DEFINING, DISCLOSING AND DISCOURAGING RELATED PARTY

TRANSACTIONS (RPT)

Presented by John K M LimCouncil Member and Hon.

SecretarySingapore Institute of Directors

Based on a paper prepared byDr Mak Yuen Teen, Associate Professor

NUS Business School, National University of Singapore

The Fourth Asia Roundtable on Corporate GovernanceMumbai, India

11 – 13 November 2002

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AGENDA

• Definitions of Related Party Transactions (RPT)• Importance of managing RPT• Legal and regulatory framework• International Practices

- USA

- UK- Australia- Hong Kong- Singapore

• ConclusionSingapore Institute of Directors Excellence in Corporate Governance

Related Party Transactions (RPT)

• RPT – a transfer of resources or obligations between related parties• Related Parties (RP) – subjected to common control or common significant influence • May expose a reporting entity to risks or provide opportunities• Tendency not to be effected on same terms & conditions as between unrelated parties• May not be given accounting recognition• Have a material effect on the operating results & financial position of an enterprise

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Related Party Transactions (RPT)

• RP and RPT not always easily identifiable• Potential for distorted or misleading financial statements in the absence of adequate disclosure• Instances of fraudulent financial reporting and misappropriation of assets facilitated by RPT• Undisclosed RP a powerful tool in the hands of unscrupulous person• Identification, disclosure and approval form basis of regulatory framework

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• Various terminology and definitions are used to describe RPT & RP in different countries

• Common law jurisdictions framework :

1) Requires information to be filed with a central registry maintained by governmental authorities2) Required to maintain up-to-date registers3) Listed companies – required to disclose information of their top management team, substantial shareholders to the Exchange4) Required to disclose identity of RP in annual reports

Legal & Regulatory Framework

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• Disclosure of RPT is make up of 3 requirements :1) Under the common law :

- Primarily concern directors, no common law rule for other RP (ie.key managers, substantial shareholders)

- Director-related transactions require shareholder approval

2) Under corporate legislation- Usually more specific than (1) & carry criminal

or penal sanctions

- Requires companies to furnish shareholders with annual report & audited accounts

3) Quasi-legislative requirements- Eg : stock-exchange listing requirements

- Focus – relevant, accurate & timely disclosure of RPT

Legal & Regulatory Framework

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• Must include disclosures of material RPT• The disclosures must include :

- The nature of the relationships involved

- A description of the transactions- The dollar amounts of the transactions &

any changes

- Amounts due from or to RP & the terms of settlement

• Disclosure of RPT that are eliminated in the preparation of consolidation financial statements is not required

International Practices – USA“FASB Statement No. 57”

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• Should include a description of all elements of RPT necessary for an understanding of its business purpose:

- The identity of RP

- How the transaction price was determined- How any evaluation of fairness was made & whether there are any ongoing commitments

as a result of RPT

• The effect on the company’s financial statements and special risks or contingencies arising from RPT

International Practices – USA“SEC Release No. 34-45321”

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• Disclosure of RPT required in the company’s annual report, proxy statements & SEC fillings• RPT is to be reviewed & evaluated by the Audit Committee or another comparable body• Some RPT require shareholder approval

- NYSE Listing Company manual Section 312.00

“Shareholder Approval Policy” should be considered

- Exemptions: - Any public offering for cash; - Any bona fide private financing

International Practices – USA“NYSE Listed Company Manual Section

307.00”

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• Disclose the existence of RP & the nature and extent of any transactions with them

• Requires 2 parts of disclosure:1) Disclosure of control2) Disclosure of transactions

• Exemptions – Transactions with :- Group entities that are eliminated on consolidation- Providers of finance in the normal course of business- Utility companies, suppliers, customers (for huge volume of business)- Government bodies

International Practices – UKFRS 8 “Related Party Transactions”

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• When entering into a RPT, the company must : - Make an announcement stating all elements of the RPT - Furnish its shareholders with a circular - Obtain shareholders approval

• Exemptions include :

- Companies without listed securities

- Overseas companies with a secondary listing- Transactions in the normal course of business- Joint investment arrangement on normal

terms- Small transactions

International Practices – UKUK Listing Authority’s Listing Rules, Chapter

11

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• Section 208 states :- Shareholders’ approval is required except for

those exempted under Section 210-216- RPT must take place within 15 months after approval

• Exemptions under Section 210-216 include :

- Transactions in the normal course of business

- Renumeration & reimbursement for employee

- Indemnities, insurance premiums & legal costs

-Transactions of small amounts (less than $2,000)

- Benefit to or by closely-held subsidiaries

International Practices – Australia

“Corporations Law, Chapter 2E”

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• Prescribe disclosure of all RPT where control or significant influence exist• Disclosure requirements for transactions within the wholly owned group are less detailed than others• Required to disclose items eliminated on consolidation• Disclosure on an individual basis is required when the sum of the RPT is significant• Exemptions – transactions in the normal course of businessSingapore Institute of Directors Excellence in Corporate Governance

International Practices – Australia

AASB 1017 “Related Party Disclosure”

• Transactions covered by this chapter include :- Acquiring & disposing of substantial assets to RP

- Issue of securities to RP

• Shareholder approval must be obtained • A report from an independent expert is needed• The following transactions are exempted :

- Between the entity & a wholly owned subsidiary

- Between wholly owned subsidiaries of the entity- Issue of securities under an underwriting

agreement; under an employee incentive scheme; on the conversion of convertible securities

- Value of securities issued do not exceed $3,000

International Practices – Australia

AASB 1017 “Related Party Disclosure”

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• Should disclose the nature of all RPT including :

- Types & elements of RPT

- Volume of the transactions- Amounts of outstanding items- Pricing policy

• Transactions of a similar nature may be disclosed in aggregate• Exemptions include :

- Transactions eliminated on consolidation

International Practices – Hong Kong

“HKSA Statement 2.120”

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• Rules 14.23 – 14.32 require companies :- To disclose details of “Connected Transactions”

- To obtain shareholders approval for material transactions

• 3 categories of “Connected Transactions”1) Rule 14.24: Not subjected to disclosure & shareholders approval2) Rule 14.25: Subjected only to disclosure requirements3) Rule 14.26: Subjected to both disclosure & shareholders approval

• Active consultation with HKSE

International Practices – Hong Kong

“HKSE Listing Rules, Chapter 14”

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• All RP relationship involving control should be disclosed regardless of whether RPT occurs• Requires disclosure of :

- The nature, types & elements of RPT• Transactions with the following are exempted:

- Common directorships- Provider of finance; Trade union- Public utilities; government department &

agencies- A single customer, supplier (transacting

huge volume of business)

International Practices – Singapore“SAS 21”

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• RPT ≧ 3% of issuer’s latest audited NTA require immediate disclosure through announcement• RPT ≧ 5% of issuer’s NTA require shareholders’ approval

- Opinion of Independent Financial Adviser (IFA) required on whether RPT is:

(i) on normal commercial terms(ii) prejudicial to the interests of the issuer and

its minority shareholders- Opinion of Audit Committee required if different from

that of IFA• Announcement required for RPT local property irrespective of value

- Review by and approval of audit committee required- Shareholder approval required for RPT ≧ 5% of

issuers’ NTA

International Practices – Singapore

SGX Listing Manual, Chapter 9

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• Exceptions :- Transactions below $100,000- Dividends, bonus issue, approved options- Director’s fees, employee remuneration- Provision of goods, services on normal

commercial terms, normal course of business- Awards by public tender- not a substantial shareholder

International Practices – Singapore

SGX Listing Manual, Chapter 9

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• Take-over offers by RP• MBO• Safeguards

- Offeree required to obtain independent advice

- Equality of information

International Practices – Singapore

Take-over Code

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• Not all RPT are necessarily disadvantageous to issuer• Accounting standards tend to focus on identification and measurement of RPT not disclosure• Over reliance on management and principal owners to identify RP and RPT• Proactive role of Audit Committee, Board and major shareholder• Check and balance• Strong regulatory framework, active watchdogs and effective enforcement are key success factors• Rule based procedures no substitute for honesty and integrity

Concluding Remarks

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Thank you

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