On 3 May 2010, the German Federal Ministry of Finance introduced a draft “Act for Strengthening Investor Protection and Improving the Efficiency of Capital Markets”, which includes an amendment to the German Securities Trading Act to tighten current provisions on market transparency.
The Bill is due to be introduced to the Federal Cabinet shortly and is expected to become effective later this year without any major changes.
Market Transparency Pursuant to Current German Securities Trading Act
Existing Disclosure Rules
The Securities Trading Act requires any person who acquires 3 per cent or more of the voting rights of a German issuer of securities to notify the issuing company and the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) within four trading days (Section 21, Securities Trading Act). Notification must also be made when a person holds other financial instruments that give it the right to acquire at least 5 per cent of the voting rights (Section 25, Securities Trading Act). The term “financial instrument” includes physically-settled equity derivatives. If a party holds a stake in a German issuer consisting of both shares and financial instruments, all voting rights arising out of both positions are to be aggregated for the purpose of the notification duty under Section 25, Securities Trading Act. This new aggregation rule was implemented under the Risk Limitation Act (Risikobegrenzungsgesetz), which came into force on 19 August 2008 and made it more difficult to acquire a significant stake in a company without triggering the notification requirements.
Cash-Settled Equity Swaps and Similar Instruments
Even under the revised Securities Trading Act, certain loopholes remained with regard to market transparency, which became apparent in the Porsche/VW and Schaeffler/Continental deals. When Schaeffler’s bid for Continental was announced, Schaeffler had already entered into cash-settled equity swaps with an investment bank backed by other investment banks for approximately 28 per cent of Continental's shares. These cash-settled equity swaps could be terminated by Schaeffler at any time, in particular during the acceptance period of the tender offer, which obliged the investment bank to dissolve the position in Continental shares in a commercially reasonable manner (including the acceptance of the tender offer by Schaeffler).
Under the current Securities Trading Act the conclusion and/or dissolution of cash-settled equity swaps does not trigger disclosure obligations. Financial instruments only result in a disclosure obligation if they “entitle the bearer to acquire, on one's own initiative alone and under a legally binding agreement, shares in an issuer”. Thus, Schaeffler did not have to disclose its cash-settled equity swaps.
This takeover sparked intense public debate in Germany regarding the use of cash-settled equity derivatives and similar financial instruments to build up stakes prior to a takeover bid without notifying BaFin or the issuer, i.e., through a creeping takeover. Similar takeover approaches are being discussed and evaluated in other European countries (see the Committee of European Securities Regulators’ consultation paper of January 2010, which proposes to extend major shareholding notifications to instruments of similar economic effect, to the holding of shares and entitlements to acquire shares).
Federal Ministry of Finance Proposal: Further Disclosure Requirements
Notification Duty for "Other Instruments"
In order to close the loopholes in market transparency, the Federal Ministry of Finance has proposed to supplement the current Securities Trading Act with an additional notification duty for “other instruments” that entitle the bearer actually or economically to acquire shares and that are not already covered by the definition of financial instruments. This includes re-transfer claims under a loan on securities or re-purchase agreements.
General (Catchall) Notification Duty
In addition, the Federal Ministry of Finance has proposed to add a further provision (Section 25a) to the current Securities Trading Act that deals with financial and other instruments not yet covered by the Securities Trading Act. Under the future Section 25a, Securities Trading Act any instrument that enables the investor “factually or economically” to acquire shares with voting rights in a German issuer will in future trigger notification duties. This will apply in particular if the contractual partner of the potential acquirer could hedge its risk resulting from these instruments by holding relevant shares. According to the explanatory memorandum to the Bill it is irrelevant whether the respective arrangement provides for a physical or a cash settlement. Cash-settled equity swaps, contracts for difference, call options with cash settlement and put options are named explicitly as transactions facilitating an acquisition of voting rights and are therefore subject to the notification duty under the proposed Section 25a, Securities Trading Act. A specific arrangement including a right to acquire shares physically is not required. According to the legislator it will be sufficient that the acquisition of shares with voting rights results from the “economic logic” of the transaction.
Similar to Section 25, Securities Trading Act, the notification threshold under the proposed Section 25a will start at 5 per cent of the voting rights. The voting rights that are subject to the proposed Section 25a, Securities Trading Act will not, however, be aggregated with financial or similar instruments to be notified under Section 25, Securities Trading Act.
Legal Consequences of Default
A breach of the notification requirements according to the Securities Trading Act currently constitutes a misdemeanour which can be fined with a civil penalty of up to EUR 200,000 per occurrence. More importantly, intentional or grossly negligent non-compliance with the notification duties may lead to the loss of voting and other rights resulting from the shares for a period of six months after the date on which the relevant notification duties are fulfilled.
If the new Bill comes into force, the maximum amount of the fine will be increased to EUR 500,000. Any breach of the notification duty under Section 25a, Securities Trading Act will not result in a loss of voting and/or other rights resulting from the shares, even if the investor finally acquires the shares underlying to the financial instruments. Given the high transaction values connected with public takeovers (several billion euro in the case of Schaeffler/Continental and Porsche/VW) even the increased penalty seems neglectable from an economic standpoint. Therefore, it is doubtful whether the proposed notification requirement will have the envisaged effect and prevent creeping takeovers.
Through these amendments to the Securities Trading Act the German legislator’s intention is to close the loopholes in market transparency that became apparent in recent takeovers. As a result, notification duties under the Securities Trading Act will become more complex and will also include instruments that are not physically settled, i.e., do not necessarily convey a right to acquire shares but have a similar economic effect, such as cash-settled equity swaps and call options. In future, any investor making use of these instruments should examine even more thoroughly whether the envisaged transaction will lead to a notification duty under the Securities Trading Act