Gaynor: Lasting legacy of flawed share law

By BRIAN GAYNOR

The Montana standing committee has a very difficult task when it meets today to decide the fate of the Lion Nathan shareholding.

In effect, the three committee members - Sir Duncan McMullin, Sir Ian Barker, QC, and Bill Wilson, QC - are playing the Last Post for Stock Exchange rules that will be replaced by the takeovers code on July 1.

Because the listing rules are poorly drafted and vague, Lion Nathan will contest any decision that reduces its Montana shareholding below 50 per cent. As a result, it may be some time before the old rules are finally dead and buried.

To understand why the Stock Exchange rules are ineffective and open to interpretation we must look back at the evolution of takeovers regulation over the past 35 years.

The basic statute regulating takeovers - the Companies Amendment Act 1963 - is seriously flawed because it applies only to offers made in writing and to seven or more shareholders.

It can be avoided by going through the Stock Exchange and in the late 70s first-come, first-served offers through the market, partial bids, differential pricing, uncontested acquisitions and other shenanigans became a common feature of our sharemarket.

In October 1983, the Securities Commission called for the repeal of the act and the introduction of takeovers laws that would require offers to be made in writing to all shareholders on equal terms.

No action was taken on these recommendations. At the time the Stock Exchange had equal-pricing rules that were vague and ineffective. These rules proved to be hopelessly inadequate in 1988 when Lion Corporation made a takeover offer for L.D. Nathan on these terms:

* $9.20 cash a share for the 35 per cent owned by Fay, Richwhite, and

* One Lion share for every one L. D. Nathan share for all other shareholders.

As Lion shares were $5.50 at the time, Fay, Richwhite received a premium of $3.70 a share, or 67 per cent, over all other shareholders and the Stock Exchange's equal-pricing rules were insufficient to prevent this.

In October 1988, the Securities Commission produced a second report recommending takeovers legislation that would give equal treatment to all shareholders and encourage a more competitive and open environment for takeovers.

In 1991, the Government finally responded, and a takeovers bill was introduced into Parliament. Its objective was to establish a takeovers panel, empower the panel to recommend a code and provide for the administration and enforcement of the code.

A takeovers panel advisory committee was formed and immediately called for submissions.

With the notable exception of the Business Roundtable, the Chamber of Commerce and Stephen Franks (the current Act list MP), all submissions were in favour of a code.

The Stock Exchange was particularly enthusiastic and wrote: "The exchange stresses the importance of speed, efficiency, fairness and effectiveness in the introduction of the takeovers code and for that reason supports the prompt implementation of the London model, which is based on 20 years' operational experience."

The exchange also argued its market surveillance panel was best suited to administer the code. The introduction of the code went according to plan, and the Takeovers Act 1993 became law on July 1, 1994. But it would become fully effective only when the Governor-General signed off on the code.

The Business Roundtable lobbied aggressively against the code. The Stock Exchange joined it when its market surveillance panel was given no administrative role.

In May 1994, just before the Takeovers Act 1993 became law, the exchange proposed a private sector alternative to the code as part of its listing rules. The exchange promoted its proposal on the basis that shareholders could chose between three takeovers regimes and one of them, called the minority veto provision, was very similar to the proposed code.

The minority veto could be implemented only if 75 per cent of shareholders in two different groups supported the proposition. The two groups were:

* All those holding 10 per cent or more of the capital.

* All those holding less than 10 per cent.

The voting procedure was hopelessly undemocratic, as 90 per cent of shareholders could vote in favour of the proposal but one minority shareholder, holding just 10 per cent of the company, could veto a regime that would allow all shareholders to be treated equally.

The Stock Exchange's takeover provisions were a facade. The exchange was now totally opposed to a code and used its flimsy proposal as a tool to convince the Government that a code was not needed.

Stephen Franks, the chief architect of the rules, was a fierce opponent of the Government's code. The regulations were drafted in a hurry, and came into force in August 1994.

They had the desired impact and the National Government finally abandoned the code in August 1995.

The Stock Exchange takeover provisions are little more than a substantial security holder notice in advance. They have done nothing to quell first-come, first-served offers through the market, partial bids, differential pricing, uncontested acquisitions and other questionable practices that have been a feature of our market since the late 70s.

The main beneficiaries of the Stock Exchange rules are the big broking firms, as they earn large brokerage fees from first-come, first-served offers but have no involvement in a written offer that goes directly to shareholders.

The Montana standing committee is the first group of legal heavyweights to review the Stock Exchange's takeover provisions, and its report identifies a huge gap between the legal interpretation of the rules and market practice.

Based on the standing committee's report, a large percentage of partial bids in recent years were in breach of the listing rules.

For example there is a strong argument, based on the committee's definition of a transfer, that Craig Heatley breached the listing rules when he recently bought 160 million eVentures shares.

If challenged, he could be declared a defaulter in respect of these shares.

The standing committee's decision will be made against a backdrop of Stock Exchange rules because the Montana transactions went through the market to avoid the Companies Amendment Act 1963.

As these rules were drafted in less than three months, and were primarily aimed at scuttling the Government's code, it is not surprising they lacked substance.

When making its decision the standing committee will have to look at several issues. These include:

* It is widely accepted that the 21.4 million shares investigated by the committee and found to be in breach of the rules will be defaulted. This will reduce Lion Nathan's shareholding from 62.3 to 52.3 per cent.

* As the committee investigated only a proportion of the Lion purchases on February 9, and found them all to be in breach of the rules, it is reasonable to assume that all the shares purchased on February 9 were in breach of the rules. If all these are defaulted, Lion's shareholding will drop to 44.1 per cent.

* Stephen Franks told National Radio that it was his intention that the defaulting party should go back to where it was before the default transaction took place. On this basis, Lion Nathan should go back to 28.3 per cent, slightly ahead of Allied Domecq's 26.8 per cent holding.

You can bet your bottom dollar that Lion Nathan will challenge any decision that takes its Montana shareholding below 50 per cent, including counterclaims against Allied Domecq.

Mr Franks may have contemplated harsh penalties for defaulters but these intentions are not reflected in the rules. The lack of clarity will give Lion Nathan plenty of scope to challenge the standing committee's decision.

* Disclosure of interest: Brian Gaynor is a Lion Nathan shareholder; as a consequence of an indirect interest in Montana he provided a statement which formed the basis of the complainant shareholder's appeal to the stock exchange.

* bgaynor@xtra.co.nz