Disclosure to investors

The provisions on disclosure to investors should support the governance role envis -aged in the AIFM Directive for investors. We now turn to consider these provisions.

Article 22 of the AIFM Directive provides that an annual report of financial performance should be made available to investors upon request. The provision is minimal as some AIFs established as corporations would be subject to company law reporting in the jurisdiction of the AIF. Article 22 merely provides a right for investors to have at least annual access to such information. The Commission Regulation supplementing the AIFM Directive elaborates on the items that are required in annual reporting but seeks to introduce only a minimum form of harmonisation.¹⁷³ Annual reports may of course contain more, and qualitative information too.¹⁷⁴Article 22(2)(e) and (f) provide that information on total and aggregate remuneration should also be provided to investors. The authors argued earlier in this chapter that further classification of such information by AIF may be relevant to stimulating investor scrutiny/governance.

Article 23 deals with pre-investment disclosure and periodic ongoing disclosure post-investment. A list of items is prescribed as pre-investment disclosure for AIFs: a description of investment objectives, investment strategy and investment restrictions; levels of leverage and use; how changes to investment policies may be made; the main features of contractual terms, applicable law and investor rights;

the identity of the AIFM, its depositary, its auditors, external valuers where

173Commission Delegated Regulation (EU) No 231/2013 of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (19 December 2012), arts 104–105.

174ESMA, ‘Final Report: ESMA’s Technical Advice to the European Commission on Possible Implementing Measures of the Alternative Investment Fund Managers Directive’ (16 November 2011) ESMA/2011/379 www.esma.europa.eu/system/files/2011_379.pdf accessed 22 December 2012, 225.

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applicable and other service providers, such as its prime broker and the main features of contractual arrangements with the prime broker; delegation of func -tions; liquidity and risk profiles and management; valuation policies; redemption procedures and rights; all fees and charges; the most recent annual report; net asset value; and historical performance, where applicable. Although the pre-crisis position on the wholesale end of the financial market relies on transactional governance,¹⁷⁵leaving intermediaries and professional investors to bargain freely, Mendales¹⁷⁶ argues that complete freedom to bargain does not necessarily facilitate effective investor scrutiny and protection, if investors rely on professional intermediaries for information and advice. Hence, post-crisis, the regulatory standardisation of disclosure of key investor protection items and risk profiles has been brought in. Such standardisation may help facilitate investor scrutiny and governance, as investor scrutiny is now based on comparable and standardised information. Regulatory standardisation does not mean that investor scrutiny is replaced by regulatory enforcement; professional investors have resources to impose market discipline, via civil litigation for example. The AIFM Directive is arguably trying to strike a balance between recognising where regulatory intervention may be needed for investor protection, without overdoing investor protection where investor governance can be brought to bear.

Article 23(4)–(5) provides for post-investment periodic disclosure of how each AIF is managing its liquidity. Disclosure items include percentages of illiquid assets (in particular, whether redemption rights may be affected if investments are made in illiquid assets), the management of risks by each AIF, amounts of leverage, use of leverage and any changes thereto. The periodic disclosure required relates generally to fair treatment of investors, and revolves around whether side letters and arrangements are in place, and whether there may be changes in liquidity positions that may affect redemption rights.¹⁷⁷Periodic reporting also includes risk management techniques and the risk profiles of the AIFs.¹⁷⁸

175 See Chapter 3.

176Richard E Mendales, ‘Collateralized Explosive Devices: Why Securities Regulation Failed to Prevent the CDO Meltdown, and How to Fix it’ [2009] University of Illinois Law Review1359.

177Commission Delegated Regulation (EU) No 231/2013 of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (19 December 2012), art 108, also see ESMA, ‘Final Report: ESMA’s Technical Advice to the European Commission on Possible Implementing Measures of the Alternative Investment Fund Managers Directive’

(16 November 2011) ESMA/2011/379 www.esma.europa.eu/system/files/2011_379.pdf accessed 22 December 2012, 77–78, 80.

178Commission Delegated Regulation (EU) No 231/2013 of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (19 December 2012), art 108, adopting ESMA, ‘Final Report: ESMA’s Technical Advice to the European Commission on Possible Implementing Measures of the Alternative Investment Fund Managers Directive’

(16 November 2011) ESMA/2011/379 www.esma.europa.eu/system/files/2011_379.pdf accessed 22 December 2012, 230.

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Regular disclosure is also imposed on AIFMs to inform investors of issues in relation to the leverage levels employed by AIFs.¹⁷⁹ ESMA has provided prescriptive guidelines on the computation of leverage, not leaving it to discretionary Value-at-Risk methods preferred by the industry.¹⁸⁰ Leverage is to be reported to investors in accordance with those standards.

Reporting prudential issues to investors may engage them in individually considering their investment decisions, but such investor protection may sometimes be contrary to systemic risk concerns. The authors are doubtful whether investor governance over prudential issues is the appropriate approach. The likely investor action or reaction to any misunderstood prudential disclosures is redemption or flight and hence regulators should monitor the systemic impact of investor governance in this area. On the whole, the disclosure provisions may be inade -quate for the new investor protection regime in the AIFM Directive. There is an excessive focus on pre-sale disclosure that harks back to the days when disclosure was meant to address market failures and information asymmetries. Moreover, pre-sale disclosure may not significantly alter the irrational exuberance and herding tendencies in investing behaviour¹⁸¹ in good times. Post-sale disclosure, which is more important for the new regime of investor protection and civil litigation, should relate to the causes of action relevant to civil litigation, such as the discharge of duties, valuation activities and how these are undertaken and management of conflicts of interest. Instead, post-sale disclosure relates largely to prudential issues, such as liquidity and leverage. It is not suggested that such information is not important. Rather, the authors propose: (a) that post-sale disclosure should support possible causes of investor civil action in order to make the prospect of investor governance possible; and (b) that although information relating to leverage and liquidity is important, it is uncertain what investor

179Commission Delegated Regulation (EU) No 231/2013 of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (19 December 2012), art 109.

180Commission Delegated Regulation (EU) No 231/2013 of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (19 December 2012), arts 7–8, adopting ESMA, ‘Final report: ESMA’s technical advice to the European Commission on possible implementing measures of the Alternative Investment Fund Managers Directive’

(16 November 2011) ESMA/2011/379 www.esma.europa.eu/system/files/2011_379.pdf accessed 22 December 2012, 192–211.

181For a selection of behavioural literature in investing, see Thomas Gilovich, Dale Griffin and Daniel Kahneman (eds), Heuristics and Biases: The Psychology of Intuitive Judgment(Cambridge: Cambridge University Press 2002); Daniel Kahneman and Amos Tversky (eds), Choices, Values and Frames (Cambridge: Cambridge University Press 2003); Robert J Schiller, Irrational Exuberance(Princeton, NJ: Princeton University Press 2000); Hersh Shefrin, Beyond Greed and Fear (Oxford: Oxford University Press 2009); Papers at the Lewis & Clark Law School Business Law Forum: Behavioral Analysis of Corporate Law: Instruction or Distraction?’ (2006) 10 Lewis & Clark Law Review; Lynn A Stout, ‘The Mechanisms of Market Inefficiency: An Introduction to the New Finance’ (2003) 28 Journal of Corporation Law635; Robert Prentice, ‘Whither Securities Regulation?’ (2002) 51 Duke Law Journal1397.

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governance in relation to these issues would bring to the overall governance landscape. In particular, the potential systemic impact of chaotic investor behaviour at any sign of bad prudential news should be considered.

6.4.6 Stakeholder considerations for private equity fund