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June 5, 2023

Cybersecurity & Governance: Navigating the Challenges

Uncover the link between cybersecurity risks and corporate governance, learn about threats, proactive measures, and safeguarding data. Stay protected with expert advice and best practices.

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Businesses today face a critical issue that cannot be ignored: the dual importance of corporate governance and cybersecurity.

The projected cost of cybercrime worldwide is expected to exceed $8 trillion annually in 2023, and the United Kingdom government’s 2022 Cyber Security Breaches Survey found that 39% of businesses had identified a cyberattack in the previous twelve months.

Indeed, as the alarming rate of cyber threats rises along with the potential of successful hacking attempts on businesses, you must remain alert and consistently proactive to secure your business data and ensure the wholesale safety of your operations. At the same time, it is important, both as a legal requirement and for the safety of your business, that you have full and effective corporate governance in place.  

By combining these two key focus areas, cybersecurity together with corporate governance, you will be able to help your clients achieve their desired long-term success whilst building trust with your stakeholders and safeguarding their reputation. Here, we explore the close relationship between cybersecurity and corporate governance and stress the importance of prioritizing both. So, let’s delve into how paying close attention to these two areas will benefit your business.  

In this article, we will cover the following:

Cybersecurity: Protecting Your Business from Digital Threats

Cybersecurity is a huge concern for governments, businesses, and individuals alike. Over the past couple of years, it has received significant political attention in both the US and the UK and is a prominent discussion topic amongst the business community. The UK government has released numerous reports on the issue, such as the FTSE 350 Cyber Governance Health Check Report in 2018, which examined how the FTSE 350 – that is, the 350 largest companies as defined by their market capitalization share on the London Stock Market – were managing their security risks. Now, in 2023, the European Union Agency for Cybersecurity is seeking to standardize EU cybersecurity legislation as a matter of urgency. This matter is being taken seriously across the board, and,  as the prestigious international law firm Slaughter and May has noted, the UK government has categorized cybersecurity as a “Tier 1 threat” that ranks alongside terrorism.  As this has become such a significant issue on the world political stage, it is essential to grant it the same level of attention in the boardroom.

With more sensitive data being stored via technological means, the risk of cyber-attacks and data breaches has increased substantially. In an attempt to mitigate these risks, companies are, by necessity, firming up their cybersecurity governance framework and best practices to ensure the safety of their digital assets. We’re sure we don’t need to tell you how the implementation of robust cybersecurity policies and procedures will help to protect your business from potential threats, as well as safeguard the valuable information you hold. However, staying ahead of the ever-changing nature of cybersecurity threats can be extremely challenging. That’s why it is so vital that you embed a fundamental cybersecurity governance strategy in your business..  

Have you considered whether your company is taking sufficient measures to ensure its cyber security? There is an ongoing danger of complacency on the part of companies, and it is crucial that directors acknowledge that cyber security is not just a trendy term or a technical issue relevant to IT teams, but an aspect that warrants attention at the board level for continued business growth and success.  

As Luis Aguilar, Commissioner at the United States Securities and Exchange Commission (SEC) warned as far back as 2014, the failure to implement strong risk and crisis management protocols could expose directors and companies to significant legal risks, including the accusation of breaches of corporate governance, directors’ duties, and disclosure obligations.

Securing the Board: Awareness of Cybersecurity Risks

As the multinational professional service firm, Price Waterhouse Coopers reported in 2022,  

“Cyber is a complex, technical area with emerging threats occurring almost weekly. Most board members are not cyber experts, yet boards have an obligation to understand and oversee this significant risk. They need active engagement with leadership, access to expertise, and robust information and reporting from management.”

The ever-evolving nature of cyber threats and the unpredictable motives and actions of malicious actors make it difficult to anticipate risks. Traditional risk governance models that have previously proven successful for physical and financial assets are mostly ineffective in tackling cyber risks – and the risks are multiple.

One of the most significant risks by which cybersecurity problems can harm an organization and its reputation occurs in the event that a hacker is able to obtain confidential information, such as bank account or credit card details, which can be sold on the “dark web”. This may result in a company’s loss of its banking or credit card privileges and the breach of privacy laws. Each month, high-profile security breaches affecting personal data are reported globally.

Recently, ransomware has become a major concern, with reports of commercially focused campaigns dating back to 2012. You also need to be aware of the many problems related to hacking. A hacker who gains access to sensitive information then achieves the ability to damage an organization’s reputation – an especially devastating risk for small companies that may struggle to recover from the loss of goodwill. That’s not to mention the risk of legal or regulatory action if customer data is lost or if a third-party files a lawsuit. A single breach of privacy laws has the potential to result in significant penalties and legal action. As the types of risks constantly evolve, companies are best advised to consult specialists to identify their most notable risks. The non-profit Bipartisan Policy Center in the United States has identified the cyber hazards that companies are most likely to face in 2023, along with the advised critical actions that directors and their company boards can take.

Corporate Governance and Effective Cyber Risk Management

The results of a study conducted by a top 200 UK law firm are very concerning. The study found that over 80% of firms had at least one vulnerable service that hackers could exploit.

It isn’t only hacking from outsiders that’s the problem. There is also the risk of insider threats, from employees who knowingly or unknowingly reveal sensitive information, not to mention the threat of disgruntled employees who may purposefully disclose information in exchange for compensation. Threats abound, from malware as a service, the lowered price of which has effectively democratized the hacking landscape. Then there are phishing links, the compromising of business emails, and the security vulnerability of cloud networks, to mention merely a few.  

All this means that it is necessary that businesses and law firms are acutely aware of any vulnerabilities and chinks in their armor and take steps to plug them. This is such a serious issue that in 2021 the Ninth Circuit Court of the United States reminded public companies of the vital importance of updating their risk factors in regard to cybersecurity, whilst the US Securities and Exchange Commission has long focused on cybersecurity risks.

Solving Common Governance Issues in Cybersecurity

The cyber risk landscape constantly evolves, and bad actors pose a constant threat. One problem with cyber risk is that it’s difficult to quantify. This means that governance boards are grappling with emerging risks and how to best exercise their duty of care to the highest standards. Companies must also be aware of the downfalls they face in the Inaccurate mapping of existing and potential risks that can lead to the underestimation of risk, as well as confirmation bias, and any overconfidence on the part of management and company directors. As a 2020 study on cybersecurity and challenges in corporate governance quoted one company director,

“Boards are illiterate about cybersecurity and the company’s reliance on information technology. But enterprise access to the internet is fundamental to delivering value, and all those transactions that rely on access to the internet are inherently unsafe”.

Yet the Corporate Governance Institute has noted that despite the increased attention firms now devote to cyber-risk. 95% of board committees only discuss both cyber and tech risks only circa four times a year.  

Many company directors have admitted the inadequacy of their board oversight processes for cyber risk, blaming its constantly changing nature. Even the boards proficient in managing intricate financial risks, like those of major banks, are still trying to determine the most effective way to oversee cybersecurity, especially in light of the never-ending demand for technology and connectivity from customers and managers. This means that thought must be paid to the creation of new, specific cybersecurity governance roles and responsibilities, as companies have discovered that they cannot simply delegate the management of cyber risk to their IT department. As one director has acknowledged, there is an ongoing blurring between operational technology and IT, so

“if we limit cybersecurity to just IT, we’re leaving ourselves vulnerable”.

Building a Strong Cyber Shield: The Art of Board Composition

As board governance is commonly expressed through the establishment of principles, a fixed set of rules may not be the best way to regulate cyber security. Instead, a principles-based method will enable every board to define and evaluate their individual direction while working within an established framework. The World Economic Forum has provided a significant reference study for companies that seek to formulate their organization's cybersecurity strategy and engage with stakeholders on cyber risk, and is particularly helpful for its provision of six consensus principles for cybersecurity board governance.

Boards need to fully understand their exposure to cyber risk whilst taking proper ownership of company security, with full orientation on detail. Then, a wholesale holistic approach is necessary that reduces the complexity of the technology and fully addresses processes as well as company culture and human vulnerabilities within the organization. Boards must ensure that cyber security provisions are independently validated and tested, just like any other important matter, and that a careful approach is taken to the legal and regulatory environment regarding cyber security as it becomes ever-more more intricate worldwide. This includes aspects such as industry-specific regulations, data protection laws, national security policies, and reporting obligations.  

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Cybersecurity Risk in ESG Oversight and Disclosures

Companies need to develop and sustain a well-thought-out global approach. It’s a tough challenge, and that’s not to mention the real risk of personal liability for company directors and officers. In fact, it's quite possible that European authorities, including the UK, may follow the lead of US counterparts and hold directors personally liable if management failings lead to a cybersecurity breach or mishandling of one. This approach is similar to the current stance taken by authorities and regulators in various jurisdictions on environmental, social, and governance (ESG) disclosure requirements & examples. In fact, this issue is so important that the SEC has emphasized its focus on cybersecurity in recent years. In 2022, the SEC Chair Gary Gensler announced plans to request staff recommendations for disclosing cybersecurity practices, risk disclosures, and public disclosure of cyber events, with the aim of providing consistent, comparable, and decision-useful information.  

The Crucial Safeguarding Role of the Executive Committee

If you are to ensure the role of transparency in your board governance, then you need to ensure that you have put a robust corporate governance system in place. For many firms, this may mean a total recalibration of the executive committee structure. Companies should now regularly evaluate their risk response and question whether it is keeping up with the pace of development. This includes the careful consideration of executive committee roles & responsibilities, and challenging executive management to ensure that the response is sufficient and evolving as required. Another major issue concerns the need to note vulnerabilities and envisage and prepare for incidents well in advance. Companies would be best served by considering the roles allocated to the executive committee versus the board of directors, considering the suppliers and service providers instead of solely focusing on the organization, and implementing appropriate response strategies across all levels of the organization.

Summary

Ultimately, it is vital to emphasize the importance of good corporate governance in protecting your company, shareholders, and clients. Whilst many companies and their boards are taking on this challenging role and performing it well by being active, informed, independent, involved, and focused on shareholder interests, there’s still a long way to go – and it isn’t helped by the way cyber-risks are evolving, with the constant emergence of malicious software.  Boards, therefore, have no choice but to adapt and oversee cyber-risk management to prevent and prepare for potential harm. Proper preparation, deliberation, and engagement are essential.

About this article

Sources

Aguilar, L. (2014) Board of Directors, Corporate Governance and Cyber-Risks: Sharpening the Focus.  US Securities and Exchange Commission.
Romanoff, T.; Neschke, S.; Draper, D.; Farschi, J.; Lord, B.; Douglas, A.(2023) “Top Risks in Cybersecurity 2023” Bipartisan Policy Center  
Caisley, L. (2023) “Directors face personal liability over cybersecurity” White & Case Tech Newsflash    
Crowe. (2018) “Fraud and cybercrime vulnerabilities in the legal sector: Research into the risks impacting the top 200 law firms”
Esentire (2022)   “Official Cybercrime Report”  
European Union Agency for Cybersecurity (2023) “How Cybersecurity Standards Support the EU Evolving Legislative Landscape”
Gensler, G. (2022). “Remarks on Cybersecurity and Securities Laws at the Northwestern University Pritzker School of Law” US Securities and Exchange Commission.  
Ivory, I.; F Pittman, F.P.; Timmons, J.; Caisley, L.; Burke, A.; Hahn, A.A.; Turgel, D (2023) “Cybersecurity Developments and Legal Issues” White & Case.  
Phelps, B.; Cleaveland, A.; Weber, S. (2020) “Resilient Governance for Boards of Directors: Considerations for Effective Oversight of Cyber Risk”. Berkeley, CA, and McLean, VA: Center for Long-Term Cybersecurity and Booz Allen Hamilton.
Price Waterhouse Coopers (2022) Overseeing Cyber Risk: The Board’s Role.  
Slaughter and May (2017) “Cyber Security: Corporate insights for companies and their directors”.
Stark, T.; Pittman, F.P.; Diamond, C. J.; Gez, M. (2021) “Time to Revisit Risk Factors in Periodic Reports” White & Case.  
Summer, P.; Day, J.; Mahoney, M. (2020) “Cybersecurity: An Evolving Governance Challenge” Harvard Law School.  
The Corporate Governance Institute (2020) @CorpGovInst. “Cyber risk massively important at boardroom level”
The World Economic Forum. (2021). “Principles for Board Governance of Cyber Risk”
UK Government. (2018) FTSE 350 Cyber Governance Health Check Report 2018  
UK Government (2022) Official Statistics: Cyber Security Breaches Survey 2022
Ursillo, S. and Arnold, C. (2023) “Cybersecurity Is Critical for all Organizations – Large and Small” International Federation of Accountants.

Images

Featured Image: Photo by Arif Riyanto on Unsplash
Featured CTA blog post: Photo by Jurica Koletić on Unsplash / Photo by Christina @ wocintechchat.com on Unsplash

Published by Alexandra Singer in Corporate Governance
Tags: Corporate Governance, Cybersecurity
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May 3, 2023

Corporate Social Responsibility in Legal Ops

The need-to-knows of corporate social responsibility and how it impacts legal operations. Explore this article to start building CSR into your legal operations.

Dear Legal Ops!
Welcome to this week’s Let’s talk about Legal Ops, offered by Newton. We tackle corporate legal departments, speed up processes, and career growth. Please send us your questions; in return, we come back with real insights and actionable tips.
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Corporate social responsibility (CSR) is an increasingly important aspect of business, encompassing a wide range of initiatives that go beyond traditional business objectives.

Due to the nature of the topic – which we’ll delve into in this blog – CSR is increasingly falling into the scope of legal departments. With this in mind, it is critical for in-house legal teams to understand the role that CSR plays in the company’s overall strategy and to ensure that wider CSR initiatives are aligned with legal requirements and best practices.

In this article, we’ll provide an overview of CSR and why it is important for businesses to consider. We’ll also explore why in-house legal professionals need to care about CSR, how it can impact legal teams and how you can start building CSR into your legal operations.

In this article, we will cover the following:

What is corporate social responsibility?

Corporate social responsibility (CSR) is a concept that refers to a company’s responsibility to contribute to sustainable development and to take into account the social and environmental impacts of its business operations. CSR is a broader framework that encompasses the ethical, social, and environmental responsibilities of companies – commonly known as ESG in the legal space – towards their stakeholders, including employees, customers, suppliers, and communities where they operate.

The evolution of CSR

The concept of CSR has evolved over time and has become an essential aspect of modern business practices. CSR activities can range from implementing sustainable business practices to reducing environmental impacts and investing in local communities. Some companies take it a step further by supporting causes related to social justice, diversity, equity, and inclusion.

Where CSR initiatives were originally driven by those with an interest in these topics, it is now a company-wide commitment with responsibility for CSR being shared across various departments. In-house legal teams have a key role to play in helping to ensure that CSR is integrated into the company’s operations, and that the business is acting in a socially responsible and legally compliant manner.

The benefits of CSR

The benefits of CSR are vast, both for companies and their stakeholders. CSR initiatives can enhance a company’s reputation, strengthen its brand image, and improve customer loyalty. Additionally, CSR activities can help reduce risks associated with social and environmental issues, improve employee satisfaction, and attract and retain talent.

In fact, 88% of employees believe it’s no longer acceptable for companies to make money at the expense of society at large.

However, the benefits of CSR are not solely selfless. It’s also about building a sustainable business model that creates long-term value for all stakeholders. In the long run, companies that embrace CSR are likely to be more successful, as they are better equipped to respond to social and environmental challenges and adapt to changing stakeholder expectations.

From a legal department perspective, the enhanced brand reputation that accompanies CSR commitments can help to attract and retain talent. This can result in a higher-performing and more engaged legal team.

Strong CSR programs can also help to reduce legal risks and liabilities, as companies that are committed to social responsibility are often seen as more trustworthy and reliable by regulators, customers, and other stakeholders. This can help to mitigate legal risks and liabilities associated with non-compliance with laws and regulations, as well as potential reputational damage resulting from unethical behavior.

Finally, CSR can provide in-house legal teams with the opportunity to take a leadership role within the company, by providing legal expertise and guidance to support the development and implementation of CSR policies and initiatives. This helps to position the legal function as a strategic business partner, elevating the profile of legal within the business.

Why should in-house lawyers care about CSR?

Lawyers, particularly in-house legal teams and general counsel, should care about CSR for several reasons.

Risk management

CSR issues can pose significant risks to companies, including legal, financial, and reputational risks. By addressing CSR issues proactively, in-house legal teams can help minimize these risks and protect the company’s interests.

Compliance

Many CSR issues are subject to legal requirements and regulations. In-house legal teams play a crucial role in ensuring that the company complies with these requirements and avoids legal liability.

Reputation

A company’s reputation is closely tied to its CSR performance. By promoting CSR initiatives and addressing CSR issues, in-house legal teams can help enhance the company’s reputation and build trust with stakeholders.

Competitive advantage

Companies that are committed to CSR can gain a competitive advantage by differentiating themselves from their competitors, attracting customers who prioritize social and environmental responsibility, and enhancing their brand value.

Employee engagement

CSR can also be an important factor in attracting and retaining talent. In-house legal teams can help support employee engagement by promoting CSR initiatives and creating a workplace culture that values social and environmental responsibility.

In essence, CSR can help manage risk, ensure compliance, enhance reputation, gain competitive advantage, and promote employee engagement. By prioritizing CSR, in-house legal teams can play a critical role in advancing the company’s social and environmental goals and promoting ethical behavior.

The four types of CSR

To deliver CSR programs effectively, it’s important for legal teams to understand the four types of Corporate Social Responsibility (CSR).

1. Environmental Responsibility

This type of CSR involves a company’s efforts to reduce its environmental impact, including reducing carbon emissions, conserving resources, and minimizing waste. In an in-house legal context, environmental responsibility can include compliance with environmental laws and regulations, advising on sustainability initiatives, and managing environmental risks.

2. Ethical Responsibility

This type of CSR involves a company’s commitment to ethical business practices, such as transparency, honesty, and fairness. In an in-house legal context, ethical responsibility can include advising on compliance with laws and regulations, developing codes of conduct and ethics policies, and managing legal risks associated with unethical behavior.

3. Philanthropic Responsibility

This type of CSR involves a company’s charitable contributions and community engagement initiatives. In an in-house legal context, philanthropic responsibility can include advising on charitable giving, ensuring compliance with tax laws and regulations, and managing legal risks associated with corporate giving.

4. Economic Responsibility

This type of CSR involves a company’s commitment to creating economic value for its stakeholders, including shareholders, employees, customers, and suppliers. In an in-house legal context, economic responsibility can include advising on corporate governance, financial disclosure, and compliance with laws and regulations related to business operations.

For in-house legal teams, it is important to understand the different types of CSR and how they relate to the company’s legal obligations and business objectives. By working closely with other departments, such as sustainability, finance, and human resources, in-house legal teams can help ensure that the company’s CSR initiatives are aligned with its legal obligations and business objectives. Additionally, in-house legal teams can provide guidance on legal compliance, risk management, and stakeholder engagement, helping the company to build a strong and sustainable CSR program.

CSR has become an increasingly important issue for businesses in recent years, and it is no different for legal operations. In this section, we’ll explore what CSR means for legal operations and how legal teams can enable and support CSR initiatives.

One way that legal operations can support CSR is by ensuring that the company’s legal operations are conducted in a responsible and ethical manner. This includes ensuring compliance with all relevant laws and regulations, as well as implementing best practices that support sustainability and social responsibility. For example, legal teams can help ensure that the company’s contracts include provisions that require suppliers and vendors to adhere to the company’s CSR policies and standards.

Legal teams can also play a key role in supporting the company’s CSR initiatives by providing legal guidance and advice. This includes identifying legal risks and opportunities associated with CSR initiatives, reviewing and drafting policies and procedures, and providing guidance on legal compliance requirements related to CSR initiatives. Legal teams can also assist with reporting on CSR initiatives and ensuring compliance with relevant regulations.

Another way that legal operations can support CSR is by promoting transparency and accountability. Legal teams can help ensure that the company’s CSR initiatives are accurately reported and disclosed to stakeholders, including investors, customers, and the general public. This includes providing legal guidance on sustainability reporting standards, ensuring compliance with relevant disclosure requirements, and assisting with the preparation of CSR reports and disclosures.

In summary, CSR is an important issue for legal operations, and legal teams can play a key role in enabling and supporting CSR initiatives. By ensuring that legal operations are conducted in a responsible and ethical manner, providing legal guidance and advice, promoting transparency and accountability, and supporting the company’'s overall CSR strategy, legal teams can help drive sustainable growth and create long-term value for stakeholders.

Governance through a CSR lens

Corporate social responsibility (CSR) and corporate governance are closely related, as both are focused on ensuring that companies operate in a responsible and ethical manner. In this section, we’ll explore the relationship between CSR and corporate governance, and provide some examples of how governance can support CSR initiatives.

Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled. Good corporate governance is essential for ensuring that companies operate in a responsible and ethical manner, and that they are accountable to stakeholders.

CSR is an important component of corporate governance, as it ensures that companies take into account the social and environmental impact of their operations. By implementing CSR initiatives, companies can demonstrate their commitment to ethical behavior and corporate citizenship, and enhance their reputation with stakeholders.

One example of how governance can support CSR is through the establishment of a board-level CSR committee. This committee is responsible for overseeing the company’s CSR strategy and ensuring that it aligns with the company’s values and goals. The committee can also provide guidance on how to address any legal or ethical issues that arise, and ensure that CSR initiatives are effectively communicated to stakeholders.

Another example of how governance can support CSR is through the establishment of a code of conduct or ethics policy. This policy sets out the company’s standards for ethical behavior, and provides guidance on how employees should behave in various situations. The policy can also include provisions that require suppliers and vendors to adhere to the company’s CSR policies and standards.

Finally, governance can support CSR through the establishment of reporting and disclosure requirements. By requiring companies to disclose information on their CSR initiatives and performance, stakeholders can make informed decisions about the companies they choose to invest in or do business with. This can help incentivize companies to prioritize CSR initiatives and enhance their reputation with stakeholders.

In summary, corporate governance is an essential component of CSR, as it ensures that companies operate in a responsible and ethical manner. By establishing a board-level CSR committee, a code of conduct or ethics policy, and reporting and disclosure requirements, companies can demonstrate their commitment to CSR and enhance their reputation with stakeholders.

Building CSR into legal operations can be a daunting task, but with a strategic approach, it can be achievable. In this section, we’ll provide a strategy for how in-house legal teams can build CSR into their legal operations.

1. Identify CSR goals and values

The first challenge lies in identifying which areas of sustainability need the most attention from the legal department.

The first step in building CSR into legal operations is to identify the company’s CSR goals and values. This requires a thorough understanding of the company’s mission and values, as well as its impact on stakeholders and the environment. The legal team can then align its operations with these goals and values, and identify opportunities to support CSR initiatives.

2. Develop a CSR policy

The legal team should develop a CSR policy that outlines the company’s commitment to CSR and provides guidance on how to integrate CSR into legal operations. The policy should include provisions that require legal team members to consider the social and environmental impact of their work, and provide guidance on how to address any legal or ethical issues that arise.

3. Establish a CSR committee

The legal team should establish a CSR committee that is responsible for overseeing the company’s CSR strategy and ensuring that it aligns with the company’s goals and values. The committee can also provide guidance on how to address legal or ethical issues that arise in legal operations, and ensure that legal team members are trained on CSR issues.

4. Review contracts and agreements

The legal team should review all contracts and agreements to ensure that they align with the company’s CSR goals and values. This includes ensuring that suppliers and vendors are required to adhere to the company’s CSR policies and standards, and that contracts include provisions for ethical behavior.

5. Provide CSR training

The legal team should provide CSR training for all legal team members, including training on the company’s CSR policy, legal requirements related to CSR, and how to integrate CSR into legal operations. This training can help ensure that legal team members are aware of the company’s CSR goals and values, and have the skills and knowledge necessary to support CSR initiatives.

6. Monitor and report on CSR performance

Finally, the legal team should monitor and report on the company’s CSR performance, and provide regular updates to the CSR committee and other stakeholders. This can help identify areas where the company can improve its CSR performance, and demonstrate the company’s commitment to CSR to stakeholders.

In summary, building CSR into legal operations requires a strategic approach that includes identifying CSR goals and values, developing a CSR policy, establishing a CSR committee, reviewing contracts and agreements, providing CSR training, and monitoring and reporting on CSR performance. By following this strategy, in-house legal teams can build CSR into their legal operations and demonstrate the company’s commitment to ethical behavior and corporate citizenship.

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A few examples to inspire your CSR initiatives

To offer a little inspiration for your own CSR initiatives, here are some real-world examples of companies making a positive impact through their social responsibility programs.

Bates Wells

Bates Wells is a law firm that focuses on social impact, and their work showcases a strong commitment to CSR. The firm provides legal services to charities, social enterprises, and businesses that prioritize social impact. Bates Wells is a certified B Corp, which means that they meet rigorous social and environmental standards, and have a positive impact on their clients, employees, and the wider community. The firm also has a Pro Bono Program, which provides free legal advice to charities and social enterprises. Additionally, Bates Wells has a Diversity and Inclusion strategy, which aims to create a more diverse and inclusive workplace. By prioritizing social impact, Bates Wells sets an example for other law firms and shows that businesses can be profitable while also making a positive impact on society.

Ecosia

Ecosia is a search engine that plants trees with its advertising revenue. Their CSR program is built around their commitment to fighting climate change and reforestation efforts around the world. Since 2009, the company has planted over 170 million trees and funded projects in more than 30 countries. Their dedication to environmental causes has earned them a B Corp certification and recognition as one of the world’s most innovative companies. By using Ecosia as a search engine, individuals and businesses can contribute to their CSR efforts and help make a positive impact on the planet.

Tier

Tier is a micro-mobility company that is committed to sustainability and social responsibility. They have several initiatives to reduce their environmental impact, such as using renewable energy sources and electric vehicles in their operations, and working to make their vehicles more recyclable. They also have programs to improve safety and accessibility in the communities in which they operate and to promote public health by encouraging active transportation.

Robson Laidler

Robson Laidler is a UK-based accounting firm committed to making a positive impact on its clients, community, and the environment. The company is recognized as a B Corp and donates 5% of its profits to its own Community Fund for charitable causes in the North East of England. It partners with Buy1Give1 to support a variety of sustainable development projects worldwide, including access to clean water, medical support, education, and nourishing meals.

Phi Capital Investments Limited (SimplyPhi)

Phi Capital Investments Limited is a UK-based asset management firm that is committed to sustainable and responsible investing. The company aims to create value for its clients by investing in companies that have a positive impact on society and the environment, while also delivering competitive returns. Phi Capital Investments Limited has a rigorous investment process that takes into account environmental, social, and governance (ESG) factors. The company also engages with the companies in which it invests to encourage them to adopt sustainable practices.

Summary

CSR is an essential aspect of modern business practices, encompassing a company’s ethical, social, and environmental responsibilities. It’s a framework for building a sustainable business model that creates long-term value for all stakeholders. By embracing CSR, companies can enhance their reputation, reduce risks, and build a more resilient and successful business.

Newton delivers an easy and intuitive platform to manage and automate your legal entities’ information, governance, and compliance. If your entity management processes are currently creating friction for your team (which they are for many), be sure to get in touch to explore how Newton can help you have everything you need to be in control of your entity portfolio.

About this article

Sources

Harvard Business School (2021). 15 Eye-opening corporate social responsibility statistics
Harvard Business School (2021). Types of Corporate Social Responsibility To Be Aware Of
Robson Laidler (2023). Impact
Ecosia (2023)
Tier (2023)
Simply Phi (2023)
Bates Wells (2023)
EY (2022).The General Counsel Imperative: How the law department is key in unlocking your sustainability strategy

Images

Featured Image: Photo by Gabriel Jimenez on Unsplash
Featured CTA blog post: Photo by Jurica Koletić on Unsplash / Photo by Christina @ wocintechchat.com on Unsplash

Published by Steph Smith in Corporate Governance
Tags: Corporate Social Responsibility, CSR, Examples
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May 2, 2023

What is ESG? A Guide for Legal Teams

ESG has become an important topic for in-house legal teams globally. But what exactly is it? This article acts as an introduction to ESG for in-house legal.

Dear Legal Ops!
Welcome to this week’s Let’s talk about Legal Ops, offered by Newton. We tackle corporate legal departments, speed up processes, and career growth. Please send us your questions; in return, we come back with real insights and actionable tips.
If you find this post valuable, don't miss the chance to check out our latest posts.

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When you think of an in-house lawyer or legal team, it’s fair to first associate these roles with traditional legal work. Yet, as the world of business evolves and global priorities shift, the role of in-house legal continues to evolve.

Whether it’s out of peaked interest or as a matter of strategic and ethical importance, one area consuming an increasing proportion of in-house legal teams’ time are the topics of environment, social, and governance; better known as “ESG”.

In fact, as of 2020, 88% of publicly traded companies, 79% of venture and private equity-backed companies, and 67% of privately-owned companies had ESG initiatives in place. This commitment indicates the rising strategic importance of these topics.

For in-house legal functions, it is critical to deliver on these new responsibilities if they are to suitably protect the company and contribute to strategic growth.

But what exactly is ESG? And what does it mean for in-house legal functions? Below, we share an introduction to ESG for in-house legal teams.

In this article, we will cover the following:

What is ESG?

ESG is a set of non-financial measurements around environmental, social, and governmental performance.

It has become a hot topic for legal departments across the globe over the last five years and it has not come without a degree of confusion and hesitation.

General Counsel (GC) report significant pressure from their employee base, institutional investors, customers, and advocacy groups to increase their company’s commitment to ESG, with 78% of GCs having faced such pressure in the past three years.

The surmounting pressure to see positive action taken on environmental, social, and governmental matters has resulted in ESG becoming a legal issue requiring a sensitive yet strategic approach.

While it might seem daunting, tackling ESG is a great opportunity for legal teams to position themselves as strategic business partners. This is thanks to a focus on these topics often uncovering more effective, more efficient ways of operating as well as establishing a stronger company reputation.

Why is ESG important?

Take a look at your personal life or the consumer market. The rise of reusable bags. The banning of plastic straws. Low-emission zones popping up in cities across the world. There’s no denying the global shift towards a more environmentally friendly and fair society, which has flooded into the business world.

Implementing ESG  practices has proven to be good for business, so much so that

investments in companies with good ESG performance have generally yielded higher returns than the average within their broader market.

Inflows into sustainable funds rose from $5 billion in 2018 to nearly $70 billion in 2021. This has likely contributed to investors demanding additional non-financial reporting to measure risks like climate change.

Moreover, customers and employees are now actively looking for companies demonstrating strong ESG values. These heightened expectations have raised the bar for environmental and ethical standards in business.

While ESG is important for many reasons, an undeniable push for companies to implement ESG programs is the introduction of regulations from governments across the world. For example, governments have introduced strict regulations on company carbon emissions following The Paris Agreement in 2015 and the EU CSRD requires broad ESG reporting from both EU companies and companies with substantial EU operations.

And these regulations aren’t for show; companies are required to transparently report on ESG factors and the actions they take to address inadequate matters. So, whether we like it or not, regulations are coming, and in-house counsel must prepare to accommodate them.

So whether your company is trying to attract and retain the best talent, improve the bottom line, or meet regulation requirements, there’s no denying the growing importance of ESG and its place in the legal function.

The ‘E’ in ESG: Environment

The world has seen the devastating outcomes of climate change over the last few years, which has put mounting pressure on companies to bring environmentally friendly and sustainable practices to the forefront.

When it comes to the environment, the best place for in-house legal teams to start is by thinking about carbon, water, and waste.

These are the three key environmental areas that the legal team can explore and impact.

While one might assume that an in-house lawyer is distant from the environmental impact of day-to-day business activities, the legal department controls the contracts and boundaries in which the company operates.

Therefore, as a common entry and exit point of business dealings, it is the legal team that has the ability to specify, regulate, and monitor the environmental standards of the business.

The ‘S’ in ESG: Social

Social is an increasingly important – and increasingly visible – pillar of ESG. On the surface, you might assume that social matters are limited to the likes of labor law, working practices, diversity, equity and inclusion (DE&I), social benefits and human rights.

These topics are certainly still a high priority.

53% of companies still currently have no diversity initiatives in place and 49% currently do not use diversity data in counsel selection.

However, ESG shines a light on the full spectrum of social challenges that a company faces and has the ability to impact. For example, increasingly, well-being and mental health, employee feedback and work/life balance are landing in the realm of legal. Why? Because the baseline expectations for each of these matters have changed – not to mention their impact on company performance.

But it doesn’t stop there. While it’s common to first think about your employees, the social aspect of ESG extends to your supply chain and the communities in which your business operates. Do your subcontractors have adequate working conditions? Do your physical premises attract or detract from their local communities?

What are the biggest levers available to your company that can impact social issues for the better?

The ‘G’ in ESG: Governance

To date, conversations around ESG have focused heavily on environmental and social matters. Perhaps this is a result of topical challenges arising that have required urgent addressing, or perhaps it is because these themes are often easier to articulate.

Nevertheless, governance is a key pillar that cannot be overlooked. Governance refers to the structures, policies, and processes that businesses use to deliver their day-to-day activities and achieve their objectives. It refers to the structure and execution of decision-making as well as the distribution of responsibilities across the company – whether that be the board of directors, managers, employees, or wider stakeholders.

Good corporate governance is all about getting the aforementioned structure and execution right. It’s about working towards company objectives in a way that is fair, right, and aligned to company commitments and expectations as far as the environment, social, and performance are concerned.

As ESG advocate Christine Uri said, “the “G” is not sexy”; and she’s right. Outside of corporate scandals - such as with Lehman Brothers or Enron - governance doesn’t tend to offer clear evidence or stories to secure buy-in and engagement.

That said, both environmental and social performance is dependent on appropriate, effective corporate governance, so it should not be underestimated.

How to achieve best-in-class Governance

We recently had the opportunity to speak with Patricia Lenkov, a New York-based corporate governance expert with over 25 years of experience as an Executive Search professional, Board Advisor, and Board Member. Patricia shared with us valuable insights and best practices to help in-house legal teams achieve effective governance.

The foundation of good governance is having a diverse board with a heterogeneous composition of expertise including strategy, business, risk, legal, cybersecurity, and finance. When first embedding diversity in your board,  you may experience longer decision-making processes as you adjust to more perspectives around the table but, ultimately, it results in better decision-making and more impactful outcomes.

Regarding governance in ESG, Patricia has observed a significant shift in practices over the last two decades. In her early career in the early 2000, board meetings were often seen as a "meet and greet" opportunity for members who had known each other for a long time. Nowadays, boards play a more significant role and are accountable to stakeholders and shareholders. Every member must bring specific expertise to justify their position in protecting and propelling the business forward.

The board must now be up-to-date, informed, have opinions, and be capable of tackling various challenges while being subject to performance reviews. While the quality of these reviews is still open to debate and can be quite inconsistent, Patricia has seen as a major improvement in corporate governance.

The best practices for achieving effective governance are those that meet the expectations of shareholders, such as institutional investors, while also taking into account and managing the increasing stakeholders’ pressures of employees, customers, and suppliers.

Patricia emphasizes that human capital has become a crucial pillar of governance, especially after the Covid-19 pandemic. Where before it was a matter of compensation for C-Suite and particular senior leadership, she has since witnessed the cultural shift towards the need for a more flexible and mission-driven work environment, particularly from Gen Z. Those needs have become a critical aspect of modern corporations to attract and retain the best talent. The importance of human capital can be acknowledged in its ability to impact M&A activities. For example, a potentially lucrative M&A deal can be threatened if the consolidation of different companies, people, and cultures is not handled with care.

How to get started with ESG, an action list

Okay, now you know what ESG is and why it’s important for in-house legal teams. Here are five steps to help you begin to shape your ESG program.

Find your ESG allies

Legal is not the only stakeholder when it comes to ESG. Identify your key internal stakeholders and start the conversations. You’ll likely want to start with Finance, Operations and HR.

Identify your key risks and opportunities

ESG is a big topic and, understandably, you can’t tackle it all at once. In collaboration with your stakeholders, identify the top ESG risks and opportunities present for your company. Are there severe labor risks in your supply chain? Is your business lacking diversity? Are your carbon emissions through the roof?

Establish the baseline

Monitoring is a big part of an ESG program. Gather data on the top risks and opportunities that you have identified to establish your baseline. When you know your starting point, you can track how your actions are impacting the topic.

Make a plan

Actions speak louder than words. From your key risks and opportunities, choose two to five areas that you’d like to focus on (depending on the size of your team and company). Agree on your key performance metrics (KPIs) and map out what actions are required to achieve them.

Share the journey

Your business and the wider business ecosystem don’t expect perfection when it comes to ESG. It does, however, expect progress. Report your plans, actions and performance transparently. While this might be or become a regulatory necessity, it is also a great opportunity to develop internal engagement, build brand reputation, and shine a light on the great work you’re doing!

Repeat

ESG is an iterative process. It is only one part of the legal workload, so be strict with what you take on. Start with what will be most impactful and review and reprioritize accordingly every year or two. ESG is a transformational change, and it doesn’t happen overnight.

Extra tip

To dive deep and gain more knowledge on how to create ESG impact, Christine Uri shares possible integration on Contracts, M&A, and Quick approaches, such as including ESG requirements in supplier agreements.

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In summary

At first, ESG might feel like a big undertaking, but when you break it down into manageable, collaborative steps, the legal team can have a real impact on environmental, social, and governmental matters, as well as the bottom line!

The best place to start is simply by assessing your company’s biggest risks and opportunities – something that you’ll already be used to doing in your role.

Of course, ESG is encompassed under the wider legal operations umbrella, which you can learn more about on our blog.

Where does Newton fit into all of this?

Newton delivers an easy and intuitive platform to manage and automate your legal entities’ information, governance, and compliance. With governance being the foundation to all ESG matters, be sure to get in touch to explore how Newton can help you have everything you need to be in control of your entity portfolio.

About this article

Sources

Navex (2021). Global Survey Finds Businesses Increasing ESG Commitments, Spending
Trinity Business Review (2020). The Greatest Governance Failings of the 21st Century
United Nations (2016). What is the Paris Agreement?
McKinsey (2022). Does ESG really matter—and why?
Harvard (2021). The General Counsel View of ESG Risk
European Union (2023). Corporate sustainability reporting
Thomson Reuters Institute (2022). 2022 Legal Department Operations Index

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Published by Steph Smith in Corporate Governance
Tags: ESG
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April 19, 2023

Maximize Real Estate ROI in Netherland and Ireland

This article will teach you about the different legal entities available to real estate investors in the Netherlands and Ireland.

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Real estate investment is a profitable endeavor, but it is definitely not without its hazards and difficulties. As a real estate investor, one of the most crucial decisions that you’ll need to make will concern the selection of the appropriate legal structure for your investments. It’s vital that you make a wise decision in this regard, and in a previous article, we discussed this very issue, considering the planning involved and the beneficial assistance that legal technology can offer in making a determinative decision.

Indeed, it’s precisely this decision that will most significantly impact your tax liability, liability protection, and ease of doing business. In this article, we’ll explore how choosing the right legal entity can help maximize your real estate investment in the Netherlands and Ireland.

In this article, we will cover the following:

The Netherlands real estate market is a popular destination for investment, thanks to its stable economy, strong legal system, and favorable tax laws. It’s also always been a popular choice for foreign companies looking to invest for a number of attractive features; these include a stable political structure, a solid infrastructure, highly educated employees, and sound government finances. The country also offers a gateway to Europe, with Schiphol airport and the Rotterdam port offering sophisticated logistics and distribution services. The Netherlands is also renowned for its open and tolerant society and high quality of life, adding to its appeal for investors and businesses seeking to establish a presence. The favorable tax climate for investors is another benefit. In fact, the Dutch tax climate is considered so beneficial for foreign entrepreneurs that international corporate structures often use intermediate holdings in the Netherlands. However, steering through the legal and financial requirements of setting up a company can be daunting.

There are various ways that companies can structure their investment in the Netherlands real estate market, although as laws and regulations change, new structures or variations of existing ones may arise. Of course, each investor’s unique legal, financial, organizational, and tax planning needs must be considered when planning an investment. The BV is a private limited liability company. The relevant legislation permits incorporation with a par value of a mere €1, and denomination in a foreign currency is also possible. Shares can be created without profit rights. There is also no requirement for an auditor’s statement for contributions in kind, nor for asset acquisitions from the shareholder within a period of two years from incorporation. This all means that Dutch BVs are attractive corporate vehicles for both foreign companies and private investors in the Netherlands real estate market.

Cooperatives are also a potential vehicle for investment in the Netherlands real estate market. International companies often choose a cooperative due to the fact that no dividend withholding is levied on the distribution of profits. However, it may not be the best choice; if a foreign member has a significant stake in a cooperative, they may also be liable to pay Dutch income tax as a foreign taxpayer under the Dutch Corporate Income Tax Act 1969 (CITA). The same goes for foreign shareholders who have a substantial interest in a BV. However, the good news is that the rules regarding this have been rendered more flexible, and foreign members or shareholders will only have to pay Dutch income tax in situations where there is evidence of artificial abuse, such where a company has been incorporated for the intention of evading taxes, as in the case of Cadbury Schweppes (ECJ, C-196/04).

The Advantages of Incorporating a Holding Company in the Netherlands

Instead, perhaps the best option if you’re investing in the Netherlands real estate market is the Dutch holding company. The reason for the holding company’s widespread use is due primarily to its adaptable nature and the use it offers for the participation exemption from Dutch corporate income tax.  Under the participation exemption, sizeable investments in both local and foreign companies are exempt from taxation. This exemption is a crucial aspect of the country’s tax laws.

There are other tax advantages to setting up a Netherlands holding company, as when it comes to owning property in the Netherlands, both Dutch and foreign investors are treated equally under the law. This means that there are no extra restrictions imposed on foreigners that Dutch investors don’t also have to follow.  Dutch and international investors are treated equally in real estate deals with regards to their compliance with investment regulations and tax implications.

The Ireland Real Estate Market: Unlocking the Benefits

The Ireland real estate market offers another option for international investors and has become a sought-after location. The country boasts a stable economy, well-trained workforce, and favorable tax laws. It’s also notable that since Brexit, Ireland has seen a huge upswing in investment from foreign companies. Ireland is a great point of entry to the European market and offers huge opportunities. As it belongs to the European Union, Ireland also offers the added advantage of free movement of goods, services, people, and capital within the EU. Being a member means that Ireland continues to have access to the benefits and opportunities that the EU offers. With all the uncertainty surrounding Brexit and international tax reform, Ireland provides a sense of stability and certainty for those looking to do business there.

Finding the Perfect Fit: Navigating Corporate Structures for Real Estate Investment in Ireland

Various corporate structures are commonly used for Irish real estate investment. The Irish fund ICAV/QIAIF is unlikely to be an attractive option for foreign investors, however, as it requires tax residence in Ireland and will be subject to regulation by the Irish Central Bank. So also does a company specifically established for property trading that is incorporated in Ireland. Rather, the option of investing in the Ireland real estate market through an Irish real estate investment fund (REIT) is a viable option. This is a tax-efficient investment vehicle that enables investors to pool their money in order to invest in a diversified portfolio of real estate assets.

REITs also enjoy favorable tax treatment, which includes exemption from liability on both income and capital gains tax arising from a property business. In addition, non-residents are able to dispose of shares in an Irish REIT without being subject to Irish capital gains tax. There are advantages for foreign investors in establishing an REIT in Ireland; however, it’s also advisable that you fully acquaint yourself with the rules relating to capital and listing requirements, as well as any restrictions placed on investors.

Title insurance (indemnity that protects lenders and homebuyers from financial loss) isn’t a requirement in the Netherlands. Although it is available, it isn’t commonly used, as the general registration process is presumed to provide a buyer with the appropriate security. The sales contract will also tend to include a clause relating to the property transfer and any accompanying assignment of insurance claims. Owners may consider purchasing property insurance to protect against environmental liability. When it comes to share or asset transactions in the Netherlands real estate market, there is a growing trend among parties to utilize warranty and indemnity insurance as well. This practice helps ensure that all parties involved are protected and can avoid potential risks.

In contrast to the Netherlands, title insurance in Ireland is always advisable. In fact, it’s especially important in circumstances in which the title deeds have been reported missing, or the title has identified defects. The identification of defects on a title is definitely an instance which calls for title insurance as this protects against unknown covenants in missing documents, or restrictive covenants that have the potential to impact on the potential of a property for development. It’s also always advisable to conduct environmental surveys, and this is in fact a common practice where any concerns exist regarding the impact that a property may have on the environment. Buyers are strongly advised to check their liability regarding the remediation of any environmental issues that may arise; the failure to do so may prove to be an expensive mistake. To safeguard your interests from environmental liability, you can procure property insurance that will provide you will full coverage for any such liability.

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Strategies for Real Estate Investors: What are examples of asset protection?

The use of a holding company for business ventures is a popular form of asset protection for investors in the Netherlands real estate market as well as in Ireland. In the Ireland real estate market, the REIT is a form of holding company. Under the ideal structure, you could create an operating entity that doesn’t hold any vulnerable assets, with a holding company that actually does own the business’ assets.

The entity that handles business operations assumes all responsibilities and liabilities, including any potential losses. While limited liability for business debts may appear advantageous for the owner, it doesn’t actually hold much relevance since the operating entity has limited assets that can be claimed, and the holding entity won’t be accountable for the debts of the other entity. This business structure can offer some security and reduce any potential accountability for individual debts. In this way, you can reduce the risk of liability for business debts, as well as benefitting from the statutory exemptions available.

Unlocking Success: Steering Through the Complexities of Real estate Investment in the Netherlands and Ireland

When it comes to a successful return on investment in real estate in the Netherlands and Ireland, a choice of the right legal entity may prove to be the difference in protecting you and your company from liability, be more tax-efficient, and make it easier to do business. You have several options to choose from, such as a Dutch BV or cooperative, or an Irish REIT or limited company. However, it’s really only by discussing your precise requirements with legal and taxation experts that you will be properly informed to make the right choice for your specific investment needs. By selecting the right legal entity, you can ensure long-term success and maximize your returns.

Our technology aids companies to manage clients’ real estate investments more effectively and precisely. It assists in automated document assembly, permitting users to promptly generate, assess, and amend records. It also helps in the monitoring of clients’ investments, reducing the risk of pricey errors and ensuring compliance with regulations, especially where multiple jurisdictions are concerned.

Our legal technology also facilitates in the strengthening of communication between you and your clients, through the provision of secure, cloud-based record sharing. By enabling users to gain access to data quickly, you can make any alterations expeditiously. All in all, legal technology is a crucial tool, facilitating the delivery of a smooth and comprehensive service to your clients, wherever they may be located.

About this article

Sources

Bernstein, J. (2019) “Tax profile: What is Happening in Holding Company Jurisdictions” Eversheds Sutherland
Corten, K.; van der Marel, L. and van Drunen, M. (2020) “In review: real estate investment in Netherlands” Lexology
de Wit, M. and Endhoven, A. (2022) “Commercial Real Estate in The Netherlands: Overview” Thomson Reuters Practical Law
Gerritsen, R. and Kuipers, I. (2012) “Netherlands: The Advantages of a Dutch Holding Company”
Grant Thornton (2022) “Investing in Irish Real Estate: Irish Tax Considerations”
Laenen, M. and Mercier, A. (2019) “DLA Piper. Real Estate Investment in the Netherlands: The Legal Perspective” DLA Piper
Mawe, D.; Kenny, C. and Toomey, K. (2022) “Commercial Real Estate in Ireland: Overview” Maples Group.
Nelson, N. (2019) “Using holding companies and operating companies to protect business assets” Wolters Kluwer
Singer, A (2022) “Maximise Real Estate with the Right Legal Entity” (Newton)
Taxgate (2023) “Dutch Holding Company”
McElroy, I.; Carey, R.; Fitzgerald, R. (2019) “Ireland” in Worldwide Real Estate Investment Trust (REIT) Regimes Price Waterhouse Coopers
Van Hovell and Stax, S. (2022) “Real Estate in the Netherlands” Allen & Overy LLP

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Published by Alexandra Singer in Corporate Governance
Tags: Investments, Ireland, Netherlands, Real Estate
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March 31, 2023

SVB disaster, what Legal Ops can learn

The recent news of Silicon Valley Bank’s collapse sent shockwaves through the industry. But what can in-house legal teams learn from the SVB disaster?

Dear Legal Ops!
Welcome to this week’s Let’s talk about Legal Ops, offered by Newton. We tackle corporate legal departments, speed up processes, and career growth. Please send us your questions; in return, we come back with real insights and actionable tips.
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Silicon Valley Bank was a trusted partner and influential player in the fast-paced world of startups and venture capital for many years.

The recent news of Silicon Valley Bank’s collapse sent shockwaves through the industry, leaving many wondering what went wrong and how it will impact their business and the wider tech ecosystem.

With risk mitigation and regulation being ever-evolving topics that in-house legal teams need to navigate, it’s critical to understand the legal context surrounding the SVB disaster and what it means for future legal operations.

In this article, we explore what happened, why it happened, and the legal implications of the collapse. We consider the potential impact on the startup ecosystems in the US, the UK, and the EU, as well as what in-house legal teams can learn from this event.

In this article, we will cover the following:

So, what happened with Silicon Valley Bank?

On March 10 2023, Silicon Valley Bank (SVB), one of the largest and most trusted banks in the startup and venture capital industry, collapsed without warning.

The bank, which had $212bn of assets, is the biggest lender to collapse since the 2008 global financial crisis.

In March, SVB faced a huge number of deposit withdrawal requests, totaling $42 billion, which pushed the already wavering bank over the edge. Regulators were required to step in and close the bank when it couldn’t raise the cash necessary to cover such outgoings.

The news came as a shock to many in the industry who had relied on SVB for their banking and financing needs for many years. Moreover, it has emphasized the need for robust compliance and controls for companies and their legal departments globally.

While the U.S. government took action to protect uninsured deposits at SVB, the bank’s downfall will likely create a series of question marks and concerns around the startup ecosystem.

What caused the collapse of SVB?

The collapse of SBV has been attributed to several factors. While it seems to have been a sum of numerous failings pushed over the edge by an incident in the face of inadequate risk mechanisms, below we explore a few of the key reasons thought to have caused the demise of SVB.

A lack of diversity in the SBV portfolio

A lack of diversity in a bank’s portfolio can create several problems. A concentrated portfolio exposes vulnerabilities to economic downturns or industry-specific events. This vulnerability can translate into increased credit risk and greater exposure to compliance violations.

Many are pointing their finger at the SVB’s overexposure to certain tech sectors including the cryptocurrency market. An article in Politico states:

This is the point where the outbreak of risk in the crypto industry might have jumped species into the banking sector.

Ed Moya, senior market analyst at Oanda, explains that SVB may not be alone. He suggested that banks that are disproportionately tied to cash-strapped industries like tech and crypto may be in for a rough ride.

SVB had invested heavily in cryptocurrency – including Bitcoin and Ethereum – and had lent money to startups that were focused on blockchain technology. However, as the cryptocurrency market experienced a significant downturn, SVB’s investments and loans began to lose value, leading to a substantial loss of capital for the bank. Evidently, failing to ensure a balanced and diverse portfolio put the bank in a precarious situation.

Regulatory challenges

Regulatory challenges played a significant factor in the collapse of SVB. The bank was subject to a range of regulatory requirements that were designed to ensure its safety and soundness, but these requirements also imposed significant costs and limitations on the bank’s operations.

One of the primary regulatory challenges facing SVB was the requirement to maintain high levels of capital and liquidity. This meant that the bank had to maintain a large sum of reserves to protect against potential losses, which limited its ability to lend and invest in new business opportunities (a common frustration but the nature of the industry for many bankers).

In addition, SVB was subject to a range of regulatory restrictions on its lending and investment activities. For example, the bank was required to comply with strict anti-money laundering (AML) and anti-terrorism financing regulations, which imposed additional costs and compliance burdens.

The bank also faced intense regulatory scrutiny in the wake of the 2008 financial crisis, which resulted in increased oversight and supervision from regulatory authorities. This scrutiny placed additional pressure on the bank and its executives to maintain high levels of compliance and risk management, which further limited its ability to pursue new business opportunities.

Despite the external pressures, SVB failed to adequately address these regulatory issues. Instead, the bank continued to operate in a manner that was not fully compliant with regulatory requirements, which ultimately led to significant fines and legal penalties.

In fact, SVB had been under investigation by the US Securities and Exchange Commission (SEC) for potential violations of anti-money laundering regulations. The investigation had been ongoing for several months, and it is believed that the potential fines and penalties associated with the investigation may have played a role in the bank’s decision to file for bankruptcy.

Inadequate risk management

Effective risk management is critical for the long-term success of any organization, particularly in the banking industry due to the significant risks associated with lending and investing.

Unfortunately, SVB failed to effectively manage its risks, which many believe played a major role in the bank’s collapse.

A lack of oversight and accountability concerning risk management was certainly an issue at SVB. The extent of this oversight was highlighted by the fact that the bank’s CFO – who was responsible for overseeing risk management – was absent for an extended period of time. This curbed the focus on risk management and created a leadership structure and culture that allowed for risky lending practices and conflicts of interest to go unchecked.

SVB did indeed engage in risky lending practices including lending money to high-risk clients without proper due diligence. As a result, SVB suffered significant losses and defaults that undermined its financial stability and reputation.

Furthermore, SVB failed to implement adequate risk management policies and procedures, which left the bank vulnerable to potential fraud and misconduct. This lack of control and oversight left room for some employees to engage in fraudulent activities, which further eroded the bank’s stability and reputation. In fact, a recent LinkedIn poll from investor and news editor Marcel van Oost found that 74% of people believed the former CEO and CFO of SBV should be sued for their actions.

Screenshot 2023-03-26 at 23.40.24.png

Had SVB’s legal department prioritized risk management and ensured that the appropriate controls were in place to prevent and manage such failures, it’s likely that the impact of such activities would have been less severe.

Ineffective leadership

In recent years, SVB’s reputation has been tarnished by a series of scandals, including allegations of mismanagement and fraud. Since the collapse, bad management has been cited as a key reason for the bank’s downfall.

The bank was plagued by a lack of accountability and oversight, which allowed for risky lending practices and conflicts of interest to go unchecked.

For instance, former CEO Greg Becker was criticized for his close ties to certain clients and for failing to properly disclose potential conflicts of interest. This lack of transparency eroded trust in the bank’s leadership and ultimately led to Becker’s resignation.

In addition, SVB was accused of engaging in risky lending practices, including lending to high-risk clients without proper due diligence. This situation highlights the importance of Know Your Customer (KYC) procedures. Proper KYC procedures could have helped identify any red flags or suspicious activities associated with clients, potentially preventing or limiting the impact of these issues. Overall, this lack of executive direction resulted in a number of defaults and loan losses, which put the bank’s financial stability at risk.

Not to mention, it’s said that the bank’s employees received large bonuses that were paid out just hours before regulators seized the bank. This might be deemed as carelessness and can reflect a lack of effective leadership from the top.

Screenshot 2023-03-26 at 23.46.08.png

At a higher level, management at SVB was slow to respond to changing market conditions and, ironically, technological advancements, which left the bank ill-prepared to compete in a rapidly evolving industry. This failure to innovate and adapt likely also contributed to the bank’s decline.

Insider trading

In-house legal teams play a crucial role in ensuring that their organizations comply with relevant laws and regulations. In the banking industry, insider trading is an area of particular concern.

In 2003, the Securities and Exchange Commission (SEC) accused a former SVB executive, Keith Ligon, of engaging in insider trading. According to the SEC, Ligon had tipped off several hedge fund managers about upcoming mergers involving SVB clients. The hedge fund managers then traded on this information, making significant profits at the expense of other investors.

The SEC’s investigation revealed that Ligon had not acted alone. Several other SVB employees were also implicated, including one who is said to have leaked information to Ligon in the first place. The investigation also uncovered evidence of lax internal controls at the bank, which had allowed the insider trading to occur.

The fallout from this event was severe. SVB was forced to pay a $5.5 million fine and to implement stricter internal controls to prevent future incidents of insider trading. Several executives, including Ligon, were also charged with criminal offences and faced jail time.

This scandal highlights the importance of vigilant compliance management by legal departments. By implementing robust internal controls and ensuring that employees are aware of their obligations under the law, in-house legal teams can help to prevent insider trading and protect their organizations from the reputational and financial damage.

Withdrawal frenzy triggered by a powerful VC

Peter Thiel, a prominent venture capitalist and co-founder of PayPal, has been widely credited with helping to shape the early years of the Silicon Valley technology scene. However, in recent years, Thiel has become something of a controversial figure, particularly when it comes to his involvement with SVB.

It was reported that Thiel advised his portfolio companies to withdraw their money from SVB, apparently due to his concerns about the bank's increasing risk exposure, particularly in the areas of real estate and international lending.

While Thiel's concerns may have been valid, his advice to withdraw money from the bank had serious consequences. The bank saw a significant outflow of deposits as a result of Thiel's advice, which meant the bank was unable to meet its regulatory capital requirements. This resulted in the bank being placed under increased scrutiny by regulators and, in turn, led to the series of regulatory sanctions and fines that ultimately led to the bank's downfall.

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The impact on the startup ecosystem

The collapse of SVB has had significant implications for the startup ecosystem, particularly in the US. Roshan Patel, Founder & CEO of Walnut, shared a conversation he had with one of the company’s investors on Twitter. The investor shared their concerns that this is a “sector-wide issue”, but with a comic twist. So what do we need to understand about how this event will impact the ecosystem?

A more cautious funding and investment landscape

There’s no denying the boom in tech funding, and venture capital in particular, over the last decade or so. Significant funding rounds and lavish celebrations have glamorized raising capital from particular sources.

However, this approach and the growth-at-all-costs attitude have fostered a culture of unsustainable practices and unprofitable business models.

SVB was a major lender to startups and venture capital firms. The bank’s downfall has created a void in the funding and investment landscape, which may lead to tighter credit conditions, increased competition for capital, and a shift in the balance of power between startups and investors.

Emphasizing this point, Maelle Gavet, CEO at Techstars, stated in a LinkedIn post:

Thanks to the explosion in tech startup investing, the proliferation of VCs, and the scale-at-all-costs culture it unleashed, we created a world where unprofitable startups (AKA nearly all startups) are perpetually fundraising, and require continuous lines of credit.

The potential for greater financing options for startups (but not yet…)

The demise of SVB will no doubt leave a gap in the market. Considering the startup ecosystem in the US, UK, and Europe does bring in economic and cultural value, there is the potential that mainstream financial institutions will view the collapse as an opportunity to offer their own versions of funding for this segment. Might we see a reinvention of the banking industry and how it supports startups more broadly? Only time will tell.

The potential for a more healthy risk appetite as it relates to funding

One of the great appeals of SVB for startups was the lack of liability required. SVB was one of the only banks on the market that offered such financing without the need to put up collateral. While it will take time and a significant shift in the perception of funding in the sector, there is an opportunity to reimagine financing in the startup ecosystem. This may be using different financing mechanisms or shifting mindsets to view offering collateral in exchange for capital as a motivation to operate more sustainably and profitably – in some cases, offering collateral can encourage more innovative enterprising activity.

Regulatory scrutiny

SVB’s insider trading scandal was only the first step that attracted regulatory scrutiny, with the SEC imposing fines and sanctions on the bank and some of its employees. This increased regulatory attention may result in more rigorous compliance requirements for startups and venture capital firms, potentially increasing the cost and complexity of doing business.

Reputational damage to the tech ecosystem

The downfall of SVB has tarnished the reputation of the bank, as well as the wider startup ecosystem in which it operated. In-house legal teams may need to work harder to rebuild trust and restore confidence in the industry, including through improved transparency, accountability, and ethical conduct.

Reduced barriers to entry

Lastly, the demise of SVB may create opportunities for new players to enter the market and fill the void left by the bank’s departure. In-house legal teams should be aware of new entities in the market, and be prepared to assess the risks and opportunities associated with working with these new players.

The demise of SVB serves as a valuable lesson for in-house legal teams on the importance of robust legal and cultural practices. Below we explore the top five learnings that legal departments can take from the bank’s downfall.

1. The importance of risk management

SVB’s demise was due, in part, to its exposure to high-risk sectors, such as the technology industry. In-house legal teams should work with their organizations to identify and manage potential risks, including exposure to high-risk industries, investments, or counterparties.

2. The need for robust internal controls

As mentioned, SVB’s inadequate internal controls played a role in both the insider trading scandal and ultimately the bank’s downfall. Legal departments should ensure that their organizations have strong internal controls in place, including policies and procedures for risk management, compliance, and reporting.

3. Build a culture of compliance

A strong culture of compliance is essential for preventing misconduct and ensuring that employees act in the best interests of the organization. In-house legal teams should work to promote a culture of compliance throughout their organizations, including through training, communications, and incentives that encourage ethical behavior.

4. The value of transparency and accountability

The demise of SVB highlights the importance of transparency and accountability in ensuring that organizations are operating in a responsible, ethical, and sustainable manner. In-house legal teams should work to promote transparency and accountability throughout their organizations, including through robust reporting mechanisms and a commitment to ethical conduct at all levels. These qualities must be evident both internally and externally - and you can learn more about the value of transparency in corporate governance here.

To evidence the impact of these themes, you simply need to look at the Wirecard fraud case currently being tried in Germany. This is a significant corporate fraud case and one that reflects poorly on the country’s regulatory authorities. You can learn more about it in our “Challenges in Corporate Governance” blog here.

5. Innovative financing options

Finally, among the drama, there is an opportunity to be creative. The startup ecosystem might see an emergence of different funding options for growth, focusing on sustainability and risk management. Whether it be bootstrapping or crowdfunding, in-house legal teams will no doubt have a rise in responsibility when it comes to strategic matters such as business and financing strategies.

Summary

The collapse of Silicon Valley Bank serves as a reminder of the importance of risk management, strong internal controls, a culture of compliance, and transparency and accountability in ensuring long-term business viability. By taking steps to address these areas, in-house legal teams can help to protect their organizations from potential legal and reputational risks, and promote a culture of ethical behavior and responsibility.

How can Newton help with corporate governance?

Newton delivers an easy and intuitive platform to manage and automate your legal entities’ information, governance, and compliance. If your entity management processes have an important role to play in the sustainability and performance of your business (which they do for most), be sure to get in touch to explore how Newton can help you have everything you need to be in control of your entity portfolio.

Following the SVB disaster, you’ll understand the importance of having strong KYC (Know Your Customer) and KYB (Know Your Business) processes in place. But you also know how time-consuming and complex it can be to ensure compliance with ever-changing regulations and requirements.

That’s where Newton comes in. We are working on customized KYC/KYB processes where you can streamline your administrative procedures and simplify previously intricate tasks. This not only helps you save time and resources, but it also helps you establish better B2B relationships and ensures adequate legal support.

But that’s not all. By partnering with Newton, businesses can establish internal compliance policies that cover a wider range of issues related to their dealings with customers and suppliers.

So if you’re looking to help your business stay ahead of the curve when it comes to compliance and legal support, chat with our team about partnering with Newton today.

About this article

Sources

EY (2021). The General Counsel Imperative: How can you evolve entity management into effective governance?
ACC (2022). Legal Entity Management Practices
The Wall Street Journal (2023). What Happened With Silicon Valley Bank?
Fast Company (2023): Silicon Valley Bank: An ‘It’s a Wonderful Life’ bank run for the digital age
Politico (2023): The crypto ‘contagion’ that helped bring down SVB
CNN Business (2023): Silicon Valley Bank collapses after failing to raise capital

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Published by Steph Smith in Corporate Governance
Tags: Corporate Governance, silicon valley bank, SVB
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February 24, 2023

The value of Transparency in Corporate Governance

Law is ever-evolving, and new challenges and regulations are constantly arising. This article dives into the unifying value of transparency in corporate governance and how this can be compared across three key jurisdictions: the UK, Europe, and Luxembourg.

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The huge advances in technology made over the course of the last decade mean that the requirement for transparency in corporate governance is more important than ever. As online platforms and social media have become integral to doing business, especially globally, companies must quickly adapt to ensure their efficiency in this new digital age. This is why corporate governance policies must fit the new requirements imposed on companies, especially in relation to corporate transparency. Who can forget the Enron Scandal, and the tale of a successful company that reached illustrious heights only to experience such a bewildering descent?

Corporate governance is vital to any business, and transparency and accountability are crucial components of good governance. This article discusses how each country has implemented corporate governance policies and practices to encourage transparency and accountability.

In this article, we will cover the following:

The Crucial Role of Disclosure, Transparency and Accountability

Enron’s Devastating Collapse: What Can We Learn from It?

The abrupt collapse of this powerful corporation Enron, once one of the largest in the world, remains astonishing even today. It’s especially difficult to comprehend how its management succeeded in deceiving regulators for years by placing bogus assets and deceitful accountancy practices. Yet the scandal inadvertently highlighted the crucial importance of transparency in corporate governance. It revealed how the unethical behaviour of specific figures within the company – illustrated through the extensive insider trading and absence of visibility into corporate and government entities – contributed to the collapse of the global financial markets.

The shocking revelations sparked the implementation of a worldwide program of proactive and vigorous reforms, as business leaders and governments understood all too well how if left ignored, such an inherent lack of transparency might one day result not only in the collapse of the markets but in worldwide economic disaster. Indeed, just last year, in an investigation into auditing problems at companies, journalists at Bloomberg News pointed out that:

It’s not clear that investors are any safer today than they were before Enron Corp. failed.

Enhancing Corporate Governance with Accountability and Transparency

Corporate governance is a wide term. Ultimately, however, it refers to the effective system of governance that companies should have in place to ensure the existence of confidence between all the different parties involved in various markets, notably the capital market, the labour force, as well as customers and suppliers. Understanding how entities react to the need for a solid legitimate, regulatory, and institutional framework in which market participants can place their faith is critical from both a local perspective as well as a global standpoint – as the devastating effects of Enron demonstrated. Various European nations' corporate governance codes and acts showcase a wide range of progressive developments, from fresh boardroom practices to new statutory regulations. Indeed, Europe is among the world's most rapidly evolving corporate governance climates.

Accountability and transparency are the key principles relevant to the efficacy of corporate governance codes in any company and in any jurisdiction, although there are subtle differences in focus between the legislation in various countries.

In the United Kingdom (UK), for example, the principles inherent to the Corporate Governance Code focus primarily on the rights and responsibilities of the company board, the shareholders and other relevant stakeholders, whilst in Germany, the Deutscher Corporate Governance Kodex establishes the key standards expected from company behaviour and outlines a company’s expected responsibilities of its board of directors, management, and shareholders.

It is critical to be aware of the rights of shareholders to safeguard them from the misapplication of corporate assets by management, as well as the power of auditing and accounting standards in assessing the level of information asymmetry, particularly from an international angle. These corporate governance characteristics determine the power balance between shareholders and the management of entities.

The Importance of Disclosure

Disclosure is highly valued in corporate governance, and it is an obligation for companies in Luxembourg, Germany, and the UK to guarantee their transparency in operations, decision-making processes, and financial reporting to maintain appropriate corporate governance.

This requires that firms are answerable to their stakeholders and furnish periodic reports on their activities and financial performance. Moreover, companies should highlight any risks or doubts that might impact their business and present regular financial statements that are easy to comprehend and available to all stakeholders.

Transparency in corporate governance means that businesses must observe the best practices. This includes the establishment of solid internal controls, the implementation of a clear command hierarchy, and the fostering of open communication and collaboration among all stakeholders. Companies must ensure the diversity of their board of directors and that it represents all their stakeholders, as well as monitor the performance of its duties.

The Key to Eliminating Market Abuse

These days, following the implementation of European wide legislation such as the EU Market Abuse Regulation, which was long awaited for its framework for preventing, detecting, investigating and punishing market abuse, the outrageous misuse, manipulation and outright deceitful appropriation of company assets has hopefully been, for the most part, eliminated.

One egregious example of such abuse occurred at the UK car manufacturing company MG Rover Group when it was discovered that four of the company’s directors had paid themselves huge dividends while simultaneously running it into the ground. The directors took large bonuses for five years until MG Rover Group finally went bankrupt in 2005.

When their greed and dishonesty were finally discovered, it was too late to rectify the £1.3 billion of debt they had left behind, along with the thousands of local people they had caused to lose their jobs, causing hugely negative implications for the local economy. Yet this is just one example.

Another case that comes to mind is the case of the Dutch international retailer Royal Ahold, which in 2003 revealed the numerous accounting irregularities of its various subsidiaries. Its CEO, CFO and, shamefully, the executive responsible for its European operations were all charged with fraud. Then in May 2006, they were judged guilty by a Dutch federal court of the falsification of paperwork and handed suspended prison sentences and substantial fines. The proliferation of fraud and the abuse of company assets at the director level across Europe was a key contributor to the development of European Union (EU) legislation on corporate governance.

Defining and Establishing Best Practices

The European Commission (EC) “Corporate Governance” Directive 2006/46/EC mandated that all publicly listed companies are required to include a corporate governance statement in their annual accounts for shareholders for the first time.

Various long-term strategies followed, such as the EC’s Europe 2020 and EU Action Plan, as the EU attempted to bolster corporate governance, enhance competitiveness, and foster sustainability among firms across the EU. To a great extent, these projects have been highly successful, with a range of EU corporate governance changes achieving substantial changes.

However, across the EU, and specifically in the UK, LUX and Germany, significant challenges continue in relation to ensuring the success and complete acceptance of corporate governance initiatives. A complicating issue with regard to the unification and harmonization of corporate governance concerns the variation in the legal forms of businesses across jurisdictions. This includes the public, private as well as in the not-for-profit sectors.

Each sector has its own particular governance issues, which must be met through the application of the best practice principles developed for their application from the German Corporate Governance Code (Deutscher Corporate Governance Kodex) that lays out the necessary rules for the oversight and administration of publicly traded German businesses, and comprises internationally and domestically accepted guidelines and suggestions to promote responsible and conscientious corporate governance to the overarching corporate legislation of the Companies Act 2006 in the UK, and then to the lattice of various statutory regulations in Luxembourg, which has not yet established any official code of best practice for the benefit of shareholders.

In the past two decades, multiple transformations have taken place with regard to corporate governance conventions among EU member states. Nowadays, numerous European businesses comply with the principles of excellent corporate governance. These practices come with certain advantages, such as improved disclosure and transparency in respect of: accurate financial statements, minority shareholder rights, connected dealings, remuneration, and acquisitions. Owing to the European Union corporate governance initiatives, a substantial amount of convergence has been accomplished regarding corporate governance practices, though conflicts continue.

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The Need for Harmonization

Yet the divergence of corporate governance best practices across the European Union (EU) still remains. In Luxembourg, the United Kingdom (UK), and Germany, the corporate governance law, statutory regulations, and models for governance in public and private business remain very different. This means that there is substantial room for improvement in terms of harmonizing corporate governance practices across the EU.

Analysis of corporate governance best practices

In the following articles, we will explore how the corporate governance law, regulations, and models of governance in public and private business in Luxembourg, the UK, and Germany, in particular, are developing. We will examine each region's current regulations and models and how each nation's corporate governance laws and regulations evolve. We will also analyze the approaches to corporate governance adopted in each region and evaluate their effectiveness. Finally, we will consider the potential for harmonising corporate governance best practices across the EU and discuss how it could occur. Through our analysis of corporate governance best practices in Luxembourg, the UK, and Germany, we hope to provide readers with a comprehensive overview of the current state of corporate governance in the EU and highlight the potential benefits that harmonization could bring.

About this article

Sources

Regulation (EU) No. 596/2014 of the European Parliament and of the Council on market abuse as complemented by the Act of 23 December 2016 on Market Abuse as last amended by the Act of 27 February 2018, implementing Regulation (EU) No. 596/2014, Directive 2014/57/EU and Directive 2015/2392/EU.
Directive (EU) The European Commission (EC) Directive 2006/46/EC amending Council
Directives 78/660/EEC on the annual accounts of certain types of companies, 83/349/EEC on consolidated accounts, 86/635/EEC on the annual accounts and consolidated accounts of banks and other financial institutions and 91/674/EEC on the annual accounts and consolidated accounts of insurance undertakings.
Deutscher Corporate Governance Kodex (German Corporate Governance Code)
UK Companies Act 2006
Boitan, A. and Maruszewska, E. W. (2021) “Corporate Governance Features among European Union Countries – An Exploratory Analysis” The Review of Finance and Banking 79-91
Constable, S. (2021). How the Enron Scandal Changed American Business Forever
European Commission (2010). European Top 20. A strategy for smart, sustainable and inclusive growth.
Farrell, G. (2021). Twenty Years After Enron, Investors Still Vulnerable to Fraud
Financial Times (2009). Fraud agency to investigate MG Rover case
Goodley, S. (2011). MG Rover directors banned from running companies after collapse
Milkiewicz, H. and Wei S. (2003). A Case of ‘Enronitis’? Opaque Self-Dealing and the Global Financial Effect
Principles for Responsible Investment. (2018). Action 10: Fostering sustainable corporate governance and attenuating short-termism in capital markets
Szalay, G. (2019). “The Impact of the Lack of Transparency on Corporate Governance: A Practical Example” Corporate Law & Governance Review Volume 1, Issue 2.
The New York Times (2006). Ex-Ahold Executives Fined in Netherlands Fraud Case
Walker, R. (2002). Enron’s Transparent Problems

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Published by Alexandra Singer in Corporate Governance
Tags: Accountability, Corporate Governance, Disclosure, Transparency
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February 3, 2023

Maximize Real Estate ROI with the Right Legal Entity

Discover how technology solutions can help lawyers navigate real estate investments and optimize legal entity management. Learn the importance of choosing the right legal entity and how to manage it efficiently in this informative article.

Dear Legal Ops!
Welcome to this week’s Let’s talk about Legal Ops, offered by Newton. We tackle corporate legal departments, speed up processes, and career growth. Please send us your questions; in return, we come back with real insights and actionable tips.
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Real estate investment can be an incredibly lucrative venture, but is also complex and challenging. Yet helping your clients to understand the complexities of the real estate investment landscape doesn’t have to be daunting. With the right legal technology company to help, as an expert in your field, you can navigate and guide your clients through the complicated legal landscape surrounding investment property with ease. Through the provision of comprehensive support and suite of services, the correct technology is crucial to ensuring the correct choice of legal entity and managing your clients’ investments.

Investing in real estate involves a great deal of intricate planning. As such, you’ll know how critical it is to select the right legal real estate structure to safeguard your clients’ investments and ensure they fully benefit from them. In this article, we’ll look at the various types of legal and business entities used for real estate investment in Luxembourg, Germany and the United Kingdom (UK). We’ll also explore other factors, such as the need for asset protection as well as how the use of certain company structures, for example the secretive company Cascade LLC used for the avoidance of holding transparency by the Microsoft founder and billionaire Bill Gates, can be best utilised for the benefit of your clients.

In this article, we will cover the following:

When it comes to real estate investment, selecting the correct legal entity is a key component in safeguarding your clients’ possessions. The ideal legal entity to use is dependent on your clients’ individual requirements and objectives. In Germany, it is common for larger property holdings to be owned by corporate entities instead of individuals. This allows for greater flexibility in managing the real estate and optimizing taxation.

Although the intricacies of registration vary between Germany, Luxembourg, and the UK, in all three jurisdictions, the options that exist for the structuring of a real investment transaction remain essentially the same. As in Luxembourg and the UK, in Germany, the acquisition of property can be organized as an asset transaction, which requires the procurement of the asset from either an individual or a holding vehicle, or as a share deal, which involves obtaining the shares in the holding vehicle from the shareholders.

Real estate can be invested in either directly through an asset transaction, or indirectly through the acquisition of shares in a legal entity possessing real estate – a share deal. In Germany, legal entities such as this are usually structured in Germany as a limited partnership (e.g. GmbH & Co KG) or a limited liability company (e.g. GmbH). The name of the GmbH highlights the fact that its proprietors (Gesellschafter, also recognised as shareholders) do not have any personal liability for the corporation’s obligations. In this way, the GmbH & Co. KG amalgamates the benefits of a partnership and those of a limited liability organization. More often than not, the general partner will be an external limited company such as a UK Limited Company or a Luxembourg S.à r.l. instead of a pure GmbH, as the combination of those legal entities provide excellent tax benefits. As with all property transactions, the conduct of full and comprehensive due diligence is vital.

However, in Germany, in contrast to many other legal systems, there is no reliable shareholder register. This means that if the ownership of the shares has changed hands multiple times, it is essential to check that there is an uninterrupted sequence of notarial transfer documents stretching back to the initial shareholder, to guarantee that the seller actually fully owns the shares. If the seller does not have a valid claim to the shares, the buyer, who may be purchasing in good faith, will lack any protection. This is quite different to the case of the direct asset purchase of real estate, where the seller is normally assumed to be the legitimate owner if it is officially registered, and so an acquisition in good faith is possible.

Another option by which to structure a real investment purchase in Germany is through the real estate investment trust (REIT). In 2007, Germany introduced the concept of real estate corporations with shares traded on the stock market as REITs. This legal entity needs to take the form of a "stock corporation" (Aktiengesellschaft), with a €15m minimum capital requirement. The REIT’s headquarters must be in Germany, and at least 15% of the shares need to be held by different investors with no single one holding more than 3% (the small investor rule). The ownership and transfer of REIT shares are supervised by the German Federal Financial Supervisory Authority (BaFin). Additionally, REITs are exempt from corporate income tax, including the solidarity surcharge, which is a potential client benefit.

Exploring the Advantages of Real Estate Investment in Luxembourg

Luxembourg is a popular destination for a real estate investment group, as its property sector has advanced to offer investors various flexible and imaginative investment possibilities. At present, there is no specific vehicle dedicated to real estate investments. However, Luxembourg furnishes an array of vehicles that can be utilised for this purpose. The selection of the vehicle will be, as you know, mainly contingent on your client’s investor profile, the form of investments to be made, the form of capital to be obtained, and any tax considerations that may need to be taken into account.

Luxembourg supplies a platform of services and structuring opportunities, and available products include standard business companies, i.e. structures that are not monitored at all or indirectly supervised by an appointed alternative investment fund manager (“AIFM”), or investment structures that are (perhaps in addition to the appointed AIFM) supervised by the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (“CSSF”), and thus regulated structures. Investment vehicles from Luxembourg can be employed for real estate investments situated in Luxembourg or abroad. As there is no particular vehicle for domestic investments, one of the benefits of using the same fund vehicle is that it can combine both local and foreign investments.

Navigating the UK Real Estate Market: Considerations for Investors

In the UK, as with Luxembourg and Germany, property investment is transacted through a direct asset purchase or a share deal, and by utilising a third-party entity like a company, partnership, or trust. A popular option for real estate investment groups for the holding of property in the UK is to use a non-UK company established in a low taxation jurisdiction, such as the Channel Islands, Cayman or the British Virgin Islands. There are various tax rules and benefits for this structure, especially as, unless the property is a residential home worth more than half a million pounds and available to the proprietor or some related person, non-UK resident companies are not obligated to pay UK capital gains tax on any profits acquired from a property sale. Using a limited partnership is also popular, due to its transparency for tax purposes. However, as the rules are complicated, advice must be provided with regard to the intricacies of each specific situation. The UK also provides other various options for the holding of real estate through non-UK Property Unit Trust (PUTs), which are popular as they are also look-through for tax purposes, as well as Property Authorised Investment Funds (PAIFs). Real Estate Investment Trusts (REITs) are also common as any income and gains from this vehicle are not subject to UK tax, but must instead distribute a minimum of 90% of its annual profits – property income dividends–within one year of the end of its accounting period.

Factors that will influence the choice of a real estate investment structure will include the level of income and capital gains taxes, as well as withholding taxes, value added tax, property transfer taxes and stamp duty, among others. Yet for investors in all three jurisdictions, where they wish to shroud the ownership of their assets, it is ultimately the use of a holding company that might be their most favorable option. This is precisely what the controversy involving Bill Gates and his use of the company Cascade LLC to conceal its investments concerned.

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The Importance of Asset Protection

The consideration of asset protection is, as always, a vitally important factor in any investment in a real estate structure, and the right legal entity can help guard your clients’ assets from possible creditors and lawsuits. The holding company offers further benefits in addition to privacy with regard to liability protection, as owners won’t be held personally responsible for its debts and liabilities. This can be especially useful for properties that involve a high risk of liability, such as rental properties. In Germany, from a liability perspective, a GmbH & Co. KG or GmbH can be appropriate for asset protection, although the choice for a particular corporate structure must take into account intensive and targeted tax advice.

Luxembourg is a desirable spot for asset safeguarding in light of its status as a major European financial centre, as well as its favorable taxation regulations and stable economic and political status. Asset protection in Luxembourg can be achieved through a variety of methods, such as the SPF (Société de gestion de patrimoine familial), special tax arrangements for intellectual property rights, expatriates, businesses, and the Luxembourg life insurance contract which is considered an investment tool.

In the UK, although the use of a trust fund to hold property can provide some form of asset protection, this might not be as foolproof as clients would hope. Investors should be advised on the development of a strategy that considers the number of their properties, the amount of equity in each one and any attendant hazards. As Gates’ concern Cascade is a private company, attempting to determine its precise assets is difficult, which is of course its objective. Luxembourg is a popular destination for the operation of a holding company, with its Société de Participations Financières (SOPARFI).Clients who invest in real estate may opt for holding companies that conceal the ultimate proprietor for reasons such as preserving confidentiality and to keep the investor’s personal information, e.g. name and location, out of public documents. Furthermore, this strategy can shield private assets from potential creditors or lawsuits, and it can even provide advantageous tax benefits.

We know exactly how intricate and laborious real estate investments can be to manage, due to the need to track so many financial and legal particulars. Now legal technology has become progressively essential for lawyers to negotiate their processes and streamline their performance.

Our technology aids lawyers in managing clients’ real estate investments more effectively and precisely. It assists in automated document assembly, permitting lawyers to promptly generate, assess, and amend records. It also helps in the monitoring of clients’ investments, reducing the risk of pricey errors and ensuring compliance with regulations, especially where multiple jurisdictions are concerned.

Our legal technology also facilitates the strengthening of communication between you and your clients, through the provision of secure, cloud-based record sharing. By enabling lawyers to gain access to data quickly, you can make any alterations expeditiously. All in all, legal technology is a crucial tool, facilitating the delivery of a smooth and comprehensive service to your clients, wherever they may be located.

About this article

Sources

Baker & McKenzie (2023). Global Corporate Real Estate Guide (Luxembourg)
DLA Piper (2023). Real Estate Investment in Germany: The Legal Perspective
Eicher, P. and Hoffman, S. (2021). In review: real estate investment in Luxembourg
The Law Reviews (2022). The Real Estate Investment Structure Taxation Review: Luxembourg
Norton Rose Fulbright (2016). Investing in UK Property. Quick Tax Guide
Rose & Partner (2023) Real estate in a company under German law
Dentons (2022). The Real Estate Investment Structure Taxation Review: United Kingdom

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Published by Alexandra Singer in Corporate Governance
Tags: Germany, Investments, Luxembourg, Real Estate, UK
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January 6, 2023

Challenges in Corporate Governance

Learn about the most important challenges of corporate governance and how three major jurisdictions, Germany, Luxembourg, and the UK differ.

Dear Legal Ops!
Welcome to this week’s Let’s talk about Legal Ops, offered by Newton. We tackle corporate legal departments, speed up processes, and career growth. Please send us your questions; in return, we come back with real insights and actionable tips.
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Corporate governance can, in theory, seem a rather obscure and vague subject, especially when confused with the issue of a company’s ethical behaviour – or lack thereof. Many definitions have been given to the concept of governance. Quite simply, however, it can be summarised as the system by which companies are controlled and directed. It comprises the processes, rules and laws governing a company’s conduct, particularly concerning its shareholders and board. In the following article, we deep dive into the challenges of corporate governance with a brief comparison of the differences between Germany, Luxembourg and the UK.

In this article, we will cover the following:

Why is Corporate Governance so important?

The Wirecard fraud case currently being tried in Germany is one of the country’s greatest corporate frauds in its history and an embarrassment for its regulatory authorities. It raises significant questions about how this scandal could have been allowed to occur – especially given the importance that German regulation places on corporate governance.

In the 21st century, good corporate governance is considered so important due to the fundamental role it plays in ensuring that a company is run both effectively and efficiently, with appropriate regard to the interests of every relevant stakeholder, including employees, shareholders, and customers. Fundamentally, corporate governance plays a key role in both building and organising relationships within companies, and generating profits for shareholders and other stakeholders.

A vital component of corporate governance is the fact that it also tends to determine the ability of a company to cope with a crisis. in this way, a company’s stability and success can be largely attributed to its level of corporate governance, given the importance of a firm framework based on clear values such as honesty and accountability. The strength of these principles in an organisation will direct the way it is managed, its success and the extent of its attractiveness to investors.

As the Organisation for Economic Cooperation and Development (OECD) notes, corporate governance is the “structure by which business corporations are directed and governed.” Good corporate governance, in terms of transparency and compliance with key principles such as accountability in organizations, also has wider implications for business and society in general, on both a national and a global scale. It results in increases in shareholder value, the ability of businesses to weather difficult financial periods and environments, and the general improvement of the global economy.

Germany has been rocked by the Wirecard scandal. The company, which grew from a small and unknown payments company to become one of Europe’s largest fintech firms, had long been held up as an example of the opportunities that Germany’s digital economy offers companies for advancement. Yet the later discovery of Wirecard’s engagement in dishonest accounting procedures and the concealment of debt of billion of euros, culminating in its collapse in June 2020, has left investors and regulators in shock. Crucially, it has raised pertinent questions about the sufficiency of Germany’s regulation of companies and corporate governance.

Understanding the Challenges and Complexity of Corporate Governance

Corporate governance does not take place in a vacuum. It is the result of a nation’s legal, cultural, historic and economic development and landscape, and it is for these reasons that governance structures vary so differently between jurisdictions. Global corporate governance is a pipe dream; there is no alternative but to accept the often-wide international variations between nations and companies, and the legislative and regulatory bases upon which their corporate governance is based. This is in any case inevitable, given the fact that corporate governance may be said to be inextricably connected to the prevailing economic development of a country’s economy and the way in which this has determined organisational ownership and control structures.

Corporate Governance in the UK

This distinction is especially noticeable in the way in which European corporate ownership patterns differ so distinctively from UK ownership structures, and this has carried over into patterns of corporate governance. In Europe, share ownership tends to be concentrated much more significantly in the hands of a smaller group of shareholders and as such, is more orientated towards bank ownership rather than that of financial institutions. Whilst this results in a strong group of owners, it also means that other shareholders are weak and scattered and subject to the control of capital-owning blockholders that have the power to appoint managers. This is precisely the opposite of the UK, or the Anglo-Saxon system, where share ownership tends to be highly fragmented. This results in the ability of a company’s board to exert a significant amount of power over a company’s direction – something that is rarely seen in Europe, where many companies are tightly owned by wealthy families in possession of over 20% of shares.

Although today most countries have corporate governance codes, such as the UK’s Combined Code on Corporate Governance, these are generally soft law that is not legally binding but is rather intended to influence behaviour and set standards. Whilst the UK Combined Code is certainly sophisticated, it is essentially a guide for company self-regulation. The overriding principle in the UK is that of “comply or explain”, by which a compromise is intended to be achieved through the allowance to companies of some flexibility whilst ensuring that reporting and governance requirements are met.

Yet this soft law has no overarching ability actually to improve director accountability and company transparency. Although the UK Code might initially appear strict, it can be criticized for its broadness as well as being open to interpretation. Many companies consider that they have complied with their duties by issuing generic policy statements.

Corporate Governance in Germany

In contrast to the UK, Germany may be said to have one of the tightest regulatory structures for corporate governance. In addition to this, in contrast to the UK, German boards are comprised of two-tier organisations, which is intended to ensure a separation between management and control. Yet, in reality, the functions assigned to the management board and supervisory board are divided differently depending on the specific industry, company size, tradition, and, especially, if one board or the other has strong leaders.

A vital reason for the mandatory policy of the two-tier board in Germany is the politically entrenched policy of labour co-determination. This powerful instrument of corporate governance enables workers to enjoy rights that allow them to actively shape their working environment. This is hardly something that a one-tier board would be likely to tolerate. In contrast to Germany, the reason for the existence of the one-tier board in the UK is likely historically due to the emergency of entrepreneurial activity and resistance to any state or trade union attempts to oversee company structures and introduce labour co-determination. Although labour codetermination is a feature in many European countries, German regulation is significant for its regulatory mandate that there must be an equal shareholder and employee membership at the supervisory board level.

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Corporate Governance in Luxembourg

Luxembourg, in contrast, is a rather more complex case; public limited liability companies, for example, have the choice between a two-tier or a one-tier board structure. It is certainly curious that the overwhelmingly preferred option in Luxembourg is the one-tier structure, suggesting that in the absence of regulatory force, companies prefer the freedom of a mixed board that does not separate supervisory and management functions.  Perhaps Germany too would not embrace two-tier boards and labour codetermination were its companies provided with such a choice. That’s not to say, however, that Germany is without fault. Local emphasis on employee representation has blocked companies from making necessary redundancies, whilst the evolving door that exists between the two tiers of a board has resulted in problematic conflicts of interest.

As an international financial centre, Luxembourg’s corporate governance principles should objectively be stricter, and yet there is no single corporate governance code that is applicable to all companies. Furthermore, the risks of short-termism have been recognised and there is a need to improve board governance structures and improve the focus on reporting requirements. Indeed, there have been various rumbles over the years regarding violations of good corporate governance principles, especially in relation to the close relationships and overlapping interests that exist between the political class, the business community, and its regulators.

Conclusion

Regardless of the differences in corporate governance between the UK, Luxembourg and Germany, rules are only as good as their enforcement. Each nation has developed its own systems and rules in the context of its historical, cultural, economic and legal features, and corporate governance is also inevitably shaped by the economic and political landscape. Regulation and the monitoring of corporate governance is a complex endeavour, and whilst the aim is ultimately to ensure accountability, an accommodation must also be made with the practicalities of business.

About this article

Sources

Financial Times (2019). German governance must be fit for purpose Recent scandals have exposed shortcomings in the corporate model
Kelleher, E. (2013). Luxembourg faces fresh criticism over good governance
European Journal of Business & Management Research (2021). Corporate Governance and Financial Fraud of Wirecard
Mondaq (2022). Luxembourg: Corporate Governance Comparative Guide
No. 13 Hans-Böckler-Stiftung, Dusseldorf (2018). Co-determination in Germany: A Beginner’s Guide
Reuters (2022). Wirecard bosses’ fraud trial begins after scandal that rocked Germany
Deakin Law Review. Vol. 23: 177-208 (2018). Are Corporate Governance Code Disclosure and Engagement Principles Effective Vehicles for Corporate Accountability? The United Kingdom as a Case Study
The Organisation for Economic Cooperation and Development (OECD) (2014). The OECD Principles of Corporate Governance OECD Publication Service
Thomson Reuters. Practical Law (2022). Corporate governance and directors' duties in Luxembourg: overview
United Kingdom (2018). The Combined Code on Corporate Governance

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Published by Alexandra Singer in Corporate Governance
Tags: Challenges, Germany, Luxembourg, UK

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