Australia: Government’s Corporation Reform Package – Fundraising

On 24 May 2007, the Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007 was presented to Parliament for its Second Reading speech. The Bill is intended to simplify aspects of the current regulatory system but it is of note that the Bill itself exceeds 70 pages and the Explanatory Memorandum exceeds 180 pages.

The reforms follow the recommendations in the ‘Rethinking Regulation’ report of the Banks Taskforce on Reducing the Regulatory Burden on Business and the release of the Corporate and Financial Services Regulation Review Proposals Paper (Proposals Paper) in November 2006.

This update addresses the reforms specific to the fundraising provisions of the Corporations Act 2001 (Cth). The reforms to takeovers, financial services and the general corporate governance and company reporting requirements are discussed in separate client updates.

Substantive amendments to the fundraising provisions are contained in the reforms. The primary drivers for the amendments include enhancing business efficacy for raising capital in a streamlined and timely manner.

According to market surveys, approximately $42.5 billion was raised last financial year in the Australian capital market. Given the current status of the financial and capital markets, this is likely to increase in the foreseeable future.

One issue with raising capital is the relative ease of making placements to sophisticated investors, compared with the complexities of rights issues. This has meant that many issuers are favouring placements, given the speed and the minimal regulatory burdens. This was reflected in the KPMG Survey of Australian Capital Markets, which found that almost twice the amount was raised by placements compared with rights issues in 2005/06. Placements accounted for approximately $11.6 billion, and rights issues approximately $5.7 billion. It is worth noting that the amount raised by placements increased by about $3.1billion over the previous year, while the amount raised by rights issues remained relatively static (and in fact decreased from 2003/04).

The other drivers for these changes include encouraging employee share schemes, to grow the number of employees that share in the accretion of shareholder wealth.

The balance of the amendments focus primarily on aligning the treatment of fundraising for securities and interests in managed investment schemes (MIS).

A rights issue is viewed as a fair way for current security holders to increase their holdings in an entity, or in the case of a renounceable rights issue, to trade those rights and receive value. Currently, there is no exemption from the comprehensive disclosure requirements for raising capital by way of rights issues.

The reforms mean that, for listed entities, rights issues will not require a disclosure document provided the following conditions are met:

• The relevant class of securities offered is quoted at the time of the offer.

• The securities have not been suspended from quotation for more than five days in the 12 months before the offer, or for as long as the securities have been listed if less than 12 months.

• The entity is not exempted from any of the relevant disclosing entity provisions.

The rights issue reforms apply to both securities and interests in managed investment schemes, so there will be relief from both the disclosure document and PDS requirements.

One further condition is the lodgement of a ‘cleansing notice’ within 24 hours before making the offer. In summary, the notice must include any information that fell within any of the exceptions to the continuous disclosure requirements. It must also include any additional information that investors and their professional advisors would reasonably require for the purpose of making informed assessments of the offer.

These new provisions will apply only where a rights issue is made to all holders in both Australia and New Zealand. The issue need not be made to persons in other overseas jurisdictions, to avoid compliance costs in those jurisdictions if there are only a limited number of holders affected. For a renounceable rights issue, the rights attributable to those overseas persons must be sold and the net proceeds given to them. This is similar to current relief provided under the Australian Securities Exchange Listing Rules.

As a word of caution, if certain issuers have failed to comply with their financial reporting and auditing requirements, or have committed other specified breaches of the Corporations Act, ASIC can determine that the issuer cannot use these exceptions.

One of the real benefits of this proposed change is that it will make issuers more likely to favourably consider rights issues, as the compliance burden will essentially be equivalent to a placement. This should enhance the ability of all current shareholders to participate in fundraisings and potentially reduce the dilutive effect of placements.

We expect that these provisions will be widely used.

Currently, a controller of a listed entity wishing to undertake a secondary sale of securities may only do so where the securities have been continuously quoted for a minimum of 12 months, a ‘cleansing notice’ is provided to the market and there have been no breaches of specified provisions of the Corporations Act (including financial reporting). Otherwise, secondary sales by controllers require a comprehensive disclosure document (unless individual relief is obtained from ASIC).

The reforms mean that controllers will obtain relief from the disclosure document requirements for secondary sales, provided:

1. A cleansing notice is given by both the controller and the listed entity.
2. The securities have been continuously quoted for three months (which is a reduction from the previous 12 months).

Additionally, a purchaser of securities from a controller can also on‑sell under the secondary sale provisions if that purchaser intended to dispose of the securities on acquisition.

Analogous relief has been made in respect of quoted interests in MIS, again aligning the disclosure requirements in respect of securities and interests in MIS.

Use of Offer Information Statements is to be easier for small scale fundraisings for new businesses. Offer Information Statements have a lower level of disclosure requirements than a prospectus. Currently, Offer Information Statements can be used only if the total amounts raised are less than $5 million. Offer Information Statements have not been widely used in the market, perhaps both because of the dollar threshold and the perception in the market that if you are going to raise capital, a prospectus is a better understood and accepted document.

The reforms will raise the threshold for the capital raising to $10 million. When calculating this amount it will be necessary to consider all funds previously raised by the issuer except under eligible employee share schemes.

Changes have been made to the definition of ‘sophisticated investor’ to align the definitions under the fundraising provisions with those in the financial services provisions. This includes a clarification that the amount controlled by a person includes net assets and gross income of a company or trust controlled by that person. The test is applied to a group of controlled entities and their assets and income, rather than the particular entity itself.

The reforms seek to support the increased use of employee share schemes to allow employees to participate in the ownership of their employers. Currently, unlisted entities are at a disadvantage as their employee share schemes and contribution plans are not exempted from the licensing and anti-hawking provisions of the Corporations Act.

The reforms address this and grant licensing relief to all employers (being the company or a controlled entity operating the scheme), whether listed or unlisted, from each of the following:

• Providing general financial product advice regarding the scheme.

• Dealing in financial products, being interests in the scheme, provided the dealing occurs through a person holding an AFSL or a person outside Australia who is authorised to deal in financial products in that jurisdiction.

• Operation of a custodial or depository service in relation to the scheme.

• Dealing in an interest in a contribution plan.

Employee share schemes are also excluded from the anti‑hawking provisions. Without this relief an employer might not be able to inform their employees about the scheme to invite them to participate.

An additional advantage for smaller employers is that, while previously all amounts raised under an employee share scheme counted towards the calculation of the total amounts raised for the purposes of an Offer Information Statement, these amounts are now excluded.

Contribution plans are excluded from the definition of a MIS and from the requirement for the preparation of a PDS, but as the employee share scheme itself needs a disclosure document or PDS, this is unlikely to be a significant benefit.

It is important to note that the disclosure obligations for employee share schemes have not been amended, so unless an employee share scheme comes within an exemption from the need for a disclosure document, disclosure will still be necessary (by way of prospectus, Offer Information Statement etc).

It had been proposed that the provisions relating to the self acquisition of shares by companies should not apply in the context of employee share schemes. This proposal has not been included in this round of reforms and will be the subject of further consultation with the Ministerial Council for Corporations.

Given the prevalence of stapled securities in capital markets, one current issue under the Corporations Act is the difference between a prospectus and a PDS. These differences apply both in respect of content requirements, but more particularly to what happens if further information becomes available after issue of the disclosure document. There is currently no provisions allowing a replacement PDS, while replacement prospectuses are well understood.

For stapled securities it is common to prepare a combined prospectus/PDS. Thus issues arise if supplementary disclosure is required. The reforms align these rules to simplify disclosure in respect of stapled securities.

The amendments permit the use of a replacement PDS and deem that a PDS includes a replacement PDS (also referred to as an RPDS). They also clarify that, if there are dates for satisfaction of conditions (eg minimum subscriptions), then the time period for satisfaction of these runs from the date of any replacement PDS.

Currently, restrictions on advertising prospectuses are more prescriptive than those relating to other financial products, including PDSs. ASIC’s stop order powers do not extend to advertising for offers of securities. The reforms align the advertising provisions relating to disclosure documents with those relating to other financial products.

Additionally, ASIC’s stop order powers have been clarified in relation to defective documents. This includes a power for ASIC to issue a stop order in respect of an advertisement or publication where there is a misleading statement about a future matter if there are no reasonable grounds for making such a statement.

A number of the amendments have been made to align the fundraising provisions with the financial services provisions of the Corporations Act. In many cases, the differences are due to historical factors, such as the date of introduction of the provisions and slight differences in drafting. Over time, it is likely there will be further amendments to address similar issues.

It will be interesting to observe the effect of the changes to the fundraising provisions in the capital markets. It seems likely that the most impact will come from the changes relating to rights issues, and this is consistent with the intention to maintain consumer participation in financial markets.

It will also be interesting to see if there is an increased use of Offer Information Statements and market acceptance of these documents, as, since these were introduced, they have not gained the traction that might otherwise have been expected.

Otherwise, the proposed changes signify an intention to continue to encourage investor participation in fundraising and streamlining the fundraising process for issuers in a number of key areas.

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