The Conference Board released guidance for directors of public companies on Wednesday, July 14, to prevent shareholders from accumulating undisclosed equity stakes by means of cash-settled derivatives, or to address situations where this has occurred.

The board said that “in a regulatory environment where disclosure requirements are triggered by voting rights rather than economic interest, derivatives can be used to conceal equity ownership of a public company–a practice generally known as ‘hidden ownership.’”

The guidance is contained in a new report in the board’s Director Notes series on European corporate governance developments, “Know Your Shareholders: The Use of Cash-Settled Equity Derivatives to Hide Corporate Ownership Interests“. According to the statement, the report cites anecdotal evidence that investors and strategic bidders are increasingly using cash-settled derivatives to discretely expand their ownership positions in business corporations listed on European stock exchanges.

“When used for this purpose, cash-settled derivatives have the potential to disrupt not only the internal governance and voting process of a corporation, but also the efficient operations of the financial markets,” Eugenio De Nardis, a corporate lawyer at Cleary Gottlieb and co-author of the report, said in the statement.

“Directors of European corporations should be aware of the risks and possible distortions caused by the undisclosed use of cash-settled derivatives,” Matteo Tonello, director of corporate governance research at The Conference Board and co-author of the study, said. “The danger is in having investors’ public filings that only tell half the story about who actually owns the company. Also, when the transactions or stakes are eventually disclosed, markets might be unable to react promptly, giving rise to speculation and volatility.”

The major recommendations included in the report:

? Monitor trading activities

? Obtain insights from large investors

? Commission perception studies

? Expect regular reporting from management

? Compile profiles of investors and prospective strategic bidders

? Notify enforcement agencies

? Understand the intentions of hidden owners

The statement said that this guidance builds on the recommendations on shareholder activism, which was endorsed by a high-level committee of experts in the field, issued by The Conference Board Governance Center in April.

Michael S. Fischer (msf7@columbia.edu) is a New York-based financial writer and editor and a frequent contributor to WealthManagerWeb.com.