The Financial Conduct Authority (FCA) has made good on its promise to protect smaller investors in investment companies from activists such as Saba Capital with proposals to strengthen rules on the independence of boards and the conflict of interest where a large shareholder is also a fund manager.

Launching a seven-week consultation nearly four months after it started a review of listing rules, the FCA said while it did not want to “impair activism and shareholders’ ability to challenge and hold boards to account”, it wanted to implement “targeted and proportionate amendments” to ensure investment company boards could act independently of any investment manager.

The regulator is inviting comments by 14 August on its proposals which, if implemented by the end of the year as planned, could stop Saba getting itself appointed as the fund manager of Edinburgh Worldwide (EWI) and Impax Environmental Markets (IEM) where it has used its stakes of around 30% to replace the boards against the previously expressed wishes of other shareholders.

The FCA’s proposals include:

• Preventing a director who is not independent of the proposed investment manager from voting on a board decision to appoint a proposed investment manager. A director would not be considered independent where they have been appointed following nomination by the proposed investment manager, regardless of whether that investment manager was a substantial shareholder.
   
• Recognising the ongoing association between a director and a substantial shareholder that proposed them for appointment.  This would mean that directors whose associate is a related party could not participate in the board’s consideration of any related party transaction.
   
• Expanding the definition of a related party and a relevant related party transaction to specifically include a proposed investment manager.  This would mean that the relevant related party rules would apply when a company enters into an agreement to appoint a new investment manager.
   
• Changing the process of shareholder votes to approve a change of investment policy. Options include excluding the votes of a substantial shareholder that is also the investment manager or capping their vote at 20% of the shares.

The Association of Investment Companies (AIC) thanked the FCA for listening to its concerns and proposing “meaningful reform”. Chief executive Richard Stone said: “These proposals would strengthen investor protection, particularly when a substantial shareholder like Saba Capital seeks to replace the board and become the manager. They address a gap in the rules where a shareholder who wants to manage the company can seize control of the board to promote its own interests at the expense of other shareholders.”

He added: “We will work with the FCA and industry to analyse the potential impact of these reforms and get them implemented as quickly as possible. In the meantime, we would expect market participants to respect the spirit of these proposals,” Stone said in a remark aimed at Saba and the new boards at EWI and IEM.

Our view

James Carthew, head of investment company research at QuotedData, said: “The FCA has launched a consultation on related party transactions between boards and managers that looks aimed squarely at Saba’s attempts to change boards to get itself appointed as the manager. The questions give a clue to the direction of travel – this looks likely to put an end to the ill treatment of minority shareholders. As this also coincides with the publication of guidance for platforms on ensuring that investors can vote, the combination of the two will go a long way to redressing the balance of power between activists and ordinary investors.”

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