460–527.
 J u r ies a nd the politica l econom y of lega l or igin 603

economy differences in intervening centuries also have affected fi nan-

cial outcomes. Indeed modern and contemporary political economy
differences that lead some nations to support capital markets and some
to denigrate them could be as important to modern financial outcomes
as thirteenth and maybe even seventeenth century political differences.
Perhaps more so.
 PA RT I I I

Miscellaneous
 33

The practitioner and the professor – is there a

theory of commercial law?
Jea n N icol as Dru ey

Of course, my title indicates a reverence to Eddy Wymeersch. He has

shown that in commercial law both practical and theoretical functions
of a highest level can be united in one person. And the lesson he teaches
goes one step further: he certainly did not undertake all the burdens
simply for honours, but because he saw a professional need to follow
both tracks. Practice requires guidelines from theory and theory the
feedback from practice.
But I am hesitating: what exactly does theory offer to commercial
practice? In our actual world, is not the flow going more and more the
other way in that innovative practice gets faster and faster, and, be it just
for the changing allocation of forces, theory slower and slower? The two
seem to become increasingly unequal, the one trying breathlessly to run
behind the other.
My question has two branches. First, it applies a sociological view on those
having to do with commercial law. This is kind of an outward look. Then, the
inward look has to follow, i.e. an analysis of the actual state of commercial
legal theory, its possible deficits and chances. All that will necessarily be lim-
ited to some observations and ideas from one of many possible viewpoints.
But before all, let us start by an example. It will allow a closer view
to the problem, and will set more players into the field than the profes-
sor and the one applying the law in commercial practice; in particular
lawmakers and courts have to come into the picture. On the other hand,
the retarding factors in the evolution of theory will be better seen. The
introductory example which I choose is the one which has particularly
brought Eddy and me together.

I. The law on corporate groups as an example

Groups of companies being directed by a common policy determined
by a parent company are a phenomenon going back to the nineteenth
607
608 Miscella n eous

century. Since then they have continuously increased – maybe not so

much in application fantasy, but in size and number, the multi-corpo-
rate structure having become organizational routine everywhere in the
world.
The legal world reacted quite promptly. Typically, in a country like the
United States the reaction was aimed at particular issues such as accept-
ing the group as not being a conspiracy in restraint of trade, whereas
the Deutscher Juristentag of 1902 placed the subject of groups as such
on its agenda. Sixty-three years later, the Federal Republic promulgated
a chapter in the Aktiengesetz titled ‘Verbundene Unternehmen’ (related
companies), thus claiming to systematically regulate the group phenom-
enon (if composed by companies limited by shares). Some other coun-
tries followed to a various extent. ‘The rest is silence’ – incredibly enough
after more than a century!
Having been, like Eddy Wymeersch, one of those sitting over this
group law subject for innumerable hours, be it reading and writing at
my desk, teaching in the classroom, or listening and discussing in many,
many conferences, seminar and meetings, I ask myself: Was all that
fruitless? I would insist on the statement that we tried hard from the side
of theory and that none of these hours was dull. But the point of depar-
ture and the object of interest were facts and phenomena. Legal theory
tried to cope with the inventions of commercial practice – and failed to
cope with itself!
What I mean is a failure to get the new legal tools ready, which always
are necessary to grasp a new phenomenon. Without that, all is mere sub-
sumption; all is measured by the pre-existing standards. Groups thereby
are an issue under minority protection, under creditors’ protection,
workers’ protection, contract law or whatever: legal action about groups
is, then, instigated by the view that groups might create a danger under
such aspects. The German Aktiengesetz of 1965 is the protagonist for
some of these purposes. Th is kind of legal thought, however, runs a ser-
ious risk to be counterproductive, creating injustice instead of justice.
Subjecting groups to a cumbersome minority protection, for example,
raises the question whether the situation is actually better or worse in
others than affi liated companies, and whether it is for those concerned
even more of an advantage than a disadvantage to be integrated in a
group etc. This is to say that, truth being on both sides, general rules
in favour of one side will soon prove to be a Procrustian bed. In other
words, to have no group law might be the better solution than this group
law. One way or the other, the start from pre-existing concepts is too
 theory of com mercia l l aw? 609

rough because theory lacks the patience to analyse the group as a phe-
nomenon of its own, as a mix of centripetal and centrifugal tendencies
which requires its proper institutions.
This example indicates a need and, at the same time, a deficit, of a
switch in paradigm. Legal thought tends by nature to be positivistic, and
lets others do the work of conceiving policies and preparing new laws.
However, groups of companies, like most issues in commercial law, are a
problem of insufficiency of the existing law, and lawyers therefore as the
‘users’ of law would have a primordial signalling function. But practice
has not the time and the systematic approach to produce such signals.
So the problem is: if practice sees no problem, it is by far not certain that
there is none.

II. The power of practice

This brings me to my question. There is in commercial law a strong inter-
relationship between the phenomena and the law. Our times are more
and more departing from the one-sided perspective that there are facts
ruled upon by laws, in favour of a cybernetic approach viewing facts as
law producers by themselves in the sense of feedbacks given to the law.
Thus, when we speak of a system this is not only the question of whether
there is, and what is, the system of commercial law, but of the system
generating the law.
I am well aware that describing the situation in this manner implies
a statement of weakness of the law. It certainly would be worth an in-
depth investigation – none is known to me from my angle – to show
the various manifestations of this position-loss in politics, in legislative,
legal or academic practice etc. This is not necessarily to blame our guild
of lawyers, but may equally well indicate a courageous opening towards
the non-legal considerations, from economic theory to statistics, or from
great scandals to innocent day-to-day-practice, and to a global or at least
European view. An opening always is a concession of weakness, but who
does it first might be the fi nal winner.
And this is also to say that, within the legal professions, the role of the
practitioner has been enhanced. Practice has become the focus on which
these various perspectives converge. And practice, in turn, has not only
the option to consider them, but it must find its way in order to elimi-
nate the major risks coming from any side whatsoever. This creates an
autonomy increasingly enlarging the gap to legislated law. Commercial
practice builds its own world by establishing standard contracts, by
610 Miscella n eous

concentrating know-how in certain places (a merger between two

middle-sized Swiss companies is normally managed from downtown
Manhattan) or by developing its own, usually abbreviated, language or
its rules of thumb.
I do not think that we must accept this evolution forever, and nei-
ther that we should do so. Let me somewhat elaborate on these two
questions.

III. Securing the connection of theory and practice

If, referring to the authority of established law, one does not accept the
autonomy of practice, one must show how the two can be tied together.
Essentially, there are two ways: either the gap is bridged over by persons
or by procedures. The fi rst is to have persons available who are in hybrid
positions, having functions on both sides, being practitioners and
simultaneously, say, professors – I would mean by ‘professors’ any legal
professionals having the overview over the existing body of law and
the theory behind it. The second is to offer channels of understand-
ing between the practitioners and the professors, such as common
seminars, periodicals publishing the views of both sides, a severe legal
education of the future practitioners safeguarding a lifetime interest for
the legal basics, or, to the contrary, trainings of professors in practice –
I am serious on that too!
Both ways have their specific advantages and specific cost. To unite all
aspects in one person is to avoid all transferring and processing of infor-
mation; what is available is so at any time. But all the more restricted
are the capacities and thus the available quantities of information. Of
course, I would not dare to express a formal choice in my few thoughts
presented here. Generally speaking, it is not entirely a matter of volun-
tary choice, not an issue of strategy of whomsoever. Rather it is rooted
in traditions which will not follow an order to change, and, in varying
proportions, there will always be a mix of both. Thus, I will limit myself
to some considerations related to this weighing. These will favour a sep-
aration of powers, specifically suggesting to let professors just be profes-
sors. That may appear to be more daring than any other proposal when I
write this precisely to the honour of Eddy Wymeersch. But I trust he will
understand what I mean.
Looking at those traditions, we might observe a difference between
bigger and smaller countries. I am not able to make final statements
on this, my view being to a great deal limited to my home country,
 theory of com mercia l l aw? 611

Switzerland. But there is a chance of more parallels to Eddy’s country,

Belgium, than for example to Germany, England or the United States.
Smaller countries are more limited in their personal resources and there-
fore tend to attribute to their best people a plurality of functions. I do not
overlook that other European countries like France or Italy, although
being important, also have a tendency to combine advocacy and (full)
professorship; I will not discuss their particular motives.

IV. The trend toward double-bind positions

If I consider the developments in Switzerland, the trend in the field of
commercial law clearly is in favour of the combination. To be sure, pro-
fessors in this area used to write opinions, to be a part in arbitration
courts or in legislative commissions in prior times as well. But today an
increasing number even of ordinarii actually mix functions particularly
by being partners in a legal office. On the other hand, members particu-
larly of big law firms tend to undertake an academic kind of tasks by
teaching courses and/or being active in publishing.
The reasons for this trend have to do, as I see it, with the better aware-
ness for career planning, both on the side of the young people and of
their potential employers. The brilliant law students and graduates are
looked for by their academic teachers and also by the big law firms, and
to ride on both tracks is for the young candidates sort of a natural way
of solving the dilemma, or rather of avoiding a solution. Differences are
merely gradual, depending on how well the inner academic fire survives
the immense challenge which is encountered in a glamorous legal busi-
ness. The amount of energy and time-management skills shown by the
runners of such hybrid careers is admirable.
Now, the evaluation of this double-bind as a bridge between practice
and theory raises positive but also negative aspects. The tie to theory
secures, I may say, a certain cleanness of practical arguing referring it to
the legal bases, but also inspires the fantasy to find maybe unusual lines
of argument, which is in the interest of the case and of the evolution of
law as such. The familiarity with practice also protects theory against
growing grey and contributes to the authenticity of academic teaching.
On the negative side I see mainly the problem that this kind of career
cannot, by simple limitations of time and attention, focus on theory as
such; the thinking is either pragmatic or positivistic. Theory, then, is a
body more or less well conserved since the times of studying and the-
sis writing, and not itself the object of elaboration. In publications and
612 Miscella n eous

courses, the choice of topics and the answers given are often preceded
by work on specific cases, which serve clients and, even if they are not
biased, there is a natural tendency to stick mentally with those cases.
However, all this starts from one presumption, namely that there is a
value in developing legal theory. The impression is rather the opposite:
commercial law practice seems to have learned to swim, to stay at the
surface without need of a solid bottom, and does so for the sake of being
faster and more flexible. We have to consider that now.

V. Commercial law in need of a theory

I understand a legal theory to be a system of sentences lying behind
the specific rules prescribing any kind of behaviour. The assertion is
that law cannot do without, and that commercial law is no exception.
Quite to the contrary: the more flexible the law is, the stronger has to
be the construction holding it together. And a theory is not just a pur-
pose, because purposes never can be followed up to their end, but are
subject to a legislative dosage which is a matter of policy, not of theory.
And theory also is more than denominating a field of action. To say
that Sarbanes-Oxley is aimed to improve corporate governance does
not relate the substance of the rules to their conceptual roots, thus has
no theoretical leverage.
Theory is a guideline for interpretation and to determine the inherent
limits of legal rules. And lack of theory may therefore be of great cost.
For example, we should have more theory on the requirement of inde-
pendence of decision makers. As a concept, independence bears hardly
a limitation in itself; however, it is clear that our segmented business
world needs an immense number of decision makers and that we may
not exclude, for reasons of bias, any friend of a friend of any person pos-
sibly interested in the outcome of a decision. The law has to draw a line, it
has to sort out the forbidden from the acceptable cases, but it cannot spe-
cifically name all cases which should not be tolerated. Theory could help
to prepare the selection, it could systematically analyse the causes of bias
and show, as a first thing, that there are many other sources of unwanted
influences beside proper interest and relations to interested parties, such
as opinions previously expressed, political or religious views, informal
quid-pro-quos etc. Then, theory could systematize the countervailing
virtues of double-bind positions. And clarity should be elaborated on
a general level about the consequences for the decisions taken with the
collaboration of excluded persons: are they invalid? Is the election of the
 theory of com mercia l l aw? 613

person invalid from the outset or only the respective contribution (vote
etc.)? Or is all valid under the provision of liability for damages? What
about confidential information given to excluded persons? And so on.
It is not without purpose that I am going into some length with this
example: uncertainties on points like those mentioned may have an
important destabilizing effect. And by no means can we expect that
the insular provisions in laws or governmental or private regulations
will actually cover the subject in the multitude of its aspects. Nor are
the short-cut methods satisfactory which usually are applied in legal
uncertainty, such as weighing of interests or conclusions by analogy.
Weighing of interests is by far not able to give the precise guidelines
required in advance on issues of independence. And analogy blurs the
limits which, as stated, always are necessary in matters of incompatibil-
ity. It cannot do without a theory indicating in turn the limits of argu-
ing by analogy.
It would be easy to multiply the examples of areas of strong, but too
pragmatic evolution of modern commercial and economic law. Probably
the most important today would be the world of fi nancial reporting, but
we could also revert to the corporate groups and show how creditors
and shareholders of Sabena could have been helped against Swissair by a
more solid state of theory.
Why is there no uproar of practice against so much uncertainty, so
much imprecision in core issues of commercial law? Why do the practi-
tioners, being the professional wolves in their cases, behave like lambs in
face of issues of legal development?

VI. Commercial law theory in need of professors

Is there at all something which may be called a body of theory of com-
mercial law? Every commercialist anywhere in the world might give the
ready-made answer ‘Yes, of course’ and will with pride point to the com-
pany law. I am not so sure. History of companies, especially of those
with limited liability, might with good reasons rather be called a distort-
ing of theory, a fruit of marketing more than of legal doctrine, in that
investors of desperately needed risk capital were called ‘members’ or
‘shareholders’, although others were clearly the entrepreneurs conceiv-
ing and initiating the business. Time worked with respect to such initial
shortcomings of theory more in the sense of forgetting than clearing.
For sure, there are other examples, where the long time available helped
steady improvement of the institution like in case of bills of exchange:
614 Miscella n eous

here, precision was the goal since the beginnings in the late Middle Ages,
and led to an admirable mechanics of rules spread over the world thanks
to its clarity.
More recent institutions such as capital market law often do have
their underlying theories, but the discussion got out of breath too soon.
The parallelism of market and investors’ protection, which seems to be
the prevailing answer with respect to the purpose of capital market law,
is not much of a statement. Naturally, legislators tend to give to their
products a broad scope, such as drugs are claimed to cure from top to
toe. Theory is all the more asked to indicate the unavoidably necessary
limitations.
One point is clear, however: economic theory is not by itself legal
theory. Law can obviously not neglect what economic science is assert-
ing and opening the law for this kind of reflection has been one of the
most deserving efforts in legal theory of the last decades. But economic
theories are models based on certain assumptions; they start with an
‘If …’, and law has to look behind such ‘Ifs’, and this always brings
contrary considerations into light. For example, market theory calls
for transparency, but a fi rm only can work when privacy is granted
to its internal developments. Maybe that economic theory itself will
deal with such confl icting aspects, possibly by taking into the picture
behavioural economy, but legal theory at least has to ask the questions
and usually has to care for fi nding the equilibrium. And there will
always be considerations flowing exclusively from the legal system.
Law is based on fundamental rights which are not derived from any-
where else. In this sense, conceptions of social values put forward by
economic theory have necessarily to be complemented by individual
values and freedoms. Property rights, for example, will never be suf-
ficiently explained by functions ascribed to them in the general eco-
nomic process.

VII. Professorship or practice

In the networks of the legal professions, theory is allocated with the
professors. They are not freed from this task by the fact that nobody
cares for theory, but it makes it all the more cumbersome. For one thing,
it puts the additional burden on them to awake the need for theory as
such, i.e. to make the community again sensible for the indispensabil-
ity of theory, to profess a ‘theory on theory’. Theoretical statements, if
they are good, have little rhetoric power and thus little chance to have a
 theory of com mercia l l aw? 615

direct impact on practice. Theory, therefore, must grow in the seclusion

of pondering and discussing, and requires the recognition of the value
of theory per se.
Secondly, we observe an intriguing phenomenon of divergence:
whereas awareness of theory diminishes, the fields of theory are becom-
ing more and more large. My observations above have alluded to eco-
nomics, but the same is true for sociology or psychology. The classical
task of ascertaining the law in the respective field can no longer restrict
itself to collecting judicial precedents and scholarly opinions under the
applicable keywords, but has to look into constitutional, procedural
and other branches of law, into linguistic, historical and philosophical
aspects as constituents of the law. And all that should not be limited to
one country or one language area. On top of this, working on theory
calls for an effort of synthesis, not just accumulating an immense pile of
materials, but extracting therefrom generalized statements, which is no
fast business.
This sounds utopian, taking into account the very small number of
professors as compared with other legal professions. But there lies no
justification for doing nothing. Thus, I plead in favour of professorship to
be a pure professorship, and of selecting professors in view of their ability
and willingness to dig into the bases of their legal fields.
Of course, theory under circumstances whatsoever will not die.
People wanting to look into larger contexts will continue to show up.
But we should be afraid of the dissociation of theory and practice.
Practice and theory must understand and watch each other. Both
are subject to fashions, and even a theory working in the unnoticed
‘underground’ may, due precisely to its one-sidedness, one day get
sufficient power to break into a practical environment inspired by a
very different culture. We lived this after World War II with radical
ideas on antitrust law, and we continue to observe it with claims for
transparency.
As stated before, the ‘purity’ of professorship therefore implies the
introduction of other institutional warranties to safeguard the con-
tacts with practice. My own way was to stay in practice for some years
between the termination of studies and entering a full professorship.
It proved to be a good experience, but it has periodically to be brushed
up. Without looking at other options, I should eliminate at least one
source of misunderstanding: an important role in fi lling the gap lies
certainly with those part-time university teachers who not only provide
the students with a sense of the practical impact of legal regulations,
616 Miscella n eous

but also are active as legal writers making known successes and failures
of the law.
I think I have sufficiently distinguished my case from that of Eddy
Wymeersch. When an academic career as his, fully devoted to teaching
and research, is crowned by one of the highest practical functions which
his country has to offer, he has deserved it – among others by his aca-
demic merits.
 34

A short paean for Eddy: Clever, Wise, August,

Funny and European*
Ruben Lee

When archaeologists finally unearthed the foundation stone of the ruins

of the modernist building close to the Arc de Triomphe with the unknown
logo ‘ESEC’ on its fascia, they were surprised to discover underneath it
the following short text:
Efficiency with our Head, Protection with our Heart, Stability with our Soul.
We are One, We are Many.
We Change, We Remain the Same.
Efficiency with our Head, Protection with our Heart, Stability with our Soul.
No Process, No Substance.
No Justification, No Action.
Efficiency with our Head, Protection with our Heart, Stability with our Soul.
No Controls, No Freedoms.
No Consensus, No Decisions.
The Facts are the Facts.
The Vision is the Vision.
Know which Must Triumph.

If there is one thing that has been universally accepted about this intri-
guing and ancient text, it is that the language seeks to capture the essence
of what is now believed to have been a widely followed cult from the early
twenty-first century, promoting a range of private and public securities and
services at the heart of a series of cultural, social, economic and financial
exchanges.
There is little doubt that the repeated chorus of efficiency, protection,
and stability reflects the three inner goals the cult’s regulators or gods
were mandated to achieve. The first verse is also broadly viewed as rep-
resenting the essence of the contradictions at the heart of the movement:
the union requires sublimation of the individual state to the one, yet at

* With great thanks and apologies to Ursula and her Acacia Seeds.

617
618 Miscella n eous

the same time, the many must remain; to meet the future the union must
be in a continuous flux of change, yet at the same time it must remain
true to itself and never abandon its underlying philosophy.
It is over the interpretation of the subsequent verses, however, that a
passionate controversy has raged for many centuries. Two major oppos-
ing schools of thought have developed. There are the idealists, those
who believe that the unknown author of the ESEC manuscript depicted
the world as he viewed it should be. The text is viewed as a mantra that
should lead to utopian harmony, if only it were followed and repeated
often enough. Its meaning is clear: no substance is possible without due
process; no action can be taken without justification; no freedoms are
possible without appropriate controls; no decisions can be taken without
consensus.
The opposing school of analysis is composed of the realists, those who
maintain that the poet must have written the ode to depict the world as
it was, rather than as it should be. For them, rather than being a mantra
to follow, the text is the author’s description of the harsh and forbidding
environment as then existed. The meaning of the language is also clear,
and, in this instance, relentlessly nihilist: there is no worthwhile proc-
ess; there is no substance; there is no justification; there is no action;
there are no controls; there are no freedoms of movement; there is no
consensus; there are no decisions that cannot be challenged.
The final verse provides no respite to this battle of wills. For the ideal-
ists, everything is true to itself and consistent. So, the facts are accepted
as facts, the vision is accepted as a vision, and there is no need to deter-
mine which will triumph. The vision can only triumph if it responds
appropriately to the facts. For the realists, in contrast, the facts and the
vision are a world apart. While they know that the facts should be deter-
minative in deciding what is to be done, they also know it is the vision
that will always triumph in the end, irrespective of the facts.
Will it ever be possible to reconcile these two opposing views? The
strength with which they are held, and the certainty of each school that
only their explanation is correct, is without question. If only we could
travel to this fascinating and distant period, and ask the mysterious
author where the truth lay and how to resolve the perpetual enigma.
 I N DE X

Accounting law structure regime (the Netherlands),

enforcement, 232 , 237, 240 326
standard setting, 235, 238 supervisory board, 138
Accounting standards (IFRS), 271 two-tier structure, 269
Agency confl ict, 167, 168 Bond, 309
Alternative dispute resolution trading, 478
securities litigation, 567 Bond market
Anti-director index, 331 market transparency, 488
Asset-backed securities (ABS), 570, transparency, 456
574 Branch
Audit committee, 140, 231, 272 CESR protocol, 469
Audit Regulatory Committee, 252 supervision (MiFID), 459
Auditing standards, 231 Branching
Audit Directive, 251, 252 costs, 93
Audit Regulatory Committee, 252 Business judgment rule, 414
Audit report standard, 255 Business organisation, 304
Clarity project, 248, 259 legal persons, 304
EU competence to regulate, 251 Business organization
genesis, 245 anatomy of the corporation, 168
harmonization, 250, 256, 261 historical overview, 27
Auditor legal person, 169, 179
audit certificate, 232 legal persons, 30
support to supervisory board, 266 Rheinland model, 29
Auditor liability, 260, 262 theory of the firm, 166, 171
Aufsichtsrat, 138, 141, 178 workers’ involvement, 177, 180
Autorité des Marchés Financiers
(AMF), 223 Cadbury Report, 153
injunctive power, 228 Capital
mediation, 228, 229 capital maintenance, 278, 279
fi nancial assistance, 293
Best execution, 454, 470, 478, 491 initial capitalisation, 283
bond trading, 493 reduction, 296
Board of directors share repurchase, 299
remuneration, 268 Capital requirements, 532
Board structure, 135, 151, 265, 308, Central Securities Depository (CSD),
329 514, 517
committees, 140 Centre of main interests, 128

619
620 Index

Class action, 200, 226 decision-making process, 465

collective action, 213 fi nancial information standards,
conduct test, 204 234
contingent fee, 202 fi nancial market monitoring, 457
effects standard, 204 guidance, 455
enforceability, 209 Himalaya report, 461
EU countries, 200, 213 issuer disclosure, 452
European Union, 218 Lamfalussy process, 449, 454
settlement, 202 , 206 network of supervisors, 453
US juridiction, 204 Peer Review Panel, 458
Clearing and settlement policy advice, 456, 462
Central Securities Depository Q & A documents, 456
(CSD), 503 quasi-enforcement, 458
CESR , 454, 465 Review Panel, 474
Code of conduct, 462 supervisory convergence, 451, 458,
Delivery versus Payment (DVP), 460, 475
504 Commodities Future Trading
EU legislation, 499 Commission (CFTC), 524
EU power to regulate, 510 Company Law Review (UK), 278,
Giovannini report, 499 287, 289, 290, 294, 296, 299
securities settlement system, 514 Company mobility, 51, 93, 94, 124
Collateralized Debt Obligations incorporation agent, 97
(CDOs), 574 Comptroller of the Currency (OCC),
Collective action, 213, 225 524
Combined Code (London Stock Concentration rule, 481
Exchange), 153 Confl ict of interest, 317, 333, 340,
Commercial law, 607 494
academia, 611 shareholder representation, 193
bridging theory and practice, 610, Consumer association, 181
614 Convertible bonds, 310
role of practitioners, 609 Corporate control, 374
theory, 612 Corporate governance code, 47, 135,
Committee of European Securities 165, 266, 329
Regulators (CESR) comply or explain, 49, 266, 267
accountability, 464, 466, 474 enforcement, 335
bond market transparency, 488 Corporate performance, 173, 328,
branch supervision protocol, 469 330
CESR-FIN, 459 Corporate reorganisation, 305
CESR-Pol, 459 Credit rating agency (CRA), 570
CESR-Tech, 460 Creditor protection, 180, 318
Charter reform, 472 company law, 311
consultation procedure, 462 , 471
consumer interests, 462 Delivery versus payment (DVP), 515
cooperation with SEC , 463 Derivative action, 226
co-ordination of enforcement , Director
459 criminal liability, 274
corporate governance reform, 457 independent director, 142
 Index 621

liability, 264, 272 , 273, 313, 317 reorganizations, 40

remuneration (disclosure), 134, requirements, 26, 34
136 statute, 26, 33
European Securities Committee
East Indian Company, 28 (ESC), 449
Enforcement European Securities Markets Expert
risk-based regulation, 429 Group, 461
Enterprise Chamber (the European System of Central Banks
Netherlands), 337, 363 (ESCB), 506
EU company law, 278 Eurosystem, 505, 506
Action Plan, 9
European Model Company Act, 9 Federal Accounting Standards Board
freedom of establishment, 8 (FASB), 237
harmonization, 6, 8, 10, 30, 43, Federal Deposit Insurance
132 , 145 Corporation (FDIC), 524
legal foundation, 149 Federal Reserve Board, 524
listed companies, 48 Financial market
Model Business Corporation Act competition, 491
(MBCA), 12 , 149 order-driven market, 478
protectionist policies, 62 OTC market, 478
SLIM Group, 280, 292 , 295 quote-driven market, 478
Winter group, 9, 280, 292 Financial reporting
European Central Bank, 509 CESR Guidance, 454
European Company (SE), 7, 12 , 47, ex post review, 232
127, 153, 178, 302 pre-clearance, 233, 234
European Financial Markets Lawyers review panels, 232 , 240, 241
Group (EFMLG), 501 Financial Services Action Plan, 49,
European Model Company Act 449
(EMCA), 5 Financial Services Authority (FSA)
co-determination, 15 injunctive power, 440
draft ing commission, 16 Financial supervision, 533
functions, 11 accountability of supervisors, 401,
goals, 9 535
scope, 14 consolidation, 525, 530
working plan, 16 enforcement, 429
European Private Company (EPC), 8 European Union, 528, 536
capital and shares, 35 Financial Services Authority
characteristics, 34 (FSA), 428
Commission consultation market abuse, 433
document, 24 regulation by objective, 527
contribution, 36 regulatory capture, 536
corporate reorganization, 40 regulatory competition, 535
dissocation and expulsion of role of central banks, 528
members, 39 supervisory convergence, 451
history, 22 takeovers, 401
internal organization, 36 US structure, 524
limited liability, 38 Fin-Net, 230
622 Index

Fiscal Compliance Experts’ Group, Institutional investors

500 securities litigation, 565
Foreign investment, 388 International accounting standards,
disclosure rules, 384 542
public security, 389 International Accounting Standards
Free movement of capital Board (IASB), 232 , 245, 542
beneficiaries and territorial scope, International Accounting Standards
65 Committee (IASC), 245
comparison with other freedoms, 64 International Auditing Guidelines
control transaction in company, 66 (IAG), 245
cross-border voting, 58 International Federation of
defi nition, 66 Accountants (IFAC), 245
establishment, 67 International Financial Reporting
general interest test, 70 Interpretation Committee
golden shares, 51, 68 (IFRIC), 232
horizontal effect, 53, 55, 83 International Financial Reporting
horizontal effects, 85 standards (IFRS), 232 , 236, 238,
private law restriction, 71 452 , 540, 542
Freedom of establishment, 12 , 43, 50, CESR-Fin, 459
91, 125 US GAAP reconciliation, 463, 548
cost of incorporation, 24 International Organization of
fraud / abuse, 126 Securities Commissions
horizontal effect, 85 (IOSCO), 542
International Standards on
Gatekeeper, 335 Assurance Engagements
Golden share, 51, 68, 382 , 421 (ISAE), 246
Volkswagen Act, 52 , 76 International Standards on Auditing
Group of companies, 172 (ISA), 244
group law, 15, 607 EU adoption, 251
history, 245
Harmonization Investigation procedure, 363
auditing standards, 256, 261 Investor associations, 225
corporate governance, 49 Investor protection, 265
EU company law, 43, 48 benchmarking, 330
EU decision making process, 45 class actions, 226
Takeover directive, 354 collective actions, 225, 226
Hedge fund, 383, 389 shareholders rights, 224
Himalaya Report, 453, 461, 464 Issuer disclosure
CESR Guidance, 452 , 456
Incorporation market, 92 foreign companies, 542
Independent directors, 158 multi-jurisdictional disclosure
Initial public offering (IPO) (MJDS), 543
non-US companies, 547 Officially Appointed Mechanism,
Insider dealing, 159, 230, 433 452 , 460
criminal prosecution, 436
Insolvency Regulation, 128 Lamfalussy process, 449, 450, 453, 464
centre of main interests, 128 review, 472
groups of companies, 129 Legal Certainty Group, 500
 Index 623

Limited Liability Corporation (LLC), Multilateral Trading Facility (MTF),

20 482
background, 19 Mutual recognition
history, 18 dispute regulatory authority, 560
rationale, 21 equivalence of regulation, 551
fi nancial intermediaries, 552
Management board, 269 fi nancial supervision, 463
appointment of members, 273 governance rules, 555
duties, 269 IFRS/US GAAP reconciliation, 548
Management report, 271 investor protection, 553
Market abuse issuer disclosure, 543, 544, 555
accepted market practices, 456 issuer fraud, 563
administrative enforcement, 440 jurisdiction of US securities law, 558
CESR Guidance, 454 MiFID passport, 454
CESR-Pol, 459 national treatment, 541
criminal prosecution, 435, 436 regulatory arbitrage, 561
enforcement, 433 securities market, 546, 547
misleading statements, 437 securities regulation, 540
Market transparency takeovers, 544
impact on best execution, 479
impact on liquidity, 479 Nomination committee, 141
Investment Services Directive, 481 Northern Rock, 430
limit order display rule, 485
MiFID, 482 Office of Th rift Supervision (OTS),
pre-trade transparency, 484 524
quote rule, 484 One share one vote, 156, 177, 306,
Memorandum of understanding , 375, 392
552 non-equity shares, 307
Mergers
cross-border mergers, 374 Payment systems, 516
MiFID Principles-based regulation
best execution, 454, 470, 478, 491 auditing standards, 258
bond markets, 487 rule of law, 444
CESR guidance, 455, 468 sanctions, 443
inducements, 454 securities regulation, 427
passport, 454 theory of responsive regulation, 431
post-trade transparency, 460 Private equity, 384
supervision of branches, 469 Proxy voting, 187
systematic internalizer, 486 banks, 197
transaction reporting, 454 confl ict of interests, 193
transparency, 456, 467, 486 EU law, 188
Minority shareholder protection, 312 EU Shareholder Voting Directive,
derivative action, 313 187
expertise de gestion, 314 management, 195
Misappropriation of assets, 274 mandatory vote, 198
Model Business Corporation Act market for proxies, 197
(MBCA), 149 overview in EU countries, 190
Mortgage-backed securities, 571 shareholder associations, 196
624 Index

Public Company Accounting Share repurchase, 319

Oversight Board, 233 Share transfer
restrictions, 320
Rating agencies, 463, 577, 578 Shareholder meeting
Code of conduct, 458 approval of remuneration report,
IOSCO Code of conduct, 580 134
Real seat theory, 51, 125, 127 cross-border voting, 56
Regulatory competition, 10 proxy voting, 187, 188, 190, 194
fi nancial supervision, 535 remote participation, 309
Remuneration report, 134 remote voting, 185
Rickford Group (UK), 282 , 287, 290 Shareholder rights, 173, 181, 274, 307,
Risk-based regulation 309, 320, 393
EU perspective, 446 disclosure, 394
securities regulation, 427 EU Shareholder Voting Directive,
theory of responsive regulation, 185
431 shareholder representation, 187,
Rules-based regulation 195
auditing standards, 258 voting rights, 184
Shareholder structure, 154
Sarbanes-Oxley Act, 544 insider dealing, 159
Securities and Exchange Shareholder value, 268
Commission (SEC), 524 Shares
cooperation with CESR , 463 no discount rule, 288
enforcement of accounting law, non-cash consideration, 291
237 par value shares, 288
IFRS, 549 redemption, 299
Securities litigation, 565, 566 share premium, 288, 290
Fin-Net, 230 Société par action simplifiée
initial public offering, 567 (Luxembourg), 304
institutional investor, 565, 566 South Sea Bubble, 28
Securities market Sovereign wealth fund, 383, 384, 388
Alternative Trading System (ATS), IMF Code of conduct, 390
546 Stakeholder
electronic communications bargaining power, 177
networks (ECN), 546 notion, 165
foreign exchanges (access to US), Subprime crisis, 571, 581
546 Subsidiarity principle, 9, 46, 519
national market system (NMS), 546 Supervisory board, 265, 269
Securities regulation, 555 composition, 138
cross-border activity, 558 independence, 141
enforcement, 224, 228, 428 members, 270
mutual recognition, 540
supervision, 223 Tabaksblat Code, 329
US and EU, 557 Takeover Directive, 375, 397
Securities settlement systems, 514 anti-frustration rule, 376, 378
Securitization, 572 , 573 breakthrough rule, 377, 378
procedure, 570 genesis, 345
Self-dealing, 333 implementation, 361, 378
 Index 625

neutrality principle, 377 minority shareholder protection,

reciprocity principle, 356, 378, 380 360
scope of harmonization, 355 mutual recognition, 544
Takeovers obstacles, 375
acting in concert, 385 poison pills, 350, 413
agency confl icts, 376 Securities and Takeover Act
applicable law, 359 (Germany), 399
civil law remedies, 407 shareholders rights, 338
controlling shareholders, 410 squeeze-out and sell-out, 315, 350,
cross-border offerings, 544 377
defense measures, 351, 356, 370, supervision, 401
416, 417 third party rights, 404
disclosure, 361 white knight, 367
fair price, 349, 360, 410 Trade Reporting and Compliance
foreign investment, 375, 381 Engine (TRACE), 480, 490
Japan versus United States, 413
litigation, 367, 369 UCITS
mandatory bid, 349, 377, 379, 383, CESR Guidance, 454
398, 400, 407, 422 UNIDROIT
market for corporate control, 374, intermediated securities, 501
376 US GAAP, 237, 452 , 540