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Investor Protection

In view of the fact – as recognized by a large number of available empirical and theoretical studies – that the level of investor protection in a country largely influences the efficiency of the firms doing business in the country, it becomes important that an extensive study of the issues relating to the protection of the investors especially in the stocks and securities is undertaken. The investor protection also influences the growth of the stock market as well as the economic growth as a whole of any nation.

Because of the simple reason that any insufficiency in the investor protection may prove to be expensive, it also becomes important to understand the causes that may lead t...

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...o the investor protection being dropped to below optimal levels. Considering the importance of the phenomenon of investor protection, the countries have adopted various legislative and regulatory measures for ensuring the investor protection. One of the important and landmark legislations in this respect is the MiFID.

This study attempts to present a detailed account of the origin, importance, provisions, and the impact of MiFID in offering effective investor protection in the European Union. Though mostly descriptive, the study will make a critical analysis of some of the important provisions of MiFID in so far as to comment on the effectiveness of such provisions in ensuring investor protection. The materials and academic and professional resources necessary for exploration of the subject have been drawn from the web sites of the government of UK, European Union, other online resources, articles, publications, and books.

Introduction Investor protection can broadly be defined to include the surveillance by the stock exchanges, effective corporate and self–regulatory measures adopted by the enterprises themselves, assurance of the markets’ functions and schemes by which the investors may be enabled to claim their rights and benefits with respect to their investments. The investor protection with the legal means thus ensures that there is no expropriation of corporate funds for private objectives at the cost of the individual investor.

Without a proper investor protection mechanism in place it would be easier for the insiders of any corporate entity to steal away the profits of the firm efficiently and methodically. With the expansion in the scope and extent of the investor protection the activities of the insiders in the form of setting up intermediary companies to channelize the profits, making expropriations in the form of excess salary payments to selves, appointing relatives in key management positions and undertaking wasteful projects can be altogether prevented.

With the strongest investor protection in place the investors can be rest assured that the companies in the stocks of which they have invested can only pay dividends and can not in any way misappropriate the corporate funds. Examples of Investor Protection Although there are several legislative measures to take care of the investor protection the following are some of the examples of the means by which the investor protection can be ensured:

• Investor protection gives the right to the individual investor to receive dividends in prorate terms along with other claimants • The investors can vote for the proper persons to become the directors • The investor protection ensures the right of the individual investor to attend the shareholder’s meetings and express his/her opinion on the conduct of the affairs of the company • The investors by virtue of the protection available to them become entitled to subscribe new shares according to the same terms as applicable to the insiders

• The protection also gives the right to the individual investor to sue the directors or other people who are in a position to control the enterprise for alleged expropriation of funds • The investors can call extra-ordinary general meetings to discuss urgent and important issues connected with the conduct of the business • There are a number of provisions concerning the bankruptcy and reorganization of corporate entities which may be found to be beneficial to the investors for safeguarding their investments

• Similarly there are legal provisions to enable the creditors to take repossession of collateral securities offered covering the advances made by the creditors • There are legislations to protect the seniority of creditors which becomes important in cases the company has become bankrupt and unable to pay its creditors in full. • The investor protection legislations virtually limit the ability of the firms to receive any sort of protection from the court in cases of reorganization

Sources of Investor Protection The investor protection can be had from the legislations governing the registration and administration of companies, regulations governing the dealings in stocks and securities, laws relating to take-over and competition laws, rules and regulations prescribed by the stock exchanges and the updated accounting standards formulated by the standard setters across the world.

Apart from these sources, the enforcement provisions put in place by market regulators, practice and decisions by courts at various levels and the actions of the market participants also provide the necessary ground for the evolution of investor protection mechanisms. Investor Protection from Legal Perspective Most of the transactions relating to individual investments in the form of loans advanced to the corporate entities take the form of private contracts. In case if the private contracts are enforced swiftly and properly by the courts there may not be any necessity to have laws and regulations governing the investor protection.

The inherent problems with the courts are that they are either unwilling or unable to invest the necessary resources for ascertaining the facts pertaining to the complicated contracts. Moreover the courts have been found to be slow in progressing with the cases and at times are also found to be corrupt vitiating the impact of judgments. They are also subjected to political and governmental pressures in dealing with complicated issues that may affect the parties ruling the country.

Hence in order to have a better and efficient investor protection it would be advisable to have in place laws and regulations that restrict contracting but and at the same time enforced than to have unrestricted contracts that can not be enforced. The investor protection can be considered under both the perspectives of common law and civil law jurisdictions. Under Common law the legal rules are promulgated by the judges based on the precedents and mostly inspired by the general principles affecting the individual cases.

It may so happen that in the opinion of the judges, even unprecedented conduct by insiders may be viewed as an unfair one to the outside investors. Therefore under common law the insiders may get the fear of expansion of the legal precedents to additional violations contemplated to be committed by them. Such fear limits the idea of expropriation by the insiders. In quite contrast, the laws under civil law system are made by the legislatures and the judges are expected to act within the jurisdiction of the established legal boundaries.

In this case the corporate insiders with the intention of expropriating the corporate funds may find ways which are not expressly forbidden by law to act to the detriment of the investors. Thus the civil law system courts do not intervene in the investor expropriation cases as long as the insiders have some tangible business purposes to satisfy the legal requirements. Therefore it can reasonably be concluded by implication that the common law judges are more inclined to protect the outsiders rather than insiders when the question of investor protection comes.

From a historical and political perspective the position of the investor protection varies to the extent that the state has relatively greater role in regulating the business in civil law countries than the common law countries. In the civil law countries the state maintained political control over firms and resisted the surrender of power to financiers. Similarly the state did not have the inclination to surrender power over the economic decisions to the courts in those countries where the civil law system is being followed.

Historically the civil law governments are found to be more interventionist than the common law governments. Investor Protection and Ownership Structure The investor protection has a large influence in the ownership structure of the corporate undertakings in any country. Under circumstances where the investor protection is weak, the benefits accruing to the private controllers of the enterprises are more. It is quite obvious that since any expropriation activity has to be carried out in secrecy the entrepreneur would not like to share the control of the enterprise with others.

The diffuse control structures are generally considered unstable, as it would be impossible for the investors to gain total control without paying for it fully. It may be the case that the entrepreneur or family may need to retain the control over the firm in order to raise external funds when the legal protection to the outside investor is poor. In such situations the creditors may expect the personal guarantees of the entrepreneur and his close family members for the settlement of his funds from the personal assets of the entrepreneur.

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