In January of this year the U.K. securities regulator, the Financial Services Authority (the FSA), issued Consultation Paper CP12/2 proposing amendments to rules applied by it as the UK Listing Authority to companies listed or seeking listings on the UK's regulated stock market (the Listing Rules). As we discussed briefly earlier this week, the paper proposes a series of changes, primarily to the Listing Rules, but also to rules which apply to prospectuses being issued in the UK (the Prospectus Rules) and to the on-going share capital, financial and other disclosures required in respect of companies listed in the UK (the Disclosure and Transparency Rules). Key proposed amendments apply to transactions, reverse takeovers (RTOs), externally managed companies (also known as special purpose acquisition companies or "SPACs"), the sponsor regime and the ability to buyback more than 15% of a company's own shares.
The changes proposed in relation to transactions are primarily the codification of existing practices.
Removal of the Class 3 Transaction
Under Listing Rule (LR) 10, when a premium listed company (i.e. one that complies with the enhanced requirements required to be eligible for FTSE participation) (or one of its subsidiaries) prepares to enter into a transaction, the company must run a number of calculations designed to demonstrate the size of the proposed transaction in relation to the size of the listed company. These calculations are referred to as "class tests". The tests compare (i) the assets and the profits which are the subject of the transaction with the assets and profits of the listed company; (ii) the consideration payable with the company's market capitalization; and (iii) on acquisition, the gross capital of the company being acquired with the gross capital of the listed company. The percentage ratios determined by these tests determine the class of the transaction (class 1, 2 3, or an RTO) which serve to dictate the regulatory requirements for the listed company. A class 1 transaction arises when the ratios are 25% or more and require a circular to shareholders and shareholder approval and if they are 100% or more, an RTO will arise requiring, normally, a new listing. A ratio of 5% or more is a class 2 transaction requiring an announcement of prescribed information. Class 3 transactions are those where the ratios are less than 5% and not normally require any additional disclosures.
Alongside the incorporation to the Listing Rules of current guidance on significant transactions, a number of additional changes to the class tests have also been proposed. Proposed additions include:
- imposing an obligation on issuers who wish to make adjustments to the figures used in class tests to discuss this with the FSA before the class tests crystallize;
- disapplying the profits test on an acquisition or disposal of an interest in an undertaking that does not result in consolidation or deconsolidation of that target;
- clarifying that when applying the class tests, adjustments for post-balance sheet transactions can only be made if those transactions have completed; and
- requiring an issuer who enters into a put or call option in a joint venture exit arrangement where the exercise is controlled solely by the other party to classify such arrangement at the point when the listed company loses discretion over the exercise of that option.
Under the proposals, there will no longer be a concept of a class 3 transaction. A class 3 transaction is the smallest of the categories and exists where all the percentage ratios under the class tests are less than 5%. The FSA considers that the notification requirements under the class 3 transaction rules are unnecessary because they result in immaterial information being disclosed to market and do not provide any additional value above the disclosure obligations in Chapter 2 of the Disclosure and Transparency Rules in relation to price-sensitive information.
The concept of a supplementary circular has been introduced into the Listing Rules; it requires that issuers provide, when the circumstances warrant, further information to shareholders so they are better informed prior to exercising their voting rights. The requirement to issue a supplementary circular will be triggered when (i) a material change occurs affecting any matter disclosed in a circular; or (ii) a material new matter that would have had to be disclosed in the circular arises after posting the circular but before the shareholder meeting. As a rule, there must be at least seven days between the sending of a supplementary circular and the holding of the meeting. If there is a material change to the terms of the transaction after shareholder approval has been obtained, the position will be, as it is now, that the company will have to comply with the class 1 provisions again which include, but are not limited to, issuing a press announcement, re-issuance of a circular to shareholders and first obtaining shareholder approval.
Class 1 Circulars
The proposals include a number of changes to Listing Rule requirements when a class 1 circular is being produced. Under the new requirements,
- a listed company, as well as its directors, must take express responsibility for a class 1 circular; and
- risk factors in the circular must be confined to those that are material to the proposed transaction or material risks that are new or have changed as a consequence of the transaction.
The FSA has also proposed a number of changes or clarifications regarding the financial information to be included in a class 1 circular. These include:
- the financial information required on an acquisition or disposal where there will not be a consolidation or deconsolidation;
- the requirement of an independent valuation of the target where financial information is required but there is no appropriate financial information available (as in the acquisition of tangible or intangible assets or an investment that is not listed on an investment exchange);
- the required financial information where the target has made acquisitions prior to the pertinent transaction;
- the circumstances in which a restatement of a target's accounts may not be required if its shares are publicly traded and the confirmations required of the sponsor in those circumstances;
- where a synergy benefits statement is included, a requirement for disclosure of the bases for the belief that the synergy will arise, an analysis and explanation of the constituent elements of the benefits (including when they are expected to be realized and if they will occur) as well as confirmations that they could not be achieved independently and that the estimated synergies reflect both the benefits and costs.
In relation to a class 1 circular of a mineral company, there will be guidance to allow equivalent information to be provided in place of an expert's report to reflect the guidelines of the EU securities regulator (ESMA).
The proposal to replace the defined term "break fee" with "break fee arrangement" reflects the FSA's view that it is the substance of the arrangement rather than its legal form which is important. Under the proposed rule, all break fee arrangements are caught under LR 10 which requires that an agreement to pay any break fee which exceeds 1% of the company's market capitalization (or if a listed company is being acquired, 1% of the offer value) is to be treated as a class 1 transaction, and is subject to the relevant Listing Rule Requirements. It is also clear from the proposed rule that if the purpose of an arrangement is that a compensatory sum will become payable by the listed company if a transaction fails or is materially impeded and there is no substantive commercial rationale for the arrangement, it will be a break fee arrangement.
Removal of the "Revenue Nature" Test for an Exemption
At present the Listing Rules provide that transactions "of a revenue nature in the ordinary course of business" are excluded from the scope of LR 10 and 11. The proposed amendment deletes "of a revenue nature" so that any transaction in the ordinary course of business will be exempt. The FSA's reasoning behind this change is twofold. Firstly, the FSA believes that the accounting treatment of a transaction (i.e. whether it is "of a revenue nature") should not determine whether it is in the ordinary course of business and, secondly, that it is difficult to distinguish between capital and revenue treatment.
2. Reverse Takeovers
According to the FSA, the proposed changes to the rules governing RTOs will ensure that they cannot be employed as a "back-door" route to listing for otherwise ineligible companies.
Definition of "reverse takeover"
Under the amendments, a reverse takeover would be defined as:
a transaction, whether effected by way of direct acquisition by the issuer or a subsidiary, an acquisition by a new holding company of the issuer or otherwise, of a business, a company or assets:
- where any percentage ratio as calculated using the class tests is 100% or more; or
- which in substance results in a fundamental change in the business or in a change in the board or voting control of the issuer.
In considering whether a fundamental change in the business has occurred, the proposals indicate that the FSA will consider the extent to which the transaction would change the strategic direction or nature of the business, the impact the transaction would have on the industry sector classification of the enlarged group and the impact on end users and suppliers. Under these proposed amendments, the RTO regime will be extended to apply to issuers with a standard listing of shares and to issuers with a standard listing of certificates representing equity securities (including global depository receipts), as well as issuers with a premium listing. According to the consultation paper, the proposed definition would remove "any uncertainty as to which structures result in a reverse takeover".
Limited scope of exemption
At present, an issuer completing a reverse takeover is generally required to cancel the listing of its shares and re-apply for listing by satisfying the relevant eligibility requirements. Exemptions, however, are available where a listed issuer acquires another listed issuer. The proposed amendments to the Listing Rules would narrow this exemption to acquisitions of listed issuers within the same listing category. The amendments would be consistent with the principles of the rules regarding transfers between listing categories and reflect the FSA's concern that RTOs can be used as a way of "avoiding the assessment of substantive eligibility conditions."
Suspension of shares
The Listing Rules currently allow the FSA to suspend the listing of shares where the "smooth operation of the market is, or may be, temporarily jeopardised" or where necessary to protect investors. Shares are typically suspended under this authority on the announcement or leak of a RTO that has been agreed to or is in contemplation, unless the FSA is satisfied that there is sufficient publicly available information about the proposed transaction.
Under the amendments, an issuer will be required to contact the FSA as soon as possible once a takeover was in contemplation or agreed to in order to discuss whether a suspension is appropriate. Guidance is provided by the FSA regarding the circumstances under which a suspension will not be necessary. For example, where a rebuttal of the presumption of suspension requires some form of confirmation (i.e. an assurance as to the alternative exchange's disclosure regime), this disclosure will need to be given to the FSA by the sponsor in instances where the issuer has a premium listing.
The current requirement in the Listing Rules that premium listed issuers, and applicants seeking a premium listing must have an approved stock exchange member as a sponsor, ensures that such issuers and applicants understand and are complying with the regulatory framework that they operate within and comply with the obligations that it imposes on them, and that the FSA and the public can be confident that this is the case. The FSA proposes to extend the definition of sponsor services to include (i) additional types of transactions and (ii) all the sponsor's communications with the FSA. The proposed rules echo what is currently regarded as "best practice" by sponsors and stipulate that the explanations and confirmations provided by sponsors to the FSA should be provided in a timeframe reasonably specified by the FSA, that communications should be accurate and complete in all material respects, and that information which materially affects the accuracy or completeness of information previously provided should immediately be provided to the FSA.
The FSA's most significant proposal in relation to sponsors aims to mitigate the conflict that can arise for a sponsor between their duties to the company as they commonly act as broker and placing agents as well as the FSA. The proposals include a specific obligation on listed companies (and applicants for listing) to co-operate with their sponsor to enable their sponsor to comply with its obligations to the FSA.
4. Externally Managed Companies
The FSA uses the term "externally managed company" to refer to a company which is listed as a cash shell with the aim of acquiring and running a target company, more commonly referred to as a SPAC. The proposed rule changes are focused on regulating the outsourcing of the management of these companies to off-shore advisory firms. If companies outsource their management function in this fashion, proposed amendments to the Listing Rules propose that:
- the persons to whom the management is outsourced must take responsibility for any prospectus in the same way as directors of the company do and will be liable for information in the prospectus;
- the persons to whom management is outsourced will also be treated as a person discharging managerial responsibilities and therefore will be required to make share dealing disclosures under the Disclosure and Transparency Rules; and
- these companies cannot have a premium listing.
5. Purchase of Own and Treasury Shares
At present under LR 12 a listed company which purchases 15% or more of a class of its own equity shares must do so by via a tender offer to all shareholders. The proposed amendment would discard the requirement of a tender offer in situations where the terms of the proposed buyback are specifically authorised by shareholders. A tender offer would still be required, however, where the buyback has been executed under shareholders' general authority, for example where that authority had been obtained at an AGM.
Feedback on the proposals put forth in CP12/2 is being accepted until April 26, 2012.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.