New Rules on the Disclosure of Beneficial Owners and the Death Knell for Bearer Shares

On 21 June 2019, the Swiss Federal Assembly passed the Federal Act on the Implementation of the Recommendations of the Global Forum on Transparency and Exchange of Information for Tax Purposes (the Act) into law. The Act sounds the death knell of bearer shares for non-listed companies. It also introduces criminal law sanctions for breaches of the obligation to disclose beneficial ownership of shares and several corporate housekeeping duties regarding the share register and the register of beneficial owners. Finally, it provides for draconian sanctions for holders of bearer shares who would fail to comply with their disclosure duties and for companies who would fail to maintain the requisite corporate registries or issue bearer shares in breach of the new provisions. At the same time, the Act also introduces some clarifications around the disclosure of beneficial owners and several issues that were subject to controversy.

By Rashid Bahar (Reference: CapLaw-2019-39)

1) International Context

As a member of the Financial Action Task Force (FATF/GAFI) and the OECD Global Forum on Transparency, Switzerland has committed to enact legislation to improve the transparency of legal entities to support the global effort to combat money-laundering and the financing as terrorism as well as the international processes for the automatic exchange of information among tax authorities. A key element of this legislation is increased transparence in relation to the legal and beneficial owners of legal entities.

On 14 December 2014, Switzerland passed legislation to address these concerns, which entered into force in July 2015. The Swiss approach consisted mainly of relying on corporate law to create the requisite framework to ensure sufficient transparency. Furthermore, following some opposition from small and medium enterprises, the Swiss parliament decided at the time to retain bearer shares albeit with an obligation for the holders of bearer shares to disclose their identity and address to the company and provide a copy of identification documents within a month of the acquisition of the shares (article 697i (1) and (2) CO). However, following peer reviews that were carried out in 2016, the system was criticized because it lacked a mean to ensure an effective compliance. In particular, the lack of sanctions – other than the corporate law mechanism provided for by article 697m CO – was deemed to be insufficient. At the same time, the amendments of 2014 raised a number of questions for practitioners which remained unsolved. 

In response to these findings the Federal Council presented a bill to amend the code of obligations in parliament last year and the Act was adopted on 20 June 2019. The main goal of the Act is to overcome the shortcoming identified by peer reviews conducted by the FATF and the Global Forum in time for the next peer review scheduled for November 2019.

2) Abolition of Bearer Shares

A central aspect of the Act will be the abolition of bearer shares for joint stock companies (article 622 (1bis) CO as amended). Swiss companies will no longer be allowed to issue bearer shares with two exceptions: first, companies with equity securities listed on a stock exchange will continue to be able to issue bearer shares (article 622 (1bis) CO as amended). This exception will, however, only be available to a limited number of companies. Second, other companies will be able to issue bearer shares only if the shares are issued as intermediated securities held by a Swiss custodian designated by the company (article 622 (1bis) CO as amended). Such intermediated securities must then be held on custody accounts with a financial institution, typically a bank or a securities dealer. In both cases, this fact will need to be registered with the commercial register (article 622 (2bis) CO as amended). Therefore, all companies which issued bearer shares will need to react: either by converting their bearer shares into registered shares or by registering the fact that they benefit from one of the two exemptions.

3) Transitional Regime for Outstanding Bearer Shares and
their Holders

Notwithstanding several motions to allow companies which had complied with the previous regime to be grandfathered, parliament decided to vote in favor of the proposition of the Federal Council and also bar companies which already issued bearer shares from maintaining their bearer shares. As a result, existing bearer shares will need to be converted into registered shares, subject to the two limited exceptions mentioned above (for listed companies and certain intermediated securities). 

To soften the blow, the Act provides for a transitional regime: the abolition will not be effective immediately when the Act comes in force. Instead, companies will have a period of 18 months to amend their articles of association and convert their existing bearer shares into registered shares unless the shares are already issued as intermediated securities or the company has listed equity securities on a stock exchange or issued as intermediated securities held by a Swiss custodian. Even if one of the exemptions applies, the company will need to record this fact with the commercial register within the same deadline (article 2 of the Transitional Rules of the Amendment of 21 June 2019). 

a) Automatic Conversion of Outstanding Bearer Shares

If bearer shares are still outstanding by the end of the transitional period of 18 months, they will be converted by law into registered shares (article 4 (1) Transitional Rules). The commercial registrar will be responsible for recording this change in the commercial register (article 4 (2) Transitional Rules). The change will also be effective against third parties (article 4 (1) Transitional Rules). The shares will retain their existing nominal value, voting rights and financial rights (article 4 (3) Transitional Rules). However, the shares will need to be endorsed to be transferred and the new acquirer will have to request the registration of their details in the share register, even if, on the face of the share certificate, they are bearer shares. However, transfer restrictions will not apply to the transfer of such shares (article 4 (3) Transitional Rules). 

To enforce a swift adjustment of the articles of incorporation after the 18 months interim period, the commercial register will not be allowed to complete any change to the articles of association until the company has implemented the changes to its articles of incorporation (article 5 (1) Transitional Rules). 

b) Reinstatement of Former Shareholders

Following the conversion, the Company will need to register the holders of bearer shares who complied with their disclosure duties in its share register (article 6 (1) Transitional Rules). If shareholders fail to comply with their disclosure duties, they will see their voting rights suspended and lose their financial rights (article 6 (2) Transitional Rules). If shareholders want to be reinstated, they will need to a claim in court within five years of the entry into force of the Act (article 7 (1) Transitional Rules). However, to do so, they will need to secure the prior consent of the company to register them as shareholders. The Transitional Rules do not define under what conditions the company must consent and the court must approve the petition. Nevertheless, we would believe that the review should be limited to ensure that the shareholder is indeed entitled to the shares and has in the meanwhile complied with its disclosure duties. 

c) Cancellation of Bearer Shares

If shareholders fail to be reinstated within this five year deadline, their shares will become null and void by law and the holders will lose any rights they have to the shares. Instead, their shares will be replaced by treasury shares held by the company (article 8 (1) Transitional Rules). 

This sanction is irremediable. If the shareholders prove that they were not a fault, they will only have the right to apply to the court to be paid out the fair value of their shares, provided, however, the company has sufficient freely disposable equity to make this payment (article 8 (2) Transitional Rules). In all other cases, the law does not provide for a compensation of expropriated shareholders. However, it needs to be seen whether courts will leave shareholders disenfranchised, e.g., if the company does not consent to the reinstatement of rights without any valid grounds.

4) Changes to the Obligation to Disclose the Beneficial Owner

In addition to the abolition of bearer shares, the Act also amends the regime for the disclosure of the beneficial owner of shareholders acquiring, alone or in concert with third parties, more than 25% of the shares in a company. This regime continues to apply to all joint stock companies, regardless of whether they have issued bearer or registered shares and also to limited liability companies.

a) Control as the Determinant of Beneficial Ownership

The amendments clarify several controversial points. In particular, they define the beneficial owner of a legal entity as the physical person exercising control by analogy with the consolidation rules of Swiss accounting law (article 697j (2) CO as amended). Therefore, a physical person controls a legal person (i) if it holds, directly or indirectly, a majority of votes in the highest management body, (ii) if it directly or indirectly has the right to appoint or remove a majority of the members of the supreme management or administrative body or (iii) if it is able to exercise a controlling influence based on the articles of association, the foundation deed, a contract or comparable instrument (article 963 (2) CO). This clarification solves numerous controversies concerning the definition of the beneficial owner in corporate structures and should therefore contribute to greater legal certainty. 

Furthermore, the new rules clarify that if no physical person controls a legal entity holding, alone or in concert with third parties, more than 25%, the legal entity is required to make a negative declaration to the company (article 697j (2) CO as amended): so, where the shareholder is a state-owned entity, has dispersed ownership, or is set up structurally so that it cannot be controlled by natural persons, e.g. with certain charitable foundations, the shareholder must make a negative declaration. This process will add an additional burden of compliance for shareholders, but will make it easier for the board of directors to ensure that the beneficial owners of shareholdings in excess of 25% have been effectively disclosed.

b) New Regime for Listed Companies and their Affiliates

A further clarification concerns listed companies and their affiliates: when the shareholder (i) is a listed company, (ii) is controlled by a listed company or (iii) controls a listed company, it will not need to make a full declaration regarding its beneficial owners. It will only need to disclose this fact as well as the name and seat of the listed company (article 697j (3) CO as amended). 

This substantially simplifies the ongoing compliance burden for affiliates of listed companies, since they will not need to report any change within the shareholders of their listed parent, without decreasing the level of transparency, since the rules on the disclosure of substantial shareholding under the Financial Market Infrastructure Act (or similar foreign laws) ensure an appropriate level of disclosure for listed companies.

c) Deadline to Give Notice of Changes

One important amendment concerns alterations made due to changes of name, surname or address of the beneficial owner: currently, article 697j (3) CO does not specify the deadline to give notice of such changes to the company, which led certain commentators to take the stance that the notice is not subject to any timing constraints. To solve the controversy, the Act specifies that shareholders have three months to disclose the change to the company (article 697j (4) CO as amended).

This deadline provides some more leeway for shareholders to report these minor changes and should avoid sanctioning shareholders for failing to update the formalities of their report.

5) Sanctions for Non-Compliance

To ensure effective compliance with the transparency obligations and the record keeping duties and respond to the concern of the global standard setters, the Act introduces new criminal offences in the Swiss criminal code: pursuant to article 327 of the Swiss Criminal Code, the failure to comply with the obligations to disclose the beneficial owners of large share-holdings (including any changes) will be subject to a fine. 

Similarly, intentional breaches of the corporate law obligations relating to the maintenance of the share register and the register of beneficial owners and other similar registers will also be subject to a fine (article 327a of the Swiss Criminal Code). 

These sanctions will apply in addition to the corporate law effects of failing to comply with disclosure duties: namely the suspension of voting rights (article 697m(2) CO) and the loss of property rights until a proper notice is given to the company (article 697m (3) CO).

Furthermore, the failure to duly maintain the required registers or unlawfully issuing bearer shares will constitute a violation of organizational duties which can, at the request of a shareholder, a creditor or the commercial register, lead the court to summon the company to comply with its duties or take steps to dissolve the company and liquidate it in accordance with bankruptcy law (article 731a CO as amended). 

6) Outlook 

The Act has now been approved by the Swiss parliament and will become law if no referendum is petitioned for by 10 October 2019. The Federal Counsel has already announced that the Act would enter into force on 1 November 2019 to remedy all outstanding issues prior to the next peer review. 

Companies and shareholders should carefully assess whether there is a need to act. All companies which have issued bearer shares should act. They should therefore assess whether they are allowed to continue to have bearer shares, i.e. whether they have listed equity securities or have issued their shares as intermediated securities held by a Swiss custodian. If they are or ensure that they meet the requirements within the 18 months interim period, they must register in the commercial register the fact of their exemption to avoid a mandatory conversion. 

For the other companies with bearer shares, it may be advisable to prospectively convert bearer shares into registered shares, or at least to ensure that the conversion of bearer shares by law is properly reflected in the articles of association and the commercial register after the interim period of 18 months.

Furthermore, all companies, including those who have only issued registered shares, should assess whether they have an effective and compliant corporate housekeeping in view of the new criminal sanctions in case of non-compliance.

Similarly, shareholders of non-listed joint stock companies and partners of limited liability companies should analyze whether they hold bearer shares or more than 25% of the share capital in any company, whether through bearer or registered shares. If so, they should carefully review their existing filings (and whether they made filings so far). Any deficiencies should be cured promptly and, if possible, before the new law enters into force to avoid the new criminal sanctions. 

Additionally, holders of non-listed bearer shares must be particularly cautious, since they may, if they do not comply with the transparency requirements, need to go through a cumbersome court procedure to have their rights re-instated, and in some cases entirely lose their rights without compensation.

Nevertheless, these amendments should be welcomed as an effort to improve transparency of shareholders and beneficial owners of Swiss legal entities. While the manner in which these reforms have been brought about may seem haphazard, they should be understood as part of an ongoing effort to find a balance between the goals of international standard setters and the legitimate concern not to place an excessive burden of compliance on companies and their shareholders, who in their very large majority are not remotely connected to money laundering and financing of terrorism or more mundane tax fraud.

Rashid Bahar (