31 March 2016

The UK's (heavy-handed) approach to increased transparency

From the middle of next week, most UK businesses will be subject to a significant new compliance burden, with criminal penalties for directors of organisations which fail to comply: on 6 April, new rules requiring companies and LLPs to maintain a public register of those with "significant control" will become effective. The complex rules can be traced to the G8 summit at Loch Erne in 2013, when the British prime minister joined other leaders in calling for more transparency about the ownership of companies, with the laudable aim of cracking down on criminals who use the corporate form as a cloak to hide nefarious activities. Millions of law-abiding companies will now shoulder the burden of that commitment, and for some it will entail a relatively high compliance cost. 

The new public register must be kept by UK privately-held companies and LLPs, and will have to include details of any controllers, including both individuals with ultimate control (wherever in the world they are based, and through whatever structures they invest), and (broadly) UK companies and LLPs who would be required to appear on the register if they were individuals. The basic tests for "significant control" are holding or controlling more than 25% of a company's shares or voting rights, or having the power to appoint or remove a majority of the board. However, unsurprisingly given their aims, the rules for determining who has "control" are extremely complicated (as evidenced by the fact that the government has issued extensive guidance), and extend significantly beyond these basic tests – for example, they include indirect interests, and "control" or "influence" exercised otherwise than through a shareholding. 

Venture capital and private equity-backed companies will have particular compliance issues, arising from the varied and often complicated ownership structures which are prevalent (for entirely legitimate reasons) in the industry. Even though the BVCA has worked hard with the UK government to mitigate the burden, deciding which entities to put on the "PSC register" of each company in the chain (including UK subsidiaries of a holding company in which the fund has invested) will often be hard.  Many firms will pre-empt the inevitable questions from their portfolio companies by providing them with the information they need in order to compile the registers, but those firms – even with intimate knowledge of their own structures – may still need to work hard to interpret the rules (and, in some cases, will have to take external advice).

Failure to keep the register – or to take steps to find out who should be on it – is a criminal offence, not just for the company itself, but also for each of its officers "in default" (including the non-executives). It is a strict liability offence, so the state of mind of the person charged with the offence is not relevant, and the penalties could be severe, including up to two years imprisonment. There are similar consequences for those who do not comply with their obligations to disclose their interests – and the company can freeze shareholder rights to force compliance. No doubt due diligence processes will have to start to examine compliance, and private equity appointed directors should take careful note of this new duty. To many, the threat of criminal sanctions, even for behaviour that is unintentional and has no ill-effects, will seem disproportionate, but it is the approach that the government has opted for. It is to be hoped (and it is widely expected) that the approach to enforcement will be more sensible.

To be fair, although the UK is ahead of the game, many other countries are working on similar rules, following the G20's endorsement of High Level Principles on Beneficial Ownership Transparency in November 2014. In Europe, all EU member states will be required to put similar (although not identical) rules in place by June 2017 (and the UK will have to make some modifications to its own). Implementation of these requirements will need to be monitored very carefully by private equity firms investing in Europe and beyond, because their less than straightforward structures may well lead to further headaches for their portfolio companies. 

King & Wood Mallesons' note on the regime is available here.
BVCA members can access the BVCA's guide to the new rules here.

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