Dialogue: Fair shares tricky to define

SUSAN WATSON examines the polarised debate over how to manage takeovers in a just manner.

Just as retailers announce a price rise in anticipation of a rush on goods before the rise occurs, it was predictable that the announcement of the implementation of a takeovers code would lead to a rush on bargain basement companies on the New Zealand Stock Exchange.

There are already rules which control takeover activity. Provisions adopted into the constitutions of listed companies by the end of 1995 were drafted by Act MP Stephen Franks in an earlier incarnation as a corporate lawyer.

Those rules were designed to provide a balance between the protection of small shareholders and the interests of major shareholders by allowing companies to decide which of three regimes to adopt into their constitutions. All companies were also required to include in their constitutions "notice and pause" provisions, which give periods of public notice before a transfer of shares can take place.

However, the ability of the stock exchange to grant waivers was retained, rendering the rules toothless in the eyes of many.

Should the waiver have been granted in the Montana case? In the foreword to its listing rules, the stock exchange says issuers are encouraged to use those powers "in circumstances in which the exchange can be satisfied that the proposals for which dispensation is sought are innocuous."

It is difficult to see the small shareholders of Montana or Allied Domecq seeing dispensation as innocuous, but the grant of the dispensation does leave unanswered the wider question of who the rules are designed to protect and what the function of the exchange really is.

The exchange is owned by New Zealand sharebrokers. Its rules are designed "to facilitate the efficient operation of the market in the interest of securities issuers, buyers, sellers and brokers."

The rules state that the market operates on the caveat emptor principle and that self-enforcement of breaches against participants will be the rule rather than the exception. From the tone of the foreword, it is clear that the stock exchange was not set up to protect small investors, and investors will attest to the fact that it does not. But should it?

The takeovers code which comes into effect on July 1 is lauded by many as a white knight for small investors.

Takeover law reform in New Zealand has a long and chequered history.

As early as 1993 the then Minister of Justice, Sir Douglas Graham, bemoaned reform of the takeover laws as having "bedevilled both Governments and [their] advisers for too long."

The reason for the prolonged debate is that takeover-law reform epitomises a philosophical divide in which there is no middle ground.

The debate centres on what the stock exchange terms the "premium for control," which allows a higher price to be paid to some shareholders than others in a takeover, or control of a company to change hands without a bidder being obliged to acquire all its shares.

Those in favour of the premium argue that imposing a requirement of equal treatment on all shareholders in a target company is unfair.

Opponents argue that the commercial reality is that large blocks of controlling shares have greater value than small shareholdings and consider that making the premium unlawful would inhibit takeover activity.

Proponents of a takeovers code point to the New Zealand experience. Under an essentially unregulated takeover regime, most takeover activity in the past 10 years in New Zealand has benefited only the holder of the controlling parcel of shares. Small shareholders have no say or control - or often even warning - over a change in management.

In December 1988, for example, Singaporean and Malaysian interests acquired 74 per cent of the shares in London Pacific from Equiticorp. The shares in London Pacific were at that time trading on the stock exchange for almost 11c a share. The bidder paid in effect 19c a share for the controlling stake. London Pacific was placed into receivership in October 1990 and was later wound up.

A Securities Commission report in March 1993 revealed that the takeover bid was financed by an elaborate sham, with the bidder stripping the company of $31.2 million.

The net result was that the shares of 7000 minority investors were worthless.

Had a takeovers code been in place, the raiders would have been obliged to offer to acquire shares in London Pacific from all shareholders. Small shareholders could then have decided either to sell their shares or remain as investors under the new regime.

Supporters of the code argue that this graphically demonstrates the perils which exist for unprotected small shareholders in a virtually unregulated environment for takeovers. More commonly, small shareholders miss out on the highest prices paid for large parcels of shares.

In an open market, where legislation on issues such as insider trading has attempted to create at least the illusion of a level playing field, code supporters say this is not acceptable.

Equally though, opponents of the code argue that apathetic small shareholders do not warrant special protection - few contribute anything to a company but all are prepared to share in the economic gains of entrepreneurial management. It is only when losses occur that disgruntled small investors call for the protection of regulation.

It is against this background that the takeover law debate has simmered since the mid-1980s, with the code on the backburner in essentially the same form since 1993.

Twice the National Government considered bringing in the code. The second time, those in favour of implementation were defeated in cabinet by the narrowest of margins.

With the change of Government, it was inevitable it would be implemented.

After July we will find out its effect on the market and see if small investors are encouraged back in.

Perhaps the most telling argument code supporters can put forward is that, despite all the theory in favour of a unregulated takeovers market, our sharemarket has performed poorly in bad economic times and sluggishly in good.

The tightening of the regulatory environment may create the impression of a level playing field in the market. This may entice small investors, burned in the 1987 crash, to trade bricks and mortar for shares and revive investor confidence in the basic soundness and fairness of the New Zealand market.

* Susan Watson is a senior lecturer in commercial law at the University of Auckland.