The dangers of estate planning

  • Author : Christopher Groves
  • Author : Colin Smith
  • Date : February 2012
ABOUT THE AUTHORS: Christopher Groves is a Partner and Colin Smith is a Solicitor at Withers LLP in London

On 16 August 2011, the Financial Services Authority (FSA) imposed the first penalty on a shareholder for failing to disclose a change in his shareholding in a UK listed company. Sir Ken Morrison, son of the founder of supermarket chain Morrisons, was fined GBP210,000 for failing to disclose that over the course of 2009/2010 his notifiable shareholding in Wm Morrison Supermarkets plc (Morrisons) reduced from 6.38 per cent to 0.9 per cent.

Sir Ken should have notified the issuer and the FSA within two trading days on each occasion his shareholding passed below the 6 per cent, 5 per cent, 4 per cent and 3 per cent thresholds. However, the FSA and Morrisons were only notified of the changes on 1 March 2011. What triggered the threshold being crossed and the notification being submitted was Sir Ken resigning as trustee of a number of family trusts that he had set up, even though the shares themselves were not transferred.

According to the regulatory submissions, which have been published, in March 2008 (following his retirement as Chairman of Morrisons), Sir Ken transferred shares to various family trusts and resigned as trustee of an existing trust. These steps were presumably taken at this point to crystallise the tax charge at 10 per cent under business asset taper relief rules before the end of the 2007/2008 tax year. This was all properly notified to the market at the time.

However, over the following years, Sir Ken undertook a number of other disposals that were not duly notified. These occurred on 16 September 2009, 16 November 2009, 13 April 2010 (following the increase in entrepreneurs’ relief from GBP1 million to GBP2 million), and 21 June 2010 (immediately prior to the UK’s emergency budget of 22 June 2010).

It is understandable that while substantial shareholders often understand the need to report when engaged in business decisions, estate planning is regularly viewed as a private matter and some may resent or simply not think about having to make disclosure. However, as Sir Ken’s example shows, failure to make full and timely disclosure is perilous.

The penalty

Sir Ken submitted he was not aware that he had an obligation to notify the FSA and issuer when he reduced his shareholding and the FSA accepted that Sir Ken had not made any profit or avoided any loss as a result of the non-disclosure.

‘Sir Ken Morrison shows that failure to make full and timely disclosure is perilous’

However, the FSA noted ‘Sir Ken is an extremely wealthy individual who held a prominent position within his industry’ and that ‘there is a clear need to impose a meaningful penalty to achieve deterrence’1. Sir Ken also cooperated with the FSA at an early stage and agreed a settlement with the regulator, with the effect that the penalty he was made to pay was reduced at step five of the calculation from GBP300,000 to GBP210,000.

The precedent

This is the first time the FSA has imposed a fine on a shareholder for a failure to comply with the Disclosure and Transparency Rules (DTR). But the FSA’s press release suggests this is an area of compliance it will be looking at more closely. The high level of the fine, which was imposed despite Sir Ken’s early cooperation and even though the FSA accepted he had nothing to gain by failing to disclose his reduction in shareholding, was intended to send a message to the market. Subsequent offenders should expect to be treated more harshly.

Tracey McDermott, Acting Director of Enforcement and Financial Crime at the FSA, said: ‘It is important that significant shareholders recognise that timely and accurate disclosure of their shareholdings and voting rights is a fundamental component of a properly informed securities market. Investors are entitled to know when major and influential shareholders significantly reduce their interest in a listed company.’

Estate planners must be particularly alive to the danger of triggering a notification requirement under the DTR when there is a change of trustees, or when shares are resettled, transferred or assigned between trusts, companies or limited partnerships. Actions that may be considered routine in the context of such planning and which the planners have every reason to keep confidential may lead to these obligations.

Notification obligations

The DTR apply not only to registered shareholders (such as a trustee who is recorded as the legal holder of the shares) but also to anyone who holds an interest directly or indirectly (through nominees, corporate entities, partnerships or trusts) in the voting rights of an issuer. The key question is whether a person (regardless of whether they hold their interest directly or indirectly) is able to exercise any control over the voting rights or is able, through a qualifying financial instrument (e.g. options, futures or swaps), to acquire shares with voting rights attached.

Also, since June 2009, the DTR apply to anyone who holds a financial instrument that has a ‘similar economic effect’ to a qualifying financial instrument. The FSA has said that, in its view, a financial instrument has a similar economic effect to a qualifying financial instrument if its terms are referenced in whole or in part to an issuer’s shares and generally the holder has, in effect, a long position on the economic performance of the shares, whether the instrument is settled physically in shares or in cash. This is because such an instrument may give the holder the potential to gain an economic advantage in acquiring, or gaining access to, the underlying shares.

In addition, any person discharging managerial responsibility over an issuer, such as a director or a senior executive who has the power to make managerial decisions affecting the development and business of the issuer, must notify the issuer of all transactions (no matter how small) carried out by them or by connected persons (such as their family members) in shares or financial instruments relating to shares in the issuer.

The thresholds for disclosure for all other shareholders are low (starting at just 3 per cent for UK issuers and 5 per cent for non-UK issuers) and the notification obligation is triggered once the percentage of voting rights in which the person is interested reaches, exceeds or falls below each threshold. Care is especially needed if a shareholder is close to a particular threshold. If, for example, the issuer was to buy back and consolidate some of its issued shares, this would change the percentage of voting rights the person holds and could lead to inadvertently crossing a notification threshold and being in breach of the rules.

Because the rules cover not just shareholdings but also financial instruments (for example, a contract that gives a particular person a right to acquire shares or direct how they are voted), care needs to be taken when drafting any agreements that relate to shares in listed companies. The agreement should not inadvertently create a notifiable interest, or, if this is unavoidable, disclosure must be made in a timely manner.

When, in aggregate, the number of shares and qualifying financial instruments, or instruments with similar economic effect, reaches, exceeds or falls below a relevant threshold (for example, increases from 2.9 per cent to 3 per cent or falls from 5 per cent to 4.9 per cent) a notification must be made to the issuer and the FSA within two trading days of the change taking place. Therefore, it is vital to involve financial services specialists when the wealth planning takes place. If the question of disclosure is only raised after the event, it may be too late. The client could face a large fine from the FSA, and their advisors may well see a claim in negligence.

FSA final notice, para 30(b):


Article Search

Browse jurisdictions by clicking on the map regions below

© 2012 Society of Trust & Estate Practitioners