IV. Investor Protection and Corporate Governance in Italy52
Core Questions, Issues, and Findings
- From an investor protection perspective, are there measures that the Italian authorities could take to strengthen corporate governance? Italy’s legal and regulatory system incorporates a significant number of investor protections. These include the concept of the Board of Statutory Auditors, which gives shareholders a formal, legally-required check on the activities of the Board of Directors; provisions for strict accounting and auditing oversight; and rigorous legal requirements for financial reporting and disclosure.
- In practice, however, the potential for investor protection that is built into the legal and regulatory framework is not fully realized. Due to heavily concentrated ownership, cross-shareholding and other factors, it may be difficult to ensure the proper monitoring of directors’ independence, particularly in the absence of a legal requirement for Board independence. Similarly, the effectiveness of the Board of Statutory Auditors in conducting its oversight role may be reduced because of requirements limiting the ability of members to act unilaterally. This difficulty is compounded by the Italian legal system, which creates disincentives for minority shareholders to enforce their legal rights.
- The effectiveness of legal requirements for financial reporting and disclosure in deterring wrongdoing and protecting investors has been limited. While Consob has strong investigative powers, it has had to call upon the Minister of Finance to impose pecuniary sanctions. Moreover, those sanctions may not themselves be sufficiently onerous so as to have a deterrent impact on the behavior of the corporate community.
- The draft Law on Market Abuse addresses these issues, as it gives Consob more resources, more staff, and the power to act independently of the Minister of Finance. It also substantially increases the maximum size of the pecuniary sanctions that can be imposed. If adopted, these provisions should enhance Consob’s ability to deter bad behavior and improve its ability to monitor and oversee the market.
- Other legal and regulatory reforms could strengthen the existing protections in practice. For example, legal requirements mandating a majority of independent directors may be warranted and, more generally, the provisions of the Preda Code could be incorporated into legal or regulatory requirements. Consideration could also be given to requiring that the Board of Directors include a representative of minority shareholders. In addition, it may be possible to strengthen existing auditor rotation requirements.
108. This paper reviews selected issues related to investor protection and corporate governance in Italy. It examines whether, from an investor protection perspective, there are vulnerabilities in the corporate governance framework in Italy and, if so, how to strengthen the system. The paper focuses on three areas: company structure and governance; accounting and auditing oversight; and the broader legislative and regulatory framework.53
109. On December 24, 2003, Parmalat Finanziaria SpA, the fourth largest food products group in Europe, shocked financial markets by filing for bankruptcy protection after announcing that a $4.8 billion account that it purportedly held at Bank of America did not in fact exist. The collapse of Parmalat54 followed the bankruptcy of another Italian food manufacturer, Cirio Finanziaria SpA. Together, the bankruptcy of the two companies reportedly wiped out € 3 billion in savings of Italian bond and shareholders.55
110. However surprising the failures of Cirio and Parmalat, they were not unprecedented. Indeed, as a result in part of other spectacular financial frauds outside of Italy, notably Enron and Worldcom in the United States, and Royal Ahold in the Netherlands,56 as well as of initiatives by the European Commission, the Italian authorities had taken steps in the years preceding the Parmalat failure to strengthen Italy’s corporate governance framework.. Many of these built on the 1998 Consolidated Law on Financial Markets,57 which itself was a major overhaul of the Italian financial system.
111. After providing some background on the Italian financial system (Section B), the plan of the paper is as follows:
- First, the paper looks at the internal controls in a company, examining some special aspects of company ownership in Italy, including the structure of the Board of Directors, the role of the Board of Statutory Auditors (Collegio Sindacale), responsibility at the corporate level for disclosure and financial reporting, and protections for shareholder rights (Section C). These issues are examined in light of the typical composition of Italian listed companies, which frequently have a single shareholder or a few shareholders with majority control.
- Second, the paper examines accounting and auditing oversight (Section D). In a number of respects Italy has for many years had a stricter level of oversight of the accounting and auditing profession than many other countries, including, for example, rules mandating auditor independence and rotation. This paper considers whether further strengthening is essential.
- Third, the paper examines the legal and regulatory framework in which the oversight of issuers takes place, focusing particularly on the roles and responsibilities of Consob, Banca d’Italia, and Borsa Italiana (Section E). The paper looks particularly at the enforcement of the existing investor protection and corporate governance framework.
- Fourth, the paper then considers draft legislation which the Italian Parliament is examining, for the purpose of addressing the shortcomings that the recent corporate failures revealed (Section F) 58.
- Fifth, the paper concludes with some observations about investor protection and corporate governance in Italy (Section G).
112. An analysis of investor protection and corporate governance in Italy must take into account the unique features of the financial system.59 Until the 1990s, the development of formal stock and bond markets was limited, families retained control of most private firms and the State owned a significant share of some large firms. Also, deposit-taking banks were precluded from acquiring significant shareholdings in non-financial companies. While the Bank of Italy possessed very broad supervisory powers, the powers of the securities regulator, Commissione Nazionale per le Societa e la Borsa (Consob) were quite weak.
113. Beginning in the 1990s, however, massive changes took place. In large part, these changes were ignited by the government’s enormous privatization program, which generated total gross proceeds of nearly 8 percent of GDP, between 1993 and 2001.
114. Privatization was accompanied by legal and regulatory changes to modernize the Italian market, including the adoption of a consolidated banking law in 1993, which abolished the previously-existing “specialization” of banks60 and enabled ordinary banks to invest in shares of non-financial companies within limits set by the authorities. The EC Investment Services Directive was transposed into Italian law in 1996, Borsa Italiana was privatized, and, most importantly, the government issued a legislative decree implementing the Consolidated Law on Financial Markets (the Consolidated Law) in 1998. The Consolidated Law dramatically enhanced protections for minority shareholders by, among other things, increasing the scope of reporting requirements and corporate disclosure, lowering the threshold for reporting equity holdings to Consob, and rationalizing the roles and responsibilities of the Board of Statutory Auditors and the external auditors for listed companies.
115. Despite these significant developments, most listed companies in Italy remain largely family-owned.61 They frequently are characterized as well by cross-shareholdings and pyramidal group structures through which the shareholder/manager exercises leveraged control.62 Parmalat, in fact, was an example of such a corporate structure, 51 percent family-owned and consisting of numerous companies, many of which were incorporated outside of Italy. As discussed below, a key question is whether existing shareholder protections are sufficient in light of the prevalence of this type of corporate structure.
C. Company Governance
116. Traditional Italian companies have a somewhat unusual corporate structure. They follow neither the Anglo-American model of a unitary board elected by the shareholders, nor the German model of a shareholder-elected supervisory board, which itself appoints a management board. Rather, the shareholders of traditional Italian companies elect two boards: a Board of Directors and a Board of Statutory Auditors. New legislation, which took effect at the beginning of 2004,63 now permits Italians companies much greater flexibility in their organizational structures, allowing them to select either a unitary board, a two-tier board, or the traditional Italian model. To date, however, virtually all listed companies continue to retain the traditional Italian model and it will therefore be the focus of discussion in this Paper.
Board of Directors
117. A Board of Directors that is independent of company management is one of the key mechanisms to protect shareholder interests. In Italy, there are no legally mandated requirements for Board independence.64 In addition, apart from privatized companies, listed companies are not required to include representatives of minority shareholders or other stakeholders on the Board of Directors, and, indeed, very few Italian companies provide for such representation in their by-laws. As underscored by the Chairman of Consob in his annual speech to the market in 2004, “mechanisms for electing the board of directors that permit minority shareholder representation are found in little more than one tenth of listed companies, in compliance with the rules for the privatizations; in only a few cases have companies made them part of their bylaws of their own volition.65
118. While the Consolidated Law did not make any changes in the structure of the Board of Directors, Borsa Italiana addressed this issue in October 1999, when it adopted a code of corporate governance. The Preda Code, which was revised in July 2002 and is expected to be revised again to reflect the recent changes in Italian company law, was adopted in an effort to improve the performance and competitiveness of Italian listed companies.66 It is a voluntary code, taking a “comply or explain” approach to issuers’ compliance with its corporate governance recommendations. Thus, issuers can choose either to comply with the Code’s guidelines, or disclose their reasons for not doing so.67
119. The Preda Code recommends that the Board of Directors have an “adequate number” of non-executive and independent directors to ensure that management is properly monitored. While the “number and standing of the non-executive directors shall be such that their views can carry significant weight in taking board decisions,” what constitutes an adequate number is not defined.68 The Board is supposed to assess the independence of the directors on a periodic basis and communicate the results to the market.
120. The Preda Code highlights the special importance of independent directors in a company where ownership is concentrated, as is the case in many Italian listed companies. The Code states that, “where the ownership is concentrated, or a controlling group of shareholders can be identified, …there emerges the need for some directors to be independent of the controlling shareholders too, so as to allow the board to verify that potential conflicts of interest between the interests of the company and those of the controlling shareholders are assessed with adequate independence of judgment.”69
121. Neither Italian law nor the Preda Code addresses the issue of representation of minority shareholders on the Board of Directors for the large majority of Italian listed companies.70 While the Board is legally required to represent the interests of the entire company,71 when ownership is concentrated, as it is for the large majority of listed companies in Italy, the Board will necessarily consist entirely, or nearly entirely, of Directors selected by the majority shareholders. With such a set-up, it may be difficult to ensure the proper monitoring of Directors’ independence, particularly in the absence of mandatory legal requirements. In addition, the ability of Consob to monitor the independence of the members of the Board of Directors is limited. This may have particularly unfortunate consequences in a financial system such as Italy’s where there is often little separation between the majority shareholders and the management of a company.
Board of Statutory Auditors
122. The traditional Italian corporate structure is unique in the oversight role it assigns to the Board of Statutory Auditors. The Board of Statutory Auditors exercises broad control of the whole management of the company. It monitors the performance of the Board of Directors and checks its activities for compliance with the law and the company’s bylaws; it reviews the adequacy of the company’s internal controls, including its administrative and accounting systems; and it ensures that the company has adequate procedures to provide its subsidiaries with the information needed for compliance purposes.72 Members of the Board of Statutory Auditors are individually liable for their activities, and infringements may be prosecuted criminally.73
123. In performing their functions, the members of the Board of Statutory Auditors have wide-ranging powers to obtain information from the Directors and other company officials. They are required to attend meetings of the Board of Directors, and may conduct inspections at any time, using employees of the company if necessary. The Board is required to report to the shareholders’ meeting on its oversight activities and on any omissions or irregularities it has found.74 If the Board discovers irregularities, it is required to notify Consob without delay. Individual Board members also may notify Consob of their concerns.
124. The Board of Statutory Auditors also has responsibility for monitoring the external auditing firm. It must express its opinion on the suitability of the appointment of the external auditor, including an evaluation of the firm’s independence. On an ongoing basis, the Board of Statutory Auditors may obtain relevant information from the external auditor, and is required to examine the work of the external auditor and to be in a position to comment to the shareholders on any qualifications or relevant issues included in the external auditor’s report. If the external auditor discovers serious irregularities in the course of its work, it must inform both the company’s Board of Statutory Auditors and Consob.
125. The qualifications to become a member of a Board of Statutory Auditors are specified by law. Members of the Board of Statutory Auditors must be selected from a pool of chartered public accountants who have exercised audit activities for at least three years (at least one member is required to comply with this condition and to be entered in the Register of Auditors maintained by the Ministry of Justice),75 experienced directors, managers, and academics in company-related sectors as specified in the company by-laws. They also must be independent of the corporate directors and management, and of its subsidiaries or parent companies.76 The position of Statutory Auditor is frequently, however, not a full-time position and members of the Board often serve on the Boards of other companies.
126. While Italian law as implemented by Consob regulation contains the building blocks for a strong supervisory role for the Board of Statutory Auditors as the representative of the shareholders, a potential weakness exists in the operation of the Board in practice. Although legally the Board is required to be independent and to include at least one member appointed by the company’s minority shareholders, in practice the effectiveness of this provision can be limited.77 Certain key actions may only be undertaken by two or more members of the Board of Statutory Auditors, acting together.78 Thus, the ability of any one of them to act unilaterally is constrained. More generally, the representative of the minority shareholders may, particularly in a company with concentrated share ownership, be influenced by the dominant controlling shareholder. Finally, there is the question of monitoring and enforcement. As will be seen below, the minority shareholders have little incentive to bring an action against the Board of Directors even when they may be legally entitled to do so (see para.31 below).79 Equally importantly, Consob has had limited resources to monitor corporate behavior and the pecuniary sanctions that it can propose for malfeasance are limited, and have to be imposed by the Ministry of Finance. As discussed below, the draft law currently before the Italian Parliament is a response to these shortcomings.
Disclosure and Financial Reporting
127. Although the disclosure and financial reporting requirements applicable to listed companies in Italy are quite rigorous, the pecuniary sanctions that could be imposed on issuers or management for breaches of these requirements have been minimal. They therefore have not served as an effective deterrent for wrongdoing.
128. Financial reporting and disclosure requirements in Italy are quite rigorous, particularly in comparison with other European countries. In recent years, the European Commission has taken a much more active role in establishing disclosure and reporting requirements, in order to promote a harmonized market across Europe for securities offerings and transactions. In particular, the recently adopted European Directive on Transparency 80 addresses the reporting obligations of listed companies. The legislative framework for financial reporting and disclosure in Italy described below is largely consistent with, and even more stringent than, the requirements of the Transparency Directive. Thus, little change is expected from the transposition of the Directive into Italian law.
129. Italian companies must publish financial statements on an annual basis.81 These are published together with a report from management,82 which is intended to provide management’s perspective on the key events of the year. Where companies exercise control over one or more subsidiaries, consolidated annual financial statements must also be approved and published.83 The Chairman of the Board of Directors signs the financial statements as the legal representative of the company, and is responsible, along with the other Directors, for any damages that result from a failure to carry out their duties properly.84
130. Both EU Accounting Directives and Italian legislation require individual and consolidated financial statements of listed companies to be audited by an external auditor.85 The external auditor must be registered with the Consob and is subject to its supervision. Annual financial statements also are submitted to the company’s Board of Statutory Auditors.
131. Listed companies are required to prepare quarterly, semi-annual and annual reports. Consob regulations require such reports to be accompanied by remarks of the Board of Statutory Auditors, if any, and a report from the company’s external auditor, if available.86 At present, all listed companies submit their semi-annual reports on a voluntary basis to a limited review by external auditors. Quarterly reports are not audited.
132. Consob exercises substantial authority over issuer disclosure. It carries out a systematic review of compliance with financial reporting standards, using a risk-based approach. Consob may seek additional disclosure from a company at any time, and request an issuer to restate its financial statements. If Consob is not satisfied with an issuer’s disclosure, and believes that a material violation has occurred, it may take action in civil court. Where it believes that a criminal violation has occurred, Consob must refer the matter to the criminal prosecutor. In addition, Consob has direct authority to sanction auditors, including suspending the activities of an auditor responsible for an audit in which irregularities were found for up to two years, and even deleting an audit firm from its Special Register.
133. The Civil Code establishes administrative penalties for the violation of disclosure obligations.87 However, the size of these sanctions has been quite limited, with the maximum sanction being only € 100,000. The Ministry of Finance reviews Consob’s proposed sanctions for their legality and fairness, and may request clarification, and even information from the persons to be sanctioned, although this has rarely occurred.
134. Criminal sanctions also are possible. Directors, general managers, members of the Board of Statutory Auditors and liquidators are all potentially subject to criminal sanctions, including imprisonment for up to 18 months, or longer if the shareholders or creditors incur losses.88 External auditors are also subject to sanction for false statements in their reports and other communications, and their potential liability for damages is unlimited.89
135. Thus, while the requirements for financial reporting and disclosure are comprehensive, the administrative sanctions that could be imposed on issuers and management have been limited in practice. Moreover, Consob can not impose penalties directly, but has to act through the Ministry of Finance. Although there is no clear evidence this prevented sanctions from being imposed, in principle, it could hamper the effectiveness of sanctions as a deterrent of malfeasance. As discussed below, these issues have been addressed in the new legislation currently before the Italian Parliament. While criminal sanctions are also possible, in practice, they are more difficult to pursue. They require Consob to make a recommendation to the public prosecutor, who is then legally required to make a formal determination as to whether to pursue the case.90 The legal standard for criminal prosecution is quite high and therefore can be difficult to meet.91 Moreover, securities fraud cases must compete with other criminal matters for prosecutorial resources.
136. The Consolidated Law was particularly important in introducing some significant protections for minority shareholders. For example, shareholders who have an interest that conflicts with those of the company must abstain from voting in shareholders’ meetings. Shareholders who believe that resolutions were adopted in violation of this provision can bring a challenge in Civil Court to claim compensation for damages suffered.92 Shareholders can also make complaints to Consob about disclosure at shareholders’ meetings.93
137. As noted above, the Board of Directors is required to act in the interests of the entire company, including the minority shareholders. The Consolidated Law for the first time introduced a provision permitting shareholders of listed companies to bring a collective action against the members of the Board of Directors for breach of their legal duties.94 Any damages that are awarded, however, are paid to the company. The shareholders may also, along with the Board of Statutory Auditors, ask the Civil Court to order an inspection of the Company and to replace or suspend members of the Board of Directors, or appoint an administrator.95
138. In practice, the legal protections that exist for minority shareholders are not fully realized.96 Although minority shareholders who represent 5 percent of the issued capital of a company may bring a collective action for misrepresentation against the members of the Board of Directors, in practice they are unlikely to do so.97 Such actions are costly, and the losing party is required to pay the costs of the other side. In addition, any damages that are awarded accrue to the benefit of the company (not the individual shareholder plaintiff). Consequently, the majority shareholder is likely to benefit most from such an action. Finally, the legal system is difficult and expensive to navigate, the concept of class actions (and contingency fees) does not exist, and there are no established procedures for investors to recover funds lost through corporate malfeasance.98 The absence of any kind of discovery system, which would afford shareholder plaintiffs access to basic information necessary to build their case, has greater repercussions when the majority shareholder also controls the management of the company - and thus access to relevant information. Given these obstacles to success, “a small investor, who has limited investments in the corporation and lacks the financial resources to face a prolonged and tenuous litigation (which in the Italian judicial system can be very prolonged 99) has little incentive even to pursue strong cases involving clear misconduct.”100 It is thus perhaps not surprising that, to date, there have been no cases recorded whereby shareholders representing 5 percent of a company’s capital have brought an action against its Board of Directors.101
D. Accounting and Auditing Oversight
139. Even prior to the tremendous changes of the past few years, Italy had in place some of Europe’s strongest provisions for regulating the accounting and auditing profession throughout Europe.102 Unlike many securities regulators worldwide, Consob has direct authority to supervise the accounting and auditing profession. All listed companies in Italy must be audited by one of the (currently) 20 external auditing firms included in the Special Register maintained by Consob.103
140. As noted above, a company’s Board of Statutory Auditors must render an opinion on the appointment of the external auditor. This opinion, which is submitted to the shareholders meeting,104 contains an assessment of the audit firm’s independence and technical suitability, with particular regard to the adequacy and completeness of the audit plan and of the firm’s organization in relation to the size and complexity of the audit engagement. The Board of Statutory Auditors is required to send to Consob a copy of the shareholders’ resolution appointing the external auditor, the audit firm’s proposal for the engagement, the Board’s opinion which it had submitted to the shareholders, as well as the attestations of the company and the external auditor, described below, regarding any potential conflict of interest.105
141. As part of its regular supervisory responsibility, Consob has the authority to monitor auditing firms on the Special Register on a continuous basis, to verify their compliance with licensing requirements. To this end, Consob has introduced a compliance program to carry out quality assurance reviews on a regular basis.106 Consob collects periodic information from the audit firms on their internal quality assurance systems, which it then collates with other information to select specific audit firms for review.107 Consob aims to achieve full coverage of the 20 registered firms within a six-year cycle, unless circumstances dictate different priorities for review.
142. As part of its oversight responsibilities, Consob may compel auditing firms and their partners, directors and general managers, to produce information, records and other documents, both on a periodic basis as indicated above and for cause. When Consob finds serious irregularities in the performance of audit activity, it may: (i) order the auditing firm not to employ the person responsible for the audit in which the irregularities were found for up to two years; or (ii) prohibit the firm from accepting new auditing engagements for a period of up to one year. Consob also can delete the auditing firm from its Register. Consob is required to report to the Public Prosecutor any instances of irregularities that could constitute criminal offenses. In the past 10 years, Consob has issued 24 sanctions against audit firms, of which 22 consisted of item (i) above.
143. Consob’s audit quality assurance system is quite comprehensive and, therefore, requires, substantial staff resources to conduct such intensive, on-going reviews. Currently, Consob dedicates approximately 20 staff members full time to this activity. Additional staff members are needed to enhance Consob’s ability to conduct effective oversight in a proactive manner.
144. Italian law prohibits audit firms from accepting or performing any audit engagement in which their independence could potentially be impaired.108 In addition, national audit standards require external auditors to be independent in both fact and appearance from the company being audited. Auditing firms are required to confirm their independence to the company when they submit their proposal for the audit engagement.
145. To protect their independence, audit firms are prohibited from accepting or performing audits when certain conflicts exist.109 These could involve the firm itself, or its partners, directors, Supervisory or Statutory Board members, or general managers. The law also provides as a general principle that audit firms should not accept any engagement in any situation in which the independence of the firm or any of its partners, directors, Supervisory or Statutory Board members or general managers may be compromised. Consob requires the directors of the client company and the directors of the audit firm to attest to the absence of conflicts at the time that the audit engagement is conferred.110 The client company and the audit firm must immediately notify Consob if conflicts are found.111
146. Audit firms must limit their activities to auditing or other services strictly related to the audit. Therefore, they are prohibited from providing non-audit services, such as consulting services, to any client. They must disclose annually the breakdown of revenues they received during the year by type of activity, e.g., statutory audits, other audits, and other services strictly related to the audit. In an effort to prevent audit firms from circumventing this requirement by setting up affiliated entities to offer consulting services, Consob prohibits audit clients from acquiring non-audit services from entities related to the audit firm.112
147. Italy is the only country among the G-7 to have adopted mandatory audit firm rotation.113 Listed companies in Italy may appoint an external auditor for a three-year term, which may then be renewed up to two times. Thus, an audit firm can serve as lead auditor for a maximum of nine years. The same auditing firm can only be appointed again following a three-year hiatus.
148. It may be that nine years is a long time for an auditor to be associated with an audit client without succumbing to pressures on its independence. In its proposed Directive on Statutory Audit, the EC would give member states the “option of requiring either a change of key audit partner dealing with an audited company every five years, if the same audit firm keeps the work (“internal rotation”), or a change of audit firm every seven years (“external rotation”). The Commission believes that mandatory rotation will contribute to avoiding conflicts of interest.”114
149. While auditor independence and auditor rotation requirements in Italy are quite strict, with active oversight by Consob, one key issue may be the application of the auditor rotation requirement only to listed companies that are organized in Italy.115 Thus, the subsidiaries of an Italian listed company, if they are not themselves organized in Italy, are not subject to the auditor rotation rules. They may therefore continue to be audited by the same audit firm.116 In addition, the effectiveness of the Italian requirement on audit rotation may be limited when a listed company is part of a large family of companies organized in many different countries. In such a case, the lead auditor, although legally responsible for the audit of the group, in practice often relies on the opinion of one or more other auditors as to the accuracy of the financial statements of the listed company’s subsidiaries. Consob has tried to address this problem by requiring the lead auditor of an issuer to take responsibility for reviewing the audits of subsidiaries with significant risks that have been audited by other audit firms.117 Under the proposed EC Directive on Statutory Audit, the auditor of the group would bear full responsibility for the audit report on consolidated accounts.
E. The Legal and Regulatory Framework for Investor Protection
150. Investor protection in Italy takes place within a legal framework in which Consob, the Bank of Italy and Borsa Italiana each exercise significant roles, with Consob taking the lead.
151. Consob was established in 1974 as an independent statutory agency principally in charge of ensuring investor protection and market transparency.118 Generally speaking, Consob has responsibility for the protection of investors and the orderly functioning of regulated markets, the efficiency and transparency of the capital market and the market in corporate control, and the proper conduct of business by intermediaries. Among other things, Consob regulates: (i) solicitations to the public, the preparation and publication of prospectuses and other documents pertaining to offers, and the procedures for making offers; (ii) the disclosure requirements for issuers listed on regulated markets, including periodic reporting obligations and disclosure of price sensitive information; (iii) the transparency of the ownership structure of listed companies; and (iv) auditing firms and the performance of auditing services.
152. As part of its responsibility for regulating public offers and disclosure requirements, Consob reviews the offering documents and the publication of financial statements by companies seeking to make a public offering of either debt or equity securities and of companies that are listed on Borsa Italiana.119 Consob reviews compliance with the financial reporting requirements discussed above, using a “risk assessment” approach. Thus, Consob places listed companies with significant “risk” factors under regular review. Risk factors include both objective standards such as financial criteria as well as other facts that come to Consob’s attention in the course of its activities or as a result of external information that causes it to be concerned about the financial health of an issuer or the quality of its financial statements. As part of this process, external auditors are required to send to Consob an annual report on every listed company, summarizing the main information regarding the issuer and any significant accounting issues that have arisen during the auditing process. Consob reviews each of these reports and, if problems are detected, conducts a review. On average, about 18-20 percent of listed companies are selected for review annually. Approximately 20 companies are on a special “watch list,” requiring them to publish certain financial information on a monthly basis.
153. Consob does not conduct merit reviews but, rather, checks to ensure that disclosure requirements are met.120 Consob has the authority to request that a company disclose additional information if it believes necessary, either before or after the company’s financial statements have been published. Since the beginning of this year, Consob has required 13 companies to supply additional information to the market, by means of explanatory notes in the financial statements or special press releases. In some cases, the issuer may decide to restate its financial statements on a voluntary basis. If an issuer fails to comply with an order to disclose information, Consob is authorized to publish the information at the expense of the issuer. If it is not satisfied with the issuer’s explanation and the disclosure violation is material, Consob may submit the matter to the civil court. In each of 2004 and 2003, Consob submitted four cases to the civil court.
154. Consob also is responsible for ensuring that listed companies inform the market on a timely basis of material developments. Listed issuers and their controlling shareholders must publicly disclose any development (including those relating to the listed companies’ subsidiaries) that would be likely to have a significant effect on the price of the listed securities.121 Disclosure must be made to Borsa Italiana, which then disseminates the information publicly, as well as to Consob and to at least two news agencies.122 Issuers frequently discuss with Consob press releases concerning their most important price sensitive information prior to their release. Consob also may require an issuer to disclose additional information if necessary, even after the release has been issued. Consob’s demands are generally aimed at clarifying the characteristics and the financial impact of the price sensitive information that is being disclosed.
155. Consob may suspend a public offering for up to 90 days if it suspects a violation of law or regulation, and prohibit the offering altogether if a violation is found. Similarly, Consob may suspend dissemination of an offering advertisement for up to 90 days if it suspects a violation of law or regulation, prohibit the dissemination of the advertisement if such a violation is ascertained, and prohibit a public offering in the event of failure to comply. The Minister of Finance can impose sanctions, upon Consob’s suggestion, for violation of disclosure obligations. Criminal sanctions, including imprisonment, are also possible.
156. While in many ways Consob has a great deal of authority, particularly in the area of investigative powers and auditor oversight, Consob nevertheless has suffered from some limitations on its ability to deter bad behavior in the market. Consob has in place an effective system for monitoring disclosure and reporting by issuers, which relies on both objective risk-based criteria as well as information that may come to its attention. Consob also has the authority to investigate any potential malfeasance that it discovers. However, Consob’s ability to sanction the malfeasance has been limited, as noted earlier. Consob has not been able to impose administrative pecuniary fines directly, but had to act via the Minister of Finance. Moreover, as noted above, the maximum size of the fines has been so small as to limit their effectiveness as a deterrent. As explained below, the Italian Parliament is currently considering reforms to address these weaknesses.
Bank of Italy
157. The Bank of Italy was established as an independent institution under public law. Its autonomy and independence are guaranteed by Italian legislation and specifically by provisions relating to, among other things, the appointment of the members of its governing bodies, the self-financing of its activity, and its internal organization and rules of operation. The shares of the Bank of Italy are registered, and may be held only by commercial banks, social security institutions and insurance companies, and by “banking foundations.” The majority of the Bank’s capital must be retained by public institutions or by companies in which the majority of the voting shares are held by public institutions.
158. The Bank of Italy has had responsibility for supervising the stability of Italian banks since 1936.123 Under the Consolidated Law, the Bank is responsible for all matters relating to financial stability and risk limitation. Thus, the Bank has wide-ranging supervisory powers, including responsibility for the prudential supervision of investment firms and asset management companies as well as of banks. It issues regulations relating to capital adequacy, limitation of risk, permissible shareholdings, and administrative and accounting procedures and internal control systems. The Bank also supervises the wholesale government securities market, and monitors the efficiency and proper operation of organized trading of inter-bank funds. Along with Consob, the Bank of Italy is responsible for the regulation of collective investment schemes, and for custody, clearing and settlement systems, including central counterparties.
159. While the Bank of Italy has extensive supervisory and enforcement powers relating to so-called “authorized persons,” that is, the entities that it supervises, it has no supervisory powers in connection with non-financial firms. Therefore, the Bank has direct access only to the published disclosure and financial reports of such issuers, and it has no power to request information of any kind from such firms.
160. Article 129 of the Consolidated Law on Banking (1993) requires that the Bank of Italy be notified prior to an offering or issuance in Italy of debt securities by domestic and foreign issuers in an amount that exceeds certain thresholds.124 The Bank has up to 20 days following receipt of the notification to postpone or prohibit the issuance. An issuance may be postponed when the Bank determines that it is too large for the market to absorb. The Bank also can prohibit a transaction if it includes features that are extremely complex or non-transparent. The Bank of Italy prohibited two securities offerings in 2002 and three in 2003. In those years, 50 and 55 proposals, respectively, were withdrawn in response to comments of the Bank.
161. The Bank of Italy is unusual for a central bank or bank supervisor in that it invests both a portion of its ordinary reserves as well as a percentage of its employees’ pension funds in Italian equities.125 Because of the potential conflict, the Bank has a series of firewalls in place. Internal regulations prevent the Bank from using supervisory information in its investment decisions. Moreover, the Bank invests only in Italian blue-chip companies, and is largely a passive investor. The Bank also states that it does not hold stocks of commercial banks nor of any entity that it supervises.126
Cooperation between Consob and the Bank of Italy
162. The Consolidated Law requires Consob and the Bank of Italy to cooperate in a coordinated manner in the areas in which they share authority, with a view to minimizing costs to those they regulate. In 1997, Consob and the Bank of Italy signed an agreement governing cooperation and exchange of information with respect to the authorization and registration of investment firms and asset management companies, and the marketing in Italy of units of foreign harmonized collective investment schemes. This agreement was updated in 2001. Pursuant to this agreement, Consob and the Bank notify one another of inspections of investment firms and asset management companies, and can satisfy their informational needs by requesting that the other undertake an inspection.
163. In addition to cooperation where they share formal authority, the Consolidated Law provides that Consob and the Bank of Italy are to cooperate “by exchanging information or otherwise for the purposes of facilitating their respective functions.”127 They therefore may not invoke professional secrecy in their mutual relations. While the arrangements for cooperation between Consob and the Bank of Italy are not made public, in practice they appear to cooperate well on a regular basis.
164. Borsa Italiana S.p.A. is responsible for the organization and management of the Italian stock exchange. The company, which was founded in 1997 following the privatization of the exchange, and has been operational since the beginning of 1998, is responsible for defining and organizing the function of the markets; establishing the rules and procedures for admission and listing on the market; managing and overseeing the market; and supervising the disclosure of listed companies.
165. Borsa Italiana is responsible for regulation and market management while Consob is responsible for supervision. Thus, while Borsa Italiana sets listing standards, which vary according to the particular market segment involved, it is Consob that establishes disclosure and financial reporting requirements. All listing requirements as well as market rules are subject to Consob’s approval. Borsa Italiana and Consob work closely together, including with regard to ensuring the timely disclosure of price sensitive information.
166. In 2002, Borsa Italiana sponsored a Forum on Corporate Disclosure following which it issued a number of recommendations contained in a Guide to the Disclosure of Information to the Market. The Guide is voluntary but serves to complement Consob disclosure requirements for listed companies.128
167. In addition to its efforts to provide guidance to enhance the disclosure by listed companies, Borsa Italiana also adopted a code of corporate governance, as described above. While the Preda Code is voluntary, it appears to have been instrumental in increasing disclosure by listed companies. The Code serves as a complement to Italian law and regulation. Since the adoption of the Code, listed companies are reported to have significantly improved the quality and quantity of information they disclose about their corporate governance practices. Indeed, by the end of 2003, almost all listed companies had in theory adopted the general principles of the Code. In particular, disclosure about the composition of boards of directors, nomination procedures for directors and statutory auditors, powers of managing directors, and the functioning of internal committees is reported to have improved, particularly in certain segments of the market, such as the Star129 segment, for which elements of the Code are mandatory in practice.
F. Response of Authorities
168. Following the collapse of Parmalat, the Italian authorities determined to review the supervisory framework to see if it could be strengthened to reduce the likelihood of other financial collapses. In his testimony before Parliament on 27 January 2004, the Governor of the Bank of Italy, made some recommendations for legislative and regulatory changes based on his analysis of the vulnerabilities revealed by the Parmalat failure. His recommendations also reflected the measures taken in the United States following the failure of Enron and Worldcom. Among other things, he recommended that Consob be given extra powers and resources to permit it to take prompt action to verify the quality and reliability of financial statements. He also recommended that the penalties for fraud be increased, as well as for serious irregularities and violations of the rules in corporate reports. The Chairman of Consob made similar proposals, which he subsequently summarized in his Speech to the Market in June 2004.
169. The draft Law on Market Abuse, now in Parliament, adopts much of the approach that the Bank and Consob originally recommended, which focused on strengthening Consob. The draft law preserves Consob as an independent agency and gives it enhanced powers and authority. In particular, Consob is granted increased power to impose sanctions directly, without the need to involve the Ministry of Finance. Moreover, the administrative sanctions that are available to Consob are greatly increased, and thus would be more likely to serve a detterent function. Finally, the draft Law provides an additional 150 staff persons for Consob, which would increase its size by approximately one-third, thus permitting it to conduct the pro-active auditor oversight program that it has introduced.
G. Concluding Remarks
170. The OECD Principles of Corporate Governance state that, “[t]he corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.” As can be seen from the above discussion, in many ways the corporate governance framework in Italy achieves these goals. The legal and regulatory requirements that affect investor protection are clear and transparent, and the division of responsibilities among the relevant authorities is clearly articulated and well understood. Indeed, the authorities seem to cooperate in practice at all levels.
171. Italy’s legal and regulatory system incorporates a significant number of investor protections. Most notably, the concept of the Board of Statutory Auditors gives shareholders a formal, legally-required check on the activities of the Board of Directors. This feature of the Italian Civil Code was further strengthened when the Consolidated Law mandated that the Board of Statutory Auditors include a representative of the minority shareholders.
172. In practice, however, due to heavily concentrated ownership, cross-shareholding and pyramid structures, the potential for investor protection that is built into the legal and regulatory framework is not fully realized. Thus, for example, even though Borsa Italiana’s corporate governance code recommends an “adequate” number of independent directors, when ownership is heavily concentrated and the Board consists of directors selected entirely by the majority shareholders, it may be difficult to ensure the proper monitoring of directors’ independence. Similarly, the effectiveness of the Board of Statutory Auditors in conducting its oversight role is reduced because of requirements mandating that certain key actions be taken only by two or more members, acting together. Thus, the ability of any one of them to act unilaterally is constrained. This difficulty is compounded by the Italian legal system, which creates disincentives for minority shareholders to enforce their legal rights.
173. Similarly, while the legal requirements for financial reporting and disclosure are quite rigorous, and often more stringent than the requirements of the newly adopted EU Transparency Directive, the effectiveness of these provisions in deterring wrongdoing and protecting investors has been limited. While Consob has strong investigative powers, it has had to call upon the Minister of Finance to impose pecuniary sanctions, which has weakened the credibility of Consob as an independent regulator and gave those being sanctioned a potential second avenue of appeal. Moreover, those sanctions have not not themselves been sufficiently onerous so as to have a deterrent impact on the behavior of the corporate community.
174. The draft Law on Market Abuse addresses these issues, as it gives Consob more resources, more staff, and the power to act independently of the Minister of Finance. It also substantially increases the maximum size of the pecuniary sanctions that can be imposed. If adopted, these provisions should enhance Consob’s ability to deter bad behavior and improve its ability to monitor and oversee the market. Thus, the draft law is an important response that should bring increased credibility and effectiveness to Consob.
175. Consob has had authority over auditors and auditing activity since its establishment more than 25 years ago. Unlike many countries, Italy has requirements in place governing the conduct of external audits of listed companies, including requirements for auditor independence and auditor rotation. More recently, Consob has put in place a comprehensive system for quality assurance review. Thus, Consob should be seen as being in the forefront among regulatory agencies in this area.
176. Pro-active auditor oversight that depends on comprehensive quality assurance reviews is highly resource-intensive. For it to be effective, Consob must have the staff, both in terms of numbers and skills, to carry out these responsibilities in a meaningful way. The new draft Law, by significantly increasing the size of Consob staff, should help in this regard.
177. Auditor independence and auditor rotation requirements were changing as this paper was being drafted. While Consob has rigorous requirements in place, consideration needs to be given to how effective they are in a financial system where listed companies are frequently just the apex of a large cross-border family of affiliated companies. This issue is applicable in many other countries as well, and is currently the subject of intense discussions among securities regulators internationally.
178. The Italian authorities may wish to give consideration to legal and regulatory reforms that could strengthen the existing legal protections in practice. For example, given the prevalence of family ownership of listed companies, legal requirements mandating a majority of independent directors may be warranted and, more generally, the provisions of the Preda Code could be incorporated into legal or regulatory requirements. Consideration could also be given to requiring that the Board of Directors include a representative of minority shareholders. In addition, it may be possible to strengthen existing auditor rotation requirement by, for example, extending it to the consolidated subsidiaries of a company as a condition for listing its securities.
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Prepared by Paulo Drummond (EUR) and Felice Friedman (The World Bank).
This paper is based on information gathered in connection with an assessment conducted in Italy in November 2004 by the International Monetary Fund pursuant to the Financial Sector Assessment Program. As such it is based on the laws and regulations in effect at that time. In addition the paper does not purport to be a formal or comprehensive assessment of corporate governance in Italy. While it draws on the Corporate Governance Principles of the OECD where relevant, it does not attempt to apply these Principles in any kind of systematic manner.
Parmalat reportedly had more than 14 billion euros worth of debt at the time of its collapse.
Italy Needs More Changes to Bankruptcy Law, Fitch Ratings Says, Bloomberg, September 21, 2004.
Since the end of 2003 when the Parmalat facts first emerged, other financial frauds have come to light, including those involving Hollinger International and Royal Dutch/ Shell.
Legislative Decree 58 of February 24, 1998. The Consolidated Law is known informally as the Draghi Law.
The paper considers the provisions on market abuse which have been segregated from the draft Law on Savings and included in the Community law. These provisions were approved by the Chamber of Deputies on December 4, 2004, and they were being examined by the Senate when this paper was written. Parliament continues to debate the “Law on Savings,” which incorporates a far-reaching reform of financial sector supervision, but it is unclear to date what final form the Law will take.
This is necessarily a very brief overview and is not intended to give a comprehensive picture of the Italian financial system but, rather, to highlight certain salient aspects that are important from the investor protection and corporate governance perspective.
Pursuant to the 1936 Banking Law, the Bank of Italy set specific limits on the purchase of shares of non-financial companies by different categories of banks.
According to Moody’s, “ninety percent of all businesses and nearly half of the top 200 companies in Italy are owned and managed by families.” Analysis, Moody’s Investors Service, October 2004.
Pyramid structures have been defined as “organizations where legally independent firms are controlled by the same entrepreneur (the head of the group) through a chain of ownership relations.” M. Bianco and P. Casavola Italian Corporate Governance: Effects on Financial Structure and Firm Performance, European Economic Review, Vol. 43, 1999, page 1059. While pyramid structures are frequently less than fully transparent to the market and the authorities, in Italy there are strict provisions requiring disclosure of ownership (2 percent threshold) and shareholder agreements.
Legislative Decree 6/ 2003. This legislation was adopted partly in response to European developments, including the creation of a single market and the reform of company law in other EU countries which increased the competitive pressures on Italian companies. It also updates the Civil Code requirements for small closely held firms so as to better address their particular needs as distinct from those of larger, publicly held companies.
Article 2387 of the Civil Code permits companies to include independence requirements in their bylaws. Article 2391 prohibits members of the Board of Directors from acting in conflict with the interests of the company.
Annual Speech of the Chairman of Consob to the Market, 1994. While privatized companies constitute only about 10 percent of listed companies, they comprise approximately 40 percent of market capitalization. Law 474/ 1994 provided the legal framework governing privatization. Among other key provisions, the law permitted the Italian government to maintain special powers (the so-called “golden share”) in privatized companies. These included having the right to approve the main shareholders, as well as the right to have representatives on the board of directors and other corporate bodies. The law gave small shareholders a voice on the board of directors by mandating proportional voting.
The Preda Code, which was based on the work of an ad hoc Committee for the Corporate Governance of Listed Companies, covers a number of different areas relating to the constitution and the operation of Boards of Directors, the establishment of special Board committees including audit, nomination and remuneration committees, special procedures to deal with price-sensitive information, and shareholder meetings, among others.
Borsa Italiana’s instructions specify that listed companies are to provide the market and shareholders with information on their corporate governance systems and their compliance with the Code. Companies are to provide this information in a special report made available for shareholders’ meetings and simultaneously conveyed to the Borsa, which is responsible for its broader dissemination.
The Code defines the term “independent” to mean a person who: (i) does not entertain, directly, indirectly or on behalf of third parties [or has not recently entertained], with the company, its subsidiaries, the executive directors or the shareholder or group of shareholders who control the company, business relationships of a significance able to influence his autonomous judgment; (ii) does not own, directly or indirectly or on behalf of third parties, a quantity of shares enabling him to control the company or exercise a considerable influence on it nor participate in shareholders’ agreements to control the company; (iii) is not an immediate family member of executive directors of the company or of persons in the situations referred to above.
According to Parmalat’s 2003 corporate governance report, five of its 13 member Board of Directors were considered to be non-executive members. Along with Parmalat’s Chairman (and Managing Director), there were 12 members of the Board of Directors, of which the large majority had close ties to the Chairman.
While Italian law requires that the boards of privatized companies include at least one representative of minority shareholders, the 2003 OECD Survey reported that only ten percent of listed companies have cumulative voting systems such that minority shareholders are able to elect at least one Board member. See, also, Annual Speech of the Chairman of Consob to the Market, 1994.
Articles 2392-2395, Civil Code.
A key area of focus of the Consolidated Law was to clarify and enhance the oversight role of the Board of Statutory Auditors. The shareholder protections that in traditional Italian companies are built into the roles and responsibilities of the Board of Statutory Auditors are being incorporated into the other two corporate models that now exist under the new 2003 legislation. Thus, regardless of the particular form of organization selected, the oversight role vested in the Board of Statutory Auditors in the traditional model is preserved.
Article 2407, Civil Code. See, also, paragraph 37, infra.
Consob has established detailed rules governing the contents of this report. Among other things, it must include specific comments on the adequacy of the company’s internal controls, the activities of the internal auditors and any action deemed necessary to rectify problems in the internal controls. Consob Communication 10255564/ 2001.
If the Board of Statutory Auditors consists of five members, then two of them must satisfy this requirement.
For listed companies, a members of the Board of Statutory Auditors may not include “spouses, relatives and the like up to the fourth degree of kinship of the directors of the company, the directors, spouses, relatives and the like up to the fourth degree of kinship of the directors of the companies it controls, the companies it is controlled by and those subject to common control [and] persons who are linked to the company, the companies it controls, the companies it is controlled by and those subject to common control by self-employment or employee relationships or by other relationships of an economic nature that compromise their independence.” Articles 148.3b and 148.3c, Consolidated Law.
Some analysts allege that the Board of Statutory Auditors failed to fulfill its responsibilities in the Parmalat case. “The Parmalat Finanziaria board of statutory auditors never sent any alert in their reports, nor reported anything to courts or to C.O.N.S.O.B.” G. Melis A. Melis, Financial Reporting, Corporate Governance and Parmalat: Was it a Financial Reporting Failure?, Conference at Queens’ University, Belfast, September, 2004.
For example, only two Statutory Auditors, acting jointly, may convene a shareholders’ meeting, or a meeting of the Board of Directors.
“Looking at the experience of listed corporations after the 1998 Reform, it should be noted that in six years, even with the lower 5 percent threshold, this instrument was never used. The reasons are relatively straightforward. First and foremost, the economic incentives for minority shareholders to bring the lawsuit are relatively low … In addition, Italian rules of civil procedure and professional regulation of attorneys do not provide for instruments that might encourage the use of such derivative actions. …Finally, the average length of a civil lawsuit in Italy seriously discourages resort to the courthouse as a means for protecting minorities.” M. Ventoruzzo Experiments in Comparative Corporate Law: The Recent Italian Reform and the Dubious Virtues of a Market for Rules in the Absence of Effective Regulatory Competition, Working Draft presented at Conference at Bocconi University, Milan, June, 2004.
The Transparency Directive was adopted in December 2004, and member states will have two years to transpose it into national legislation.
Beginning in 2005, all listed companies are required to prepare their consolidated accounts using international accounting standards (IFRS) issued by the International Accounting Standards Board. As for individual company accounts, Consob regulations mandate the use of IFRS and national
accounting standards. Consob Regulation DAC/99088450/ 1999.
Article 2428, Civil Code.
Legislative Decree 6/ 2003 mandates increased disclosure by financial groups. Under Legislative Decree 6/ 2003, financial reports of subsidiaries must disclose information about leading financial officers of the parent company, intra-group group relationships and the effects of the group’ policies on the subsidiary. In addition directors of a subsidiary must justify any decision effected by the parent company, and disclose this information in the annual report.
When the Transparency Code becomes effective in Italy, the Chief Financial Officers of listed companies also will be required to sign the financial statements. Under the Civil Code, external auditors may be jointly liable with members of the Board of Directors for damages caused by the Directors’ actions, if the damages would not have occurred had the auditors performed their duties properly. Article 2409, Civil Code.
Starting with the audits of companies’ financial statements for the year ended 31 December 2002, Consob has recommended the adoption of a new set of auditing standards based on the International Standards on Auditing (ISA), as supplemented by Italian national audit standards.
Consob recommends a limited review by the external auditor of the semi-annual report. Consob Communication 97001574/ 1997. It is performed on the basis of the criteria established in Consob
Resolution 10867/ 1997.
Articles 191-193, Civil Code.
Article 2621, Civil Code. Criminal sanctions may be imposed on persons who, with the intent of deceiving the shareholders or the public with a view to making an unjust profit for themselves or others, in financial statements, reports or other corporate disclosures provided for by law, directed to the shareholders or the public, set forth untrue material facts, even if the result of valuations, or omit information whose disclosure is provided for by law on the profit and losses, assets and liabilities or financial position of the company or the group to which it belongs, in a way that is likely to mislead recipients.
Article 2624 of the Civil Code establishes criminal penalties for persons responsible for an audit who, “with a view to making an unjust profit for themselves or others, in reports or other communications, aware of the falsehood and with the intention to deceive the recipient thereof, make a false statement or conceal information concerning the profits and losses, assets and liabilities or financial position of the company, entity or person subject to audit in a way that is likely to mislead the recipients of the communications.” The Civil Code also provides for criminal penalties for certain persons who willfully obstruct a Consob investigation. Article 2638, Civil Code.
In 2003, Consob reported 159 matters to the public prosecutor.
In order for the criminal sanctions to apply, the misrepresentation of the profit and losses, assets and liabilities or financial position of the company must be considered to be material. In addition criminal sanctions will not apply if the falsehoods or omissions caused a variation of 5 percent or less in the profit of the company for the year (before tax) or of 1 percent or less in the shareholders’ equity. In addition criminal sanctions cannot apply if the misrepresentations result from valuation estimates that, taken individually, do not differ by more than ten percent from the correct one. Articles 2621-2622, Civil Code.
“But a comprehensive analysis of the case law in this area shows that in only one instance has the court invalidated a board resolution challenged by a minority shareholder, suggesting that this is not a very effective remedy.” L. Enriques Off the Books, But on the Record: Evidence from Italy on the Relevance of Judges in the Quality of Corporate Law, Global Markets, Domestic Institutions: Corporate Law and Governance in a New Era of Cross-Border Deals, Curtis J. Milhaupt ed., Columbia University Press, October 2003.
The Civil Code contains a number of additional protections for minority shareholders. Article 126 of the Consolidated Law provides that certain key resolutions must be approved by two-thirds of the shares represented at the meeting. In this way, shareholders were given the potential ability to block transactions promoted by the controlling majority shareholders.
Individual shareholders who have suffered damages also are entitled to initiate legal action; however, the expense and other difficulties in doing so have motivated the creation of derivative and other types of collective actions. In Italy “this action is rarely brought and even more rarely successful.” Rucellai & Raffaelli, Directors and Officers Liability in Italy.
Article 2409, Civil Code. Threatening an Article 2409 action could be a useful bargaining tool for minority shareholders.
See L. Enriques supra, in which it is argued that none of the four types of possible shareholder suits against the boards of directors of listed companies has been effective in practice for minority shareholders of listed companies.
There also may be a question about potential conflicts faced by a minority shareholder considering a possible action. For example, in Italy, mutual funds are frequently owned by banks and may be reluctant to express an interest contrary to that of the controlling shareholder of a company with whom the bank does significant business. While the Consolidated Law provides that funds owned by banks are to be managed independently, practice may in fact vary. “And Italian fund managers rarely take issue with company management [because], and perhaps more important, banks have a conflict of interest since they conduct considerable business (i.e., lending) with the corporate clients in which their funds also invest. Thus banks and their mutual funds do not have an unambiguous interest in controlling firm managers in the interest of minority shareholders.” R. Deeg Remaking Italian Capitalism? The Politics of Corporate Governance Reform, forthcoming in West European Politics. See, also, M. Ferrari The State of the Art of Corporate Governance in Italy from a Multiperspective Point of Views and Some Key Point to Achieve a Real Turning Point: “…the actions taken by institutional investors [were] inadequate [because] in Italy almost all the institutional investors are part of the big banking and insurance groups, while important independent asset managers do not exist.”
“This unsettled regulatory framework, which affects such key issues as the division of the burden of the proof between investors and the issuer, the measure of damages, the statute of limitations and so on, is in itself a disincentive to pursue civil litigation in cases of misinformation.” L.A. Bianchi, C. A. Rogers M. Ventoruzzo, Legal Recourses to Protect Shareholders’ Interests, paper presented at International Corporate Governance Network, 8th Annual Conference, Milan July 2002.
For a broader discussion of the legal system in Italy and its economic impact, see the chapter III, “Institutions, Business Environment and Economic Performance: Cross-Country Evidence and the Case of Italy”.
Id., page 6.
Limited shareholder activism may be a contributing factor as well. Nevertheless, as noted by the Chairman of the Consob in his 1994 Speech to the Market, “Investor activism is discouraged by the limited scope afforded by the concentration of ownership of listed companies.” The Chairman goes on to note that, while recent years have shown a trend towards more widely distributed ownership in larger companies and in the banking sector, “even in these cases the real opening of control to the market remains limited by shareholders’ agreements and legislative restrictions on the contestability of control.”
The conduct of audits in Italy is governed by Legislative Decree 88 of January 27, 1992, the Consolidated Law, and Consob Regulation 11971/ 1999, implementing provisions of the Consolidated Law.
When a firm applies to be included in the Special Register, Consob conducts an inquiry to determine whether the firm would be capable of performing the audit activity adequately. This includes checking the previous activity of the firm to verify compliance with both auditing standards and with standards of independence.
Article 159, Consolidated Law.
Consob Regulation 11971/ 1999.
The European Commission has proposed a new Directive on Statutory Audit that would, among other things, introduce a requirement for external oversight or quality assurance at the national level, and set out common criteria for the constitution of oversight bodies. While the Directive seems to envision an independent stand-alone oversight entity at the national level, it is possible that, if Consob meets the Directive’s criteria for the composition of the oversight body, it may well be that the current arrangement could continue largely unchanged.
The information required to be provided to Consob as part of this process is contained in Communication 3047871/ 2003, and is posted on Consob’s website.
Article 3 of the Decree of the President of the Republic, 136/1975.
A conflict would include having an equity interest or contractual relationship with the client company, having a personal or employment relationship with the client company or its parent, or holding an appointment as a director or member of the Board of Statutory Auditors of the client company or its parent.
These statements must be updated annually, and in the event of key changes in personnel. Consob Communication 94006824/ 1994.
Italian law also prohibits the above-mentioned persons and the staff of audit firms from accepting any kind of engagement or employment in client companies for three years from the end of the audit engagement or from the termination of their employment with the audit firm.
Consob Communication 96003558/ 1996.
See US General Accounting Office, International Experience with Mandatory Audit Firm Rotation, Appendix V, Public Accounting Firms: Required Study on the Potential Effects of Mandatory Audit Rotation, November, 2003.
European Commission Proposal for a Directive on Statutory Audit: Frequently Asked Questions. See Article 40 of the proposed Directive.
Under Legislative Decree 6/ 2003, listed companies may issue corporate bonds in an amount up to twice the amount of paid-in net capital, thus eliminating at least some of the incentive for listed companies to incorporate subsidiaries outside of Italy with the purpose of issuing corporate bonds to finance the needs of the controlling parent. The new law also for the first time assigned liability to a parent company if it causes damage to minority shareholders or creditors of a controlled corporation through its mismanagement of the controlled corporation. This is likely to be a difficult standard to meet and it will apply only where the controlling parent is itself a company or legal entity.
This was in fact the situation with Parmalat, where after nine years, the company switched its lead audit firm from Grant Thornton S.p.A. to Deloitte & Touche S.p.A. However, Grant Thornton continued to audit certain subsidiaries of Parmalat, including Bonlat Financing Corporation, a Cayman Islands corporation, which held the purported Bank of America account.
Consob Resolution 14186, July 2003. This regulation is at issue in the post-Parmalat litigation.
Consob’s powers and responsibilities are set forth in Law 216/ 1974 (as amended) and in the Consolidated Law.
Currently, banks that issue corporate debt are not required to issue a prospectus subject to Consob’s review, but are subject to the review by Banca d’Italia (see paragraph 53). The latter, though, is quite minimal and it is not comparable to a disclosure-based review as carried out by Consob. With the implementation in Italy of the EC Prospectus Directive, expected in July 2005, this exception from the prospectus requirement will be eliminated.
The International Organization of Securities Commissions recognizes that most regulators review financial and non financial information disclosed by issuers to determine whether information that is required to be disclosed is disclosed. Merit-based regulation, in which the regulators takes some responsibility for the quality of the offering, is generally associated with emerging markets and is not considered necessary in more developed markets. IOSCO Objectives and Principles of Securities Regulation, Footnote 44, May 2003.
Article 114 of the Consolidated Law, and Consob Regulation 11971/ 1999.
European Commission Directive 2003/6 requires the disclosure of all price-sensitive information unless the issuer claims a legitimate interest in delaying the publication of confidential information. In Italy the issuer may only delay publication if it is authorized to do so by Consob. In addition Consob currently receives the information shortly before the market. These regulations are likely to be changed so as to be consistent with the EC Directive.
The Bank of Italy also has the legal responsibility to promote competition in the banking sector in Italy. While this would seem to present potential conflicts with its objective of preserving financial stability, the Bank of Italy views the issue of mergers among banks as relevant to the goals of sound and prudent management of banks and of systemic stability. One iteration of the draft Law on Savings would have removed this function from the Bank of Italy and given it to the Anti-Trust Authority.
Mutual funds and government securities of OECD member countries are not subject to this requirement.
G Di Giorgio C. Di Noia L. Piatti, Financial Market Regulation: The Case of Italy and a Proposal for the Euro Area, The Wharton School, University of Pennsylvania, June 2000.
However, at the end of 1999, the Bank of Italy owned more than 2 percent of the capital of 10 listed issuers including a bank, a financial holding company, and many insurance companies that were themselves controlled by or involved in the control of Italian banks. G. Di Giorgio C. Di Noia L. Piatti, supra. Currently, the Bank owns more than 2 percent of the capital of eight listed issuers.
For example, Recommendation 2 concerning information likely to have a significant effect on the price of listed financial instruments states that “issuers and the persons controlling them should disclosure material information promptly to the market.” The term “material information” is defined and the Recommendation provides a non-exhaustive list of events that are likely to be considered material.
The Star segment is the “high standard, mid-cap” market segment dedicated to companies with a market capitalization lower than € 800 million euros, and complying with specific requirements for liquidity, transparency and corporate governance.