A FRAMEWORK FOR DISCLOSURE AND REGULATION OF RELATED PARTY TRANSACTIONS Robert D. Strahota, Assistant Director * US SEC Office of International Affairs Prepared for 5 th Meeting of the South East Europe Corporate Governance Roundtable Ohrid, Macedonia June 10-11, 2004 * The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This presentation expresses the author's views and does not necessarily reflect those of the Commission, individual Commissioners, or other members of the staff.

FINANCIAL VS. NON-FINANCIAL DISCLOSURE F Both are necessary F Adopt IAS No. 24 re Related Party Transactions –But recognize its limitations –Related party disclosure in financial statements is generally limited to disclosure that is material to the financial statement presentation as a whole F Non-financial disclosure requirements should be based upon a lower materiality threshold so that all transactions that are material to an assessment of the integrity of management are required to be disclosed

WHO SHOULD BE COVERED? F U.S. Approach –CEO and next four highest paid officers –All directors –All officers and directors as a group –More than 5% beneficial owners of equity [voting] securities –Immediate relatives and family members of the above –Entities in which these persons are officers, directors or owners of more than a specified percentage of the equity

WHAT SHOULD BE COVERED? F All items of remuneration –From the issuer, subsidiaries and affiliates –Other persons? F All financial interests and transactions involving the specified persons and the issuer, subsidiaries or affiliates. For example: –Loans (to and from) –Sales of products and services (to and from) –Leases (to and from) F Both direct and indirect interests and transactions

WHAT SHOULD BE DISCLOSED AND WHERE? F Material terms of each transaction, including the person’s interest F A representation as to the fairness of the transaction compared to an arm’s length transaction (between unrelated parties under no compulsion to deal with each other) F Transactions since at least the beginning of the issuer’s last fiscal year (even if the transaction has been discontinued or the potential conflict no longer exists; e.g. a loan has been repaid) F Disclosure should be made in offering and listing particulars documents (perhaps for three years instead of one year), in annual reports, in informational materials relating to the election of directors, and in information relating to transactions requiring a shareholder vote where an interest or conflict exists with respect to the matter being voted upon

DISCLOSURE VS. PROHIBITED TRANSACTIONS F Some transactions may pose such direct conflicts or instances of self-dealing that they should be prohibited. For example: –Personal loans to executive officers and directors –Insider trading –Short-term trading and short sales regardless of whether inside information is used –Affiliated party transactions in investment funds and pension plans –Conflicts that render an auditor not independent

MECHANISMS FOR MONITORING, DETECTION AND APPROVAL OF RELATED PARTY AND CONFLICT OF INTEREST TRANSACTIONS F Monitoring –Internal accounting control requirements –Codes of ethics or corporate conduct –Audit and compensation committees comprised of independent directors F Approval – Delaware corporate law approach –Related party transactions excluded from the business judgment rule –Approval by a disinterested majority of directors –Approval by shareholders. Query, should an interested shareholder be entitled to vote? –If approvals not obtained the interested party bears the burden of proving the fairness of the transaction, if it is challenged

REMEDIES F Derivative lawsuits F Shareholder lawsuits; difficult unless class action permitted F Government lawsuits to recover on behalf of shareholders F Governmental pre-approval or injunctive remedies F Importance of equitable remedies –Disgorgement –Accounting –Appointment of receivers –Bar voting of unreported significant shareholdings –Officer and director bars –Freeze assets F More than actual damages for certain violations; e.g. insider trading F Criminal sanctions – burden of proof and prosecution problems F Problems with incompetent or corrupt judicial authorities