Interactive Investor

Scottish Mortgage seeks to reduce ‘skin in the game’ threshold

We explain a rule change Scottish Mortgage shareholders are being asked to vote on.

2nd June 2021 09:37

Kyle Caldwell from interactive investor

We explain a rule change Scottish Mortgage shareholders are being asked to vote on. 

The UK’s largest investment trust is proposing a change to its directors’ share qualification rule in its forthcoming annual general meeting.

At present, new members to the board of Scottish Mortgage (LSE:SMT) will need to put nearly £57,000 of their own money into the investment trust.

This is due to an historic rule, under which a minimum amount is required by directors to sit on Scottish Mortgage’s board. A minimum nominal value of £250 is required, which up until a share split in June 2014 was based on a nominal per share value of 25p per share. At the time, 1,000 shares needed to be purchased by new directors.

But, following the share split, which reduced the nominal per share value from 25p to 5p per share, a new director is required to buy 5,000 shares in Scottish Mortgage.

Scottish Mortgage points out that due to its share price significantly exceeding its nominal per share value “any new director appointed to the board needs to make a substantial personal financial commitment when joining”.

It is therefore recommending at its AGM on 24 June that shareholders vote to remove the directors’ share qualification rule.

Scottish Mortgage notes that based on its financial year-end (31 March 2021) share price of £11.37, any new director appointed at that time would have needed to purchase 5,000 shares at an aggregate cost of nearly £57,000 to satisfy the rule.

To have your say by voting electronically ahead the event, sign up to interactive investor’s free voting service.

What is ‘skin in the game’ and why it matters

Directors and fund managers having their own personal investments in the companies they direct or manage aligns interests with shareholders. Bear in mind, though, that this does not guarantee success. 

Alan Brierley, director of investment companies research at Investec, says he is relaxed regarding whether an investment trust has a rule in place that requires a minimum amount to be invested. The main thing, he notes, is that “directors have some of their personal wealth in the investment trust”.

He adds: “It is important that directors’ interests are aligned with shareholders. Investors are being asked to treat investment trusts as long-term shareholdings, so board members should adopt the same approach.”

James Carthew, head of research at QuotedData, says he completely agrees with Scottish Mortgage’s rationale for amending the rule.

He adds: “It isn’t reasonable to expect that a new director should be able to stump up £57,000 before being allowed to join a boar. Apart from anything else, it entrenches a lack of diversity among boards whose members should not only be drawn from the ranks of the wealthy.”

But, in echoing the same sentiments as Brierley, he says “unless there are extenuating circumstances to prevent it, directors should also be shareholders”.

He adds: “There is something of a lobster pot situation with directors’ shareholdings. It is always seen as a bad sign if a director sells shares, unless there are very good reasons why a sale is forced on them. For that reason, not only are the directors’ interests aligned with shareholders, they should also be focused on what is best for the business in the long term.”

While board directors are required to disclose their personal stakes in the investment trust, the fund manager making all the investment decision is under no obligation.

Brierley, who authors the annual ‘skin in the game’ report, which details the personal investments of investment trust board members and fund managers who are willing to disclose this, adds: "A fund manager having skin in the game sends a clear and powerful message to both existing and potential investors.

For funds across the pond, the US’ Securities and Exchange Commission has since 2005 required fund managers to disclose how much they invest in their own funds. Fund managers disclose by band – rather than the precise amount. The bands are: none, $1–$10,000, $10,001–$50,000, $50,001–$100,000, $100,001–$500,000, $500,001–$1 million, and more than $1 million.

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