When Directors Should Talk to Investors

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Company boards have long spoken to investors in indirect ways, through their votes and organizational performance. But as powers shift to large investors and governance norms have changed, investor groups have demanded more one-on-one conversations with bank directors.

Allowing directors to speak to investors comes with risk, and not just due to the potential for legal missteps. The director becomes a public representative of the bank and anything he or she says will be scrutinized, resulting in possible backfire.

“You can’t really say you’re not speaking for the company,” says Peter Weinstock, a partner at the global law firm Hunton Andrews Kurth. “You’re speaking for the company.”

But in an age where activist shareholders have an increased presence and institutional investors such as Blackrock and State Street Corp. have greater power, organizations find that some investors expect this one-to-one interface with directors. When done right, it can ease tension among the investor base, allowing management to maneuver more freely. When done wrong, however, it can result in proxy fights and changes to the board and management.

The topics that investors care about impact the moves that directors and boards make. Board discussions on compensation, for example, are becoming more important. Last year saw the lowest level of shareholder support for executive pay — only 87.4% of S&P 500 companies received shareholder approval in advisory voting during proxy season, according to PwC. That indicates a higher bar for boards to get shareholder buy-in for executive compensation.

Companies also must deal with an increasing amount of activist shareholder proposals. PwC reports there was a 17% increase in shareholder proposals last year. Out of 288 proposals related to environmental, social and governance (ESG) matters, a popular topic last year, 41 proposals passed.

One way to provide context for the company’s efforts on those matters: director conversations.
Institutional investors and shareholder analysis groups have turned their focus to three big concerns – audit, governance and compensation – all of which reside at the board level. With questions surrounding those specific concerns coming from many different groups, banks have turned to so-called “roadshows.” In those organized conversations, directors speak to shareholders or investor services groups about specific governance or audit topics. During those roadshows, board members stick to a prewritten script.

“The advent of the one-way listening session allayed director fear,” says Lex Suvanto, global CEO at the public relations firm Edelman Smithfield. “There isn’t much risk in what they shouldn’t say.”

Certain concerns may require more direct conversations with a specific investment group. When entering those conversations, it’s important to remember what information the shareholders want to glean. “Understand who you are speaking to and what they are all about,” says Tom Germinario, senior managing director at the financial communication firm D.F. King & Co. “Is it a governance department or a portfolio manager, because there’s a difference?”

Each investor will come to the conversation with different goals, investment criteria and questions they want addressed. It’s on the company to prepare the director for what types of questions each investor may need answered.

During those different calls, banks should ask to receive the questions ahead of time. Many investors will provide this, since they understand that the director cannot run afoul of fair disclosure rules, a set of parameters that prevent insider trading. But not all investors will provide those insights upfront.

To head off such concerns, the bank’s communications or investor relations team should run a rehearsal or prepare the director with possible questions, based on the reason for the meeting.

The investors will look for anything that might give them insight. Directors that veer off script could run afoul of what they can legally disclose. Plus, the tenor of the answers must match what the CEO has said publicly about the company. Without practice, the conversation can unwittingly turn awry.

“If a director is on the phone with an investor and something is asked that the company hasn’t disclosed, the director can table that part of the discussion,” says Weinstock. “The company can then make a Regulation Fair Disclosure filing before following up with the investor on a subsequent call. That’s an option if the company wants to release the information.”

It’s important to remember the practice will also protect you, since you will have a significant amount riding on the conversation as well. “Directors may reveal that they’re not in touch with important investor priorities,” says Suvanto. “Directors need to understand and be fully prepared to represent the values and behaviors [of the company].”

Suvanto adds that many directors would have been better not to speak at all than to go into a room with a large institutional investor, unprepared. In a public bank, such a misstep can lead to a proxy battle, which may result in the director (or many directors) being replaced by members the investors view as more favorable or knowledgeable.

The conversation also works differently, depending on the size of the bank and whether it’s a private or public institution. Institutional investors likely will focus on larger banks. Small banks may not account for an oversized spot in the institutional investor’s portfolios. Instead, for smaller companies, it’s often about getting the CEO and chief financial officer in front of investors to encourage investment. Often, this does not need a director’s voice.

For private banks, however, there are certain moments where directors may be asked to step in. If, say, an organization has questions about its auditing practices. Or what if a competitor bank has major governance violations? To address questions from investors concerning those issues, it may be advisable to have the committee head for the specific concern speak to investors about the bank’s practices.

But even a private bank cannot ignore concerns about releasing information that’s meant to stay within the board room. “It’s important to realize that information does not belong to a director,” says Weinstock. “It’s also important to realize that private companies could have insider trading violations.”

What else could go wrong? A director could overpromise when the company isn’t ready to address the issue. This can happen in the environmental, social and governance (ESG) space with regards to addressing social concerns, for example. If a director commits to social commitments that the company cannot yet adopt, it can pit the director against the board or management. Either the company will decide to adopt the promised measures, or the director will have misled the investor.

“A director should never get on the phone alone,” says Germinario. “You never want an investor to misconstrue a promise.”

Fed’s New Control Rule Brings Transparency, Consistency

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The Federal Reserve Board has announced its much-anticipated final rule that addresses the often-confusing question of when a company controls a bank and when a bank controls another company.

The rule revises existing regulations that address the concept of “controlling influence” for purposes of the Bank Holding Company Act or the Home Owner’s Loan Act. It goes into effect on April 1.

The control rule is important: any entity in control of, or controlled by, a bank is subject to the same regulatory supervision and limitations as the bank. These limitations have created hurdles for bank investments by private equity firms and other entities, and have made partnerships between banks and fintech firms difficult to negotiate and structure.

Under the current Bank Holding Company Act, an investor is deemed to control another company if (1) the investor directly or indirectly owns, controls, or has power to vote 25% or more of any class of a target’s voting securities, (2) the investor controls in any manner the election of a majority of a target’s directors or trustees, or (3) the Federal Reserve determines, after notice and opportunity for a hearing, that the investor directly or indirectly exercises a “controlling influence” over the management or policies of the target.

Under the Bank Holding Company Act, there is a presumption that directly or indirectly owning, controlling, or having the power to vote less than 5% of any class of a target’s voting securities is not considered control. Where a transaction created ownership that exceeded the 5% threshold, it was necessary to address the question of whether there was a controlling influence. Since that term wasn’t defined, parties relied on the Fed’s interpretations in similar situations or sought informal guidance of Fed staff on a case-by-case basis, which led to uncertainty.

“Previously, control reviews have been situation-specific and often followed precedents that were not available to firms or to the public,” the Fed notes in its press release announcing the new rule.

This made business planning difficult, if not impossible. Seeking feedback in the proposal stage often resulted in excessive delays and left the parties with uncertainty as to acceptable structure and permissible relationships going forward.

The new rule seeks to provide more bright-line guidance with a tiered approach to determining  control based on the ownership of voting shares. The indicia of control used for ownership are similar to those applied by the Federal Reserve under the old rule when providing guidance on individual transactions, and vary based on the following levels:

  • less than 5%;
  • 5% to 9.99%;
  • 10% to 14.9%; and
  • 15% to 24.9%.

There are more relationship restrictions as the ownership percentage increases. Those restrictions relate to director representation; officer and employee overlaps; business relationships (including size and terms of relationships); and contractual powers or limitations on operation of the organization. The Federal Reserve outlined the interplay between percentage ownership and restrictions in a chart that was included in the press release. 

Equity investors will have more power to influence a bank’s business, which may spur the influx of capital from new sources. Banks, however, may encounter that influence and the increased rights of investors through proxy solicitations challenging the board. 

From the perspective of banks investing in other companies, the industry had hoped for more relief from the limitations on business and contractual relationships. Large banks have shown interest in investing in fintech startups and limiting their competitor’s ability to participate.

There are other areas the new rule does not address. It does not impact existing investments that have been approved because the parties have agreed with the Fed not to take certain actions (referred to as passivity commitments). The regulator stated it will no longer require or seek those commitments but will consider relieving firms from any existing commitments. 

The new rule also does not impact the concept of control for purposes of other regulations, including the Change in Bank Control Act, Regulation O and Regulation W. So a person or entity will still be required to obtain approval to acquire control of a bank or a bank holding company with the presumption that the acquisition of 10% or more of voting securities being considered a change in control.

There are other aspects of the rule that will need to be considered, including calculating equity ownership, accounting rules and the impact of convertible securities. While the new rule does not provide the level of relief that some in the industry had hoped for, it does provide much-needed guidance that will allow parties to create business relationships with more certainty and efficiency.