Effect of the Proposed Changes
Will the proposed amendments under the SRS Bill materially affect the regulatory burden associated with a rights issue offering?
At face value, the removal of the requirement to lodge prospectus would seem to substantially lessen the regulatory hurdles on a company, and thereby cost, of raising capital in this manner. However, it appears that there would be risk in companies taking this view and simply preparing offer documentation and issuing the cleansing notice without undertaking the necessary due diligence cross checks, to ensure that the negative assurances provided in the cleansing notice are in fact accurate as at that date.
As illustrated in the table below, the due diligence programme that would be required to be undertaken now under a rights issue (where a prospectus is required to be lodged) would not be, in our view, substantially different to that which would be required under the proposed regulations in order to ameliorate an issuing company's potential for liability arising in relation to the offer made under the new regime. This is because whereas previously liability for misstatements (or omissions) in a prospectus would fall within the Chapter 6D liability regime (and defences), it would appear that under the new regime under the SRS Bill liability for misstatements (or omissions) in the cleansing notice could potentially give rise to liability on the company under the general liability provisions under Section 1041E and Section 1041I of the Corporations Act (described above).
Additionally, companies ought also be mindful that where shareholders rely upon the assurances given by a cleansing notice in subscribing for shares under the rights issue (in circumstances where the contents of the cleansing notice are false and misleading), then the company may be liable to compensate shareholders for the amount of their loss arising out of those false and misleading statements.
Suggested due diligence requirement
Required under current regime?
Required under new regime as proposed under the SRS Bill
The cleansing notice requires the issuing company to confirm that it has complied with the financial reporting provisions within the Corporations Act.
Yes - to ensure it is able to issue a short form prospectus.
Yes - to conform with the cleansing notice content requirements.
The issuing company will still need to satisfy itself that it has discharged its financial reporting requirements under the Corporations Act under the proposed new regime.
Has the issuing company discharged its continuous disclosure obligations?
Yes - to conform with the rights issue content disclosure requirements.
Yes - to conform with the proposed content requirements of the cleansing notice.
An audit of a company's previous ASX disclosures against the company files and directors' minutes will still be required under the new regime to conform with the cleansing notice content requirements.
Include any material information that has otherwise been excluded from previous ASX releases.
Yes as this is a disclosure requirement under the current regime.
Yes - to conform with the cleansing notice content requirements. An issuing company is required to provide any material information that has previously been excluded from market releases.
There is no difference between the content requirements of the rights issue prospectus (under the current regime) and the corresponding cleansing notice requirements.
In addition to the regulatory requirements of the new system proposed under the SRS Bill, which as the table above illustrates, appear to be largely unaltered to the current requirements, liability may continue to arise on the company and those persons involved in any contravention (including directors) under both the current and proposed regime.
It would appear to us that despite the best efforts of the Government in seeking to remove the requirement of companies to lodge a prospectus for a rights issue as a means of simplifying the fund raising process for listed companies, liability will ultimately drive the due diligence requirements (and therefore cost) of undertaking a capital raising. On this basis, the above table illustrates that we consider any cost savings associated with due diligence to be illusory. There would however appear to be a saving under the new regime with respect to removing the requirement to prepare, print and distribute (to each shareholder) an offer document.
Companies and their advisors must also be mindful of the potential scaling back of available defences under the Corporations Act to exonerate or mitigate liability arising out of a rights issue under the new regime. The new reduced regulatory regime has a potential sting in the tail for issuing companies in that, whereas under the current regime, companies and their directors may avail themselves of the "due diligence defence" (amongst others), these defences would not appear to apply to liability arising under the new regime. The Proposals Paper is silent as to the issue of liability and corresponding defences and it remains to be seen as to whether the SRS Bill ultimately introduced into Parliament will address what we see to be a potential downside to the new "simplified" regime.
Additionally, even if a company is not specifically required to include disclosures within a cleansing notice or any associated offer document, companies may be required to do so in a commercial, as opposed legal sense, in order to entice their own shareholders to take up their entitlement under the issue. Such statements would also bear the same degree of scrutiny under the liability provisions of the Corporations Act, and due diligence would need to be undertaken in order to verify the accuracy and completeness of those statements, in order to avoid or mitigate potential liability under the Corporations Act.
New Zealand Offerings
In addition to the suggested amendments under the Proposals Paper, on 11 September 2006 the Commonwealth Government released the draft Corporations Amendment (NZ Closer Economic Relations) Bill 2006 (NZ Bill) for public exposure, to implement the agreement between the Governments of Australia and New Zealand in relation to mutual recognition of securities offerings.
In introducing the Bill, the Honourable Chris Pearce MP, Parliamentary Secretary to the Treasurer described the NZ Bill as follows:
"When enacted, the provisions will allow the offer of securities and managed investment interests to be made in either country with the same offer documents, therefore reducing duplication and cost which inevitably get passed on to consumers. The reduced filing requirements provisions of the draft Bill are intended to exempt New Zealand companies operating in Australia from lodging the same information with ASIC that the companies have already lodged with the New Zealand Companies Office."19
Currently, where Australian companies conduct initial public offerings of their shares and wish to extend those offers to New Zealand residents, companies may be able to rely upon the Securities Act (Australian Issuers) Exemption Notice 2002 (Exemption Notice).
The Exemption Notice is designed to ensure that Australian issuers are not required to fully comply with the Prospectus requirements of both Australia and New Zealand (where undertaking a dual jurisdiction offer), but does not exempt Australian issuers in their entirety. In summary, the Exemption Notice currently requires the issuing company to prepare and distribute an Investment Statement which describes:
- The type of investment;
- The issue price;
- The risks of the investment;
- Details of the returns; and
- Details of how the particular securities may be disposed of.
Whilst logically the requirement to prepare an Investment Statement under the Exemption Notice is a lower requirement than preparing a Prospectus, ordinarily, New Zealand legal advice would be required to be obtained by an issuing company, thereby increasing cost.
Once enacted in both Australia and New Zealand, the legislation is designed to reduce the level of additional substantive (as opposed procedural) steps that issuers are required to comply with in cross jurisdictional issues of securities.
Whilst we have principally reviewed the NZ Bill below (which is a legislative amendment proposed by the Australian Government to the Corporations Act) for the purposes of this paper, the effect of the Australian part of the legislative amendments is provide for certain exemptions for New Zealand companies seeking investment in Australia. The proposal is for similar legislation to be passed in New Zealand, which would therefore have similar effect for Australian issuing companies seeking investment in New Zealand. An exposure draft of the corresponding New Zealand regulation (under the Securities (Mutual Recognition of Securities Offering – Australia) Regulations 2006) has also been released for comment and mirrors the NZ Bill in substance.
The comments below are therefore also applicable to the proposed New Zealand legislation.
By virtue of proposed amendments to the Corporations Act, if enacted, the NZ Bill will provide that where a New Zealand company lodges20 (at least 14 days before the date the first offer is made within Australia)21:
(a) The offer document complying with New Zealand law;
(b) A warning statement in relation to the company as may be prescribed under the regulations relating to the NZ Bill;
(c) The constitution of the company; and
(d) Certain other specified information (including contact details),
then on the date that the offer document is lodged with ASIC, the New Zealand offering will be eligible as a "recognised offer" within Australia. Where an offer is a "recognised offer", then Chapter 6D of the Corporations Act (containing the Australian Prospectus requirements) will not apply to the recognised offer.22
Under the proposed amendments, scope is given for Government regulations to be promulgated to require that "recognised offers" contain certain minimum conditions that must form part of the offer. No additional guidance is given in that regard.
Whilst the proposed amendments seem to require that procedural as opposed substantive steps be taken by companies is seeking cross-jurisdictional recognition, importantly, where ASIC considers those requirements have not been complied with, it may issue a stop order on the offering document. Care must therefore be taken. This will particularly be the case where any regulations introduced as part of the amendments require that additional conditions be included as part of the offer (which may therefore require additions to the original Prospectus lodged).
Key Impact of The Amendments
Whilst final judgment on the impact of the proposed amendments can only be given once the full regulation package has been released, it appears possible that offering securities by an Australian company in New Zealand will be significantly easier, principally by removing the obligation to prepare and lodge a specific New Zealand-complying document, but rather requiring only that Australian companies lodge a prescribed form containing certain prescribed information, together with the Australian-compliant Prospectus. That is, the new requirements appear procedural as opposed substantive. As a result, it is likely that such amendments may ultimately reduce the cost and regulatory difficulty in offering securities by an Australian company in New Zealand. This is on the proviso that the ultimate form of regulations prepared for the purposes of the new Bill do not add additional information-giving requirements.
Other Amendments Proposed Under The Corporate and Financial Services Regulation Review
A large number of other proposals are currently being considered for the purposes of enhancing the Corporate and Financial Services Regulation, as identified in the Proposals Paper.
Whilst a number of these are of a relatively minor or technical nature, the following proposals are noteworthy:
Offer Information Statement
The Government is proposing amendments, in addition to the changes to "rights issues" as described above, to facilitate small scale fundraisings by granting some further measure of relief from the full disclosure requirements of the Corporations Act 23.
As part of this proposal, the Government is considering increasing the current maximum amount of funds that are able to be raised under an Offer Information Statement (OIS) from $5,000,000 to $10,000,000.
An OIS is a "disclosure document" for the purposes of Chapter 6D of the Corporations Act in the same way that a prospectus is a disclosure document. However, an OIS contains lower disclosure requirements than a full prospectus issued under Section 710 of the Corporations Act. To illustrate, an OIS must only contain the following information:24
(a) The identity of the body and the nature of the securities;
(b) A description of the body's business;
A description of what the funds raised by the company are to be used for;
(d) The nature of the risks involved investing in the securities;
(e) The nature of all amounts payable in respect of the securities (that is, the issue price and any other amounts);
(f) A statement that a copy of the document has been lodged with the ASIC and that the ASIC takes no responsibility for it;
(g) A statement that the OIS is not a prospectus and that it therefore has a lower level of disclosure requirements;
(h) A statement that investors should obtain their own professional advice before accepting the offer;
(i) A copy of a financial report for the body (which must of an audited report for a 12 month period and have a balance state that occurs within the last 6 months before the offer under the OIS); and
(j) Any other information required by the Regulations.
The information required under an OIS should be significantly less than that required under a full prospectus.25
Currently, Section 709 of the Corporations Act provides that a company can only use an OIS instead of a prospectus where the amount that the company is seeking to raise together with all amounts previously raised under other OISs issued by the company is $5,000,000 or less.
The Government states in their Proposals Paper that the market to date has not made appropriate use of the instrument.26 Presumably, they take this view on the basis that the $5,000,000 cap is too low and on the basis that an OIS cannot be used for the purposes of seeking listing of the company on a recognised Stock Exchange.
Accordingly to address part of the limitations on OISs, it is proposed that the $5,000,000 cap be increased to $10,000,000, thereby increasing the scope for companies who may wish to take advantage of the lower disclosure requirements of an OIS, and consequently reducing the costs of fundraising for entities seeking to raise between $5,000,000 and $10,000,000.
Many companies will be aware of the impact of the so-called "secondary sale" restrictions under Section 707 under the Corporations Act. In summary, as a result of certain deeming provisions in Section 707,27 where shares are issued by a company or sold by a controller of the company,28 any resale of those shares by the recipient within twelve months after the issue or transfer may require a prospectus to be issued. This will be the case unless it can be proved from the circumstances of the initial receipt of the shares by the proposed transferor (ie. the initial recipient of the shares from the company or the controller) that there are reasonable grounds for concluding that:
(a) the shares were received by the proposed transferor; and
(b) issued by the company or transferred by the controller, as the case may be,
other than for the purposes of resale.
It is problematic, particularly in the context of quoted securities, to "disprove" the deemed intention of the recipients of shares and issuing companies (or transferring controllers). As a result, it is only in fairly limited circumstances that a prospectus can be avoided for a proposed resale.
To alleviate this consequence, Section 708A (and its predecessor ASIC class orders) provide relief from the prospectus requirement for quoted securities.
Importantly however, the exemptions only apply where the shares the subject of resale were issued by a company (and not transferred by controller) to a person who proposes then to resell those shares.
The Government states in its Proposals Paper that in order for proposed transferors to avoid the prospectus requirement (where the shares were originally transferred from a controller where Section 707(6) would otherwise apply), specific case by case relief would need to be applied for from the ASIC.29
In effect, the proposal is for the existing "cleansing notice" that a company is able to give under Section 708A(5)(e) to be given (with minors amendments) by the company and a controller in circumstances where a recipient of shares from a controller is seeking to resell those shares.
That is the Government is therefore seeking, in effect, to extend the circumstances where the existing "cleansing notice" that a company is able to give under Section 708A(5)(e) can be given where a recipient of shares from a controller is seeking to resell those shares.
Under the proposal, a prospectus can be avoided provided that the controller and the company provide a notice to a relevant Stock Exchange of information of the type currently required by Section 708A in relation to share issues. Although the form of the amendments to the Corporations Act have not been released, it would appear that if the current Section 708A model is adopted (with minor alternations), the prospectus requirements may be able to be avoided in the case of a resale following a transfer from a controller where notice is given to a relevant Stock Exchange which:
(a) Is given within five business days after the date on which the relevant shares were transferred by the controller;
(b) States that the controller transferred the securities without disclosure to investors;
(c) States that notice is being given for the purposes of seeking an exemption to the secondary sale prospectus requirements;
(d) States that as at the date of the notice the company is in compliance with the provisions of Chapter 2M and Section 674 of the Corporations Act; and
(e) Sets out any additional information that has been excluded from disclosure to a relevant exchange that an investor and their professional advisor would reasonably require for the purposes of making an informed assessment of the assets and liabilities, financial position performance, profits and losses and prospects of the body, or the rights and liabilities attaching to the relevant shares.
Employee Unlisted Share Schemes
Employee share schemes are a common method for companies to reward and incentivise employees, by offering employees an ability to buy shares or options in a company pursuant to a formal scheme.
There are four key regulatory impacts of such schemes:
- Disclosure - generally unless the offer is to less than 20 persons in any twelve month period and raises more than $2,000,000 (together with all other similar issues of securities by a company in a twelve month period), a disclosure document may be required for the offer;
- Licensing - Where an employee share scheme offer document contains advice about the scheme, the issuer may be technically required to hold an Australian Financial Services Licence for giving financial product advice;
- Advertising - an employee share scheme may breach the advertising restrictions in the Corporations Act relating to offers of shares made other than under a prospectus;
- Hawking - Similarly, the offers of securities may breach the "hawking" provisions of the Corporations Act.
Currently, ASIC Class Order 03/184 provides for relief from these requirements. However, the relief is limited to listed companies.
The Government in its Proposals Paper is considering exempting unlisted companies from each of the above requirements (with the exception of disclosure relief) provided the requirements of the Class Order are met.
As unlisted companies are not subject to the continuous disclosure regime in the same way as listed companies, the Government does not consider it appropriate to remove the obligation on a company to issue a disclosure document. However, the Government expressly states30 that the lesser disclosure requirements under an OIS (described above) (rather than a full prospectus) would be appropriate in the circumstances. Further, to facilitate the use of an OIS, amounts raised by a company under an OIS for the purposes of an employee share scheme would be exempt from the $5,000,000 cap (which cap is proposed to be extended to $10,000,000, under Proposal 5.2 described above).
As part of the proposal to increase the ease with which companies can undertake employee share schemes, the Government also proposes relaxing the current restriction in Section 259C(1)(b) of the Corporations Act on a subsidiary company owning shares in its parent provided that:
(a) The ownership occurs for the purposes of acquiring shares on market to allocate those to employees under a scheme, or results from a forfeiture of shares already held by an employee back to a subsidiary;
(b) The maximum holding is 0.5% of the company's shares; and
(c) The subsidiary must dispose of the shares within 14 days after they are acquired for the purposes of allocating to an employee, or within 60 days after they have been re-acquired as a result of forfeiture.
Whilst the November 2006 proposals paper alludes to this particular "self acquisition" exemption potentially being made available to unlisted companies, no additional details have been given as to how or if such a proposal will ultimately be implemented.
Other minor amendments proposed in the Proposals Paper include:
(a) Large proprietary company - Increasing the minimum threshold for a company to be classed as a "large proprietary company" - and therefore subject to reporting obligations under Chapter 2M of the Corporations Act. It is proposed that a company will be a large proprietary company if either it has gross operating revenue of $25,000,000 or more or consolidated gross assets of $12,500,000 or more (up from $10,000,000 and $5,000,000 respectively);
(b) Annual Reports - A proposal to change the default option for members to receive annual reports such that, unless members actually request hard copies, all reports prepared under the Annual Financial Reporting to Members provisions of the Corporations Act31 will be done via a company's website;
(c) Related Party Approvals - It is proposed that the Corporations Act provide an exemption from the requirement to obtain shareholder approval for giving financial benefits to a related party,32 by providing for an exemption for amounts up to a $5,000 threshold;33
(d) Telephone Monitoring - It is proposed to remove the obligation on bidders and targets to record all telephone calls to retail shareholders to discuss a takeover bid during the bid period, given compliance costs in doing so; and
(e) 100 Member Rule - Although not forming part of the Proposals Paper, it is also noteworthy that pursuant to the Corporations Amendment Bill (No.2) 2006, it is proposed to amend the Corporations Act by removing the so called "100 member rule" (which currently allows 100 shareholders to require a company to convene a general meeting of shareholders) by setting a minimum threshold at such a number of shareholders (collectively or individually) as hold 5% of the total voting shares.
The Government ought to be applauded for seeking to reduce the regulatory burden on companies, particularly smaller companies, in fundraising and in dealing with their shareholders. It is notoriously time consuming and costly to prepare prospectuses and report annually to shareholders and there is clearly some scope for improvements to be made in the current regulatory regime.
The difficulty that we see with the rights issue proposal outlined in the Proposals Paper is that where a company's approach to due diligence on a prospectus is primarily (or at least in part) driven by liability concerns, those liabilities concerns do not appear to have been lifted or addressed by virtue of the Proposals Paper. Final judgment on how those proposals will be received by companies has to be reserved until the final regulations are ultimately put forward in the SRS Bill. However it appears that many companies, being duly diligent, will undertake the same due diligence activities as they currently do under a rights issue offering.
These same sentiments can be also addressed to the Government's proposed introduction of the NZ Bill (and similar associated New Zealand legislation). Provided the ultimate final form of the regulation package is not substantially different to that proposed in the NZ Bill, there does appear to be some scope to reduce the burden in Australian companies offering securities in New Zealand (and vice versa).
If enacted, the electronic distribution of annual reports and the like should significantly reduce costs for companies with a larger shareholder base and these amendments are likely to be applauded by their boards.
The final word, however, on the effectiveness of the above changes can only be given following passing of the relevant bills and their implementation. It will be interesting to see, assuming the proposals are implemented, how the proposals impact upon the use of rights issue as a capital raising vehicle and, particularly, whether there is any consequent increase in the number of actions taken by shareholders (or the ASIC) against companies who fail to comply with the mandated content requirements of the cleansing notice.
1. Australian Government Website - Department of Prime Minister and Cabinet ("Legislation Proposed for Introduction in 2007 Autumn Sittings").
2. Corporate and Financial Services Regulation Review - Proposals Paper November 2006.
3. Section 706 of the Corporations Act.
4. See subsection 713(2) of the Corporations Act.
5. See Listing Rule 3.1 and Chapter 6CA of the Corporations Act.
6. See subsection 713(5) of the Corporations Act.
7. There is a potential for liability under the common law for negligent misstatement or on the basis of the tort of deceit. Importantly, the Corporations Act defences will not apply to this form of liability, though certain common law defences may be available.
8. Under section 728(3) of the Corporations Act.
9. Under section 729(1) of the Corporations Act.
10. See subsection 731(1) of the Corporations Act.
11. See subsection 732(1) of the Corporations Act.
12. See Sections 1041E and 1041I of the Corporations Act.
13. See Section 1041H of the Corporations Act.
14. See exception 1 within Listing Rule 7.2.
15. See exception 2 within Listing Rule 7.2.
16. See exception 3 within Listing Rule 7.2.
17. See Listing Rule 7.11.3 - this rule does not apply to a bonus issue or to a renounceable offer where the issue price is not more than the average market price for the previous five days before the issue was announced.
18. Listing Rule 7.12 requires a company to accept evidence of entitlements under certified contract notes from market participants (such as sharebrokers) of ASX.
19. The Hon. Chris Pearce, Parliamentary Secretary to the Treasurer; press release No. 032; "Corporations Amendment (NZ Closer Economic Relations) Bill 2006" 11 September 2006.
20. Section 1200B(6) Corporations Act (contained within Schedule 1 of the Corporations Amendment (NZ Closer Economic Relations) Bill 2006 (Exposure Draft).
21. See proposed Section 1200C Exposure Draft
22. Section 1200M Exposure Draft.
23. Section 5.2 of the Corporate and Financial Services Regulation Review Proposals Paper; November 2006
24. Section 715(1) Corporations Act
25. Section 710 of the Corporations Act requires that a prospectus must contain, generally, all information that investors and their professional advisers would reasonably require to make an informed assessment of the rights and liabilities attaching to the securities, the assets and liabilities, financial position and performance, profits and losses and prospects of the body.
26. Section 5.2 Proposals Paper
27. Section 707(4), (6)
28. Except where such sale by a controller is via an on-market sale of quoted securities
29. Section 5.3 Proposals Paper
30. Section 5.4 Proposals Paper (page 64)
31. Section 314
32. Chapter 2E of the Corporations Act
33. It is proposed that payments will be aggregated to ensure the exception is not misused.
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