The Enforcement Committee of the French Autorité des Marchés Financiers (AMF) has fined LVMH Moët Hennessy-Louis Vuitton (LVMH) €8 million for failing to inform the market that it was preparing to raise its stake in Hermès, and for breaches of disclosure requirements when publishing its consolidated financial statements for 2008 and 2009. The AMF’s decision to impose its largest fine (by some measure) to date reflects its view of the seriousness of the successive breaches of public disclosure requirements, which concealed each stage of LVMH’s stake-building in Hermes.

Background

LVMH had taken a 4.9% stake in Hermès through two subsidiaries in 2001 and 2002. In December 2008, LVMH sold a number of these shares – the investigators note that this was to ensure that the 5% disclosure threshold was not passed as a result of the cancellation by Hermès of some 640,702 shares it had bought back.

In meetings in December 2006, February 2007 and March 2008, LVMH and Rothschild discussed the possibility of securing a stake in Hermès with a view to an acquisition of control (Project Mercury). LVMH also had some discussions with Lazard about a possible stake in Hermès in March 2008.

In the first half of 2008, through two subsidiaries in Luxemburg and in Hong Kong indirectly controlled by it and consolidated into the group, LVMH – through its CFO and its Corporate Finance head, and with the authority of the its Vice-chairman – entered into equity linked swap contracts (ELS) with three banks, Nexgen, Société Générale (SocGen) and Crédit Agricole Corporate & Investment Bank (CA-CIB). Each of the banks hedged their position through the purchase of shares in Hermès; it was LVMH who identified counterparties to various hedging transactions entered into by each of the three banks. The ELS were due to be cash-settled (although in relation to the CA-CIB transaction, LVMH refused to accept a clause which would have prevented CA-CIB from selling its hedge to its ELS counterparty). In each case the ELS gave an economic exposure of no more than 5% to Hermès’ share price. The swaps were due to mature on dates ranging from January, April and May 2011, June 2012 (initially June 2010 but later extended), through to June 2014.

In June 2010, LVMH approached each of the three banks about the possibility of physical settlement of the ELS. CA-CIB declined to alter the mode of settlement of the ELS, but by 21 June 2010 the two other banks had indicated they would be willing to settle the ELS in shares rather than in cash. LVMH later explained that it had been concerned that there would be an overhang in the stock, forcing the price down and leaving Hermès exposed to an opportunistic bidder if the banks sold the shares into the market upon the ELS being cash settled.

On 29 July 2010, Rothschild discussed with LVMH the possibility of taking a stake of between 18 and 25% in Hermès. On 22 September 2010, LVMH mandated Lazard to consider options for unwinding the ELS (Project Cézanne). LVMH then broached the issue of physical settlement of the ELS with Nexgen and SocGen on 13 October, and then with CA-CIB on 15 October.

On 19 October Lazard advised that whatever strategic decision LVMH took regarding Hermès, in view of market conditions, liquidity in Hermès, its free float and the amounts involved, the most effective means for LVMH to maximise its investment through the underlying of the ELS would be to unwind the ELS by means of physical settlement in shares, assuming the banks were willing. The banks agreed to unwind the ELS on that basis – CA-CIB’s agreement was conditional on LVMH making full disclosure to the market.

On 21 October 2010, the LVMH Board was told of the acquisition of Hermès shares in 2001/2002 and of the existence of the ELS – apparently for the first time. The Board was advised that to maintain the contracts until expiry would require the company to identify the swaps in its consolidated accounts for 2010, which could impact on the performance of the ELS contracts. The Board agreed that the swaps should be unwound by means of physical settlement in shares. Rothschild was mandated to assist LVMH with its communication strategy

On 23 October 2010, LVMH announced it held 14.2% of Hermès shares, and was in a position to increase that holding to 17.1%. LVMH further stated that its intention was to be a long-term investor, and that it had no intention of making a bid, taking control of Hermès, or of seeking a place on its Board.

On 21 December 2010, the LVMH group announced that it held in excess of 20% of the share capital in Hermès International, and informed the AMF that it held 20.21% of the share capital and 12.73% of the voting rights, and that there was a further ELS to be physically settled for 204,056 shares from 4 April 2014. LVMH currently holds a stake of around 22.6% in Hermès.

In September 2012, Hermès filed a criminal complaint accusing LVMH of insider trading and share-price manipulation in the course of building its stake in Hermès: the criminal case is ongoing, but is, we understand, based on insider dealing and manipulation arising from the possession of inside information regarding the 2002 acquisition of a 4.9% stake in Hermès, and the building of an interest in 17% of Hermès through the combination of the ELS and the pre-existing 4.9% stake.

The enforcement decision

The AMF’s investigation began in November 2010, and the Enforcement Committee handed down its decision on 25 June 2013. LVMH unsuccessfully raised a number of procedural challenges, including in relation to access to documents, a perceived lack of impartiality, the alleged inconsistency of the position taken by the AMF in relation to the criminal proceedings, and a perceived infringement of the presumption of LVMH’s innocence (alleged bias resulting from the AMF’s desire to amend the regime relating to reporting thresholds).

At the relevant time, cash-settled swaps were not caught by the disclosure requirements for major shareholdings. The AMF’s case was therefore based on the making of false or misleading statements to the market in respect of the accounting treatment of LVMH’s share-holding and economic interest (through the ELS) in Hermès; and failure to make timely disclosure to the public of a proposed financial transaction.

  1. False or misleading statements in relation to LVMH’s share-holding in Hermès:

LVMH included the 4.9% holding in Hermès as non-current assets without including the sales value, and divided it under the heading “financial investments” (a small minority) and “other non-current assets” (the majority), which was not in accordance with the thrust of IAS 1 which should have led LVMH to account for all the group’s interests in Hermès as a single item. As a result, the information in LVMH’s accounts for 2007, 2008 and 2009 was misleading, with the object (and the effect) of concealing LVMH’s holding in Hermès.

However, since the holding, being below the 5% threshold, was not required to be disclosed to the market, the charge that the accounts were false and misleading was not upheld by the Enforcement Committee. Nevertheless, this was one element to be taken into account in analysing the separate charge of whether information regarding a proposed financial transaction had been withheld from the public.

  1. False or misleading statements in relation to LVMH’s economic interest in Hermès through the ELS:

IFRS 7 requires annual accounts to provide qualitative and quantitative information to enable the assessment of risks relating to financial instruments. In the IFRS 7 disclosures, LVMH’s 2008 and 2009 accounts failed to highlight the significant concentration risk in connection with the exposure to Hermès through the ELS. The Enforcement Committee accordingly upheld this count.

  1. Failure to make timely disclosure to the public from 21 June 2010 in respect of a financial transaction in preparation:
    1. Was a relevant financial transaction being prepared?

Article 223-6 of the AMF’s General Regulation requires issuers that are preparing a financial transaction liable to have a significant impact on the market price of a financial instrument, or on the financial position and rights of holders of that financial instrument, to disclose the characteristics of the transaction to the public as soon as possible. if confidentiality is temporarily required to carry out the transaction and if the issuer is able to ensure such confidentiality, he may assume responsibility for delaying disclosure of those characteristics.

The AMF concluded that article 223-6 covers transactions which either impact the market price, or the financial position and rights of holders.

The announcement of a stake of over 13% in Hermès was clearly likely to have an impact on the shares and other financial instruments of both Hermès and LVMH:

  • it was difficult to argue that a reasonable investor would not have taken this into account
  • information about a significant long-term stake in Hermès by a competitor could be perceived either positively or negatively from the perspective of an investor in Hermès
  • LVMH’s CFO had noted at the Board meeting on 21 October 2010 the potential impact of announcing the existence of the ELS
  • information about a significant long-term stake in Hermès by a competitor was likely to be perceived positively from the perspective of an investor in LVMH
  • on the first trading day following the announcement, the price of shares in both Hermès and LVMH increased by 15.12% and 2.38%

Although the transaction did not give LVMH control, it significantly changed the composition of share-holding in Hermès, and had the stake been built openly, it would in the ordinary course have given LVMH the opportunity to obtain Board representation. The Enforcement Committee concluded that if had an impact on the holders of shares by the Hermès family and on the exercise of their rights. The transaction was therefore one that should have been disclosed.

  1. When should disclosure have been made?

The Enforcement Committee took into account the following points:

  • LVMH entered into ELS with three different banks, each creating an economic exposure to Hermès of less than 5%, and ensured that the banks’ purchases of physical shares to hedge their own exposures did not trigger the disclosure threshold, and therefore did not alert the market;
  • the ELS were atypical in nature and size , concentrated on a single underlying;
  • it was unusual for a counterparty to locate blocks for the banks to enable them to hedge their exposure;
  • the deliberately opaque nature of the accounting treatment of LVMH’s physical shareholdings, through Luxembourg and US subsidiaries that were not listed within LVMH’s consolidated accounts until the annual report for 2010;
  • LVMH also failed to include within the annexes to the 2008 and 2009 accounts very substantial guarantees it had given to the banks in connection with the ELS;
  • the sale of the hedges on the natural unwinding of the ELS (most were due within the same 4 month period) to a party other than LVMH would have potentially been detrimental to LVMH and would have created the risk of either a decrease in the price of Hermès shares or the sale of a block of Hermès shares to a LVMH competitor;
  • LVMH had already rejected a clause in the CA-CIB contract which would have limited its options on unwinding;
  • consideration of the possibility of physical settlement was prompted by the decision to extend the ELS with CA-CIB on its initial expiry date in June 2010;
  • CA-CIB’s internal opinion that an agreement to yield its delta to the client on the unwinding of the hedge might expose the bank to a claim of having assisted in misleading the market;
  • the in-principle agreement of SocGen and Nexgen to physical settlement of the ELS given to LVMH on 15 June 2010 and 21 June 2010 respectively;

and concluded that from 21 June 2010 LVMH knew that it was in a position to obtain physical settlement of the ELS and acquire (off-market) at any time a further 9.3% stake in Hermès (which would take its total stake to 14.2% of the share capital of Hermès). This information was specific and precise: the maturity and the size of the ELS, the nature of the underlying instruments, and the proposed mechanism for settlement should have been disclosed at that point.

The AMF further noted that the delay in disclosing of this information until physical settlement had been effected and the thresholds crossed had the result that the market was taken by surprise.

Fine

At the time the conduct took place, the maximum applicable fine was €10 million. The seriousness of the various failures to disclose, which concealed LVMH’s stake-building, amounted to a “circumvention of the rules intended to ensure transparency, which is so vital to orderly markets, must be punished to the same extent as the disruption it causes”. LVMH has said that it plans to appeal, and calls the decision and size of the fine levied “totally unjustified”.

Commentary

This is not the first AMF enforcement action in respect of covert stake-building – in December 2010, the AMF Enforcement Committee fined the company Wendel and Mr J.B Lafonta – its Chairman at the time of the conduct in question– an amount of €1.5 million each for failing to disclose the preparation of stake-building by Wendel in the capital of Saint Gobain, through the use of total return swaps. Since October 2012, following these two cases, the French rules on shareholding disclosure have required cash-settled securities to be aggregated within the calculation of threshold disclosure obligations, in order to hinder creeping acquisitions of control of listed companies through cash-settled derivatives.

The AMF’s decision does not suggest that any of the banks had any knowledge of the transactions which LVMH had entered into with the other bank counterparties, and there is no overt criticism of the conduct of the banks. That said, the AMF clearly endorses the analysis performed by CA-CIB who concluded that in accepting the alteration to the mode of settlement of the swap, the “final reality” of the transaction was revealed as no longer being hedging or speculation, so that in aiding its client to acquire a significant stake in the underlying and an immediate crossing of the disclosure thresholds, market transparency would be adversely impacted. The AMF’s decision notice comments, rather dryly, that LVMH might have been well advised to have drawn its own lesson from this analysis.

Despite the Enforcement Committee’s ruling (in respect of LVMH’s procedural complaint) that the concept of preparation of a financial transaction is wholly distinct from the consideration of inside information, and did not require a finding that the information was precise, the AMF’s findings appears to provide some clear pointers for the ongoing criminal prosecution. The AMF concludes that the accounts were misleading because they failed to include certain specific and precise information, and identifies the point at which the “final reality” of the transaction was revealed (or, to adopt the ECJ’s language from the Geltl v Daimler case, an intermediate step taken in the context of a protracted process leading towards a future event or circumstance which could be precise, and therefore “inside information).