Rachel Taylor: Change must remove doubt

COMMENT

Much is being made in the media of recommendations to amend the Securities Markets Act to require disclosure of economic interests in equity swaps following the recent Privy Council decision.

It is worth noting that reform was initially recommended after the decision of the High Court (which found in favour of GPG and was subsequently overturned in the Court of Appeal).

It has been proposed that the act be amended to extend disclosure obligations to parties acting "in concert" with each other.

There is doubt that this, by itself, would require disclosure of equity swaps of the type entered into by Perry Corp.

For example, in Australia, rules requiring disclosure by substantial shareholders who were acting "in concert" with one another were considered in a case involving Industrial Equity Ltd.

In that case, the court found disclosure rules were breached when shares were purchased by a subsidiary on behalf of a third party.

The subsidiary retained rights to voting and dividends. The court found that while acting in concert does not require an overt act, it requires a common object and purpose.

In trade practice cases, "acting in concert" requires communication or agreement between the parties, being more than simultaneous actions occurring spontaneously.

Unlike Australia, the United States and Britain, Hong Kong has legislated to require disclosure of equity swaps transactions.

It has done this by specifically requiring disclosure of interests in the underlying shares held to hedge cash settled and physically settled swaps.

If the law here is to be amended to require disclosure of interest in equity swaps, it is critical that this is done in a way to promote certainty in the market place. The Perry/GPG case ran on for nearly two years, and the PPCS/Richmond litigation (also involving Securities Markets Act disclosure) even longer.

Substantial security holder laws are designed to benefit shareholders in listed companies.

Avoiding protracted litigation over the interpretation of those laws will do the same.

In the meantime, the Privy Council decision reinforces that equity swaps like those entered into by Perry do not require disclosure under present law.

Equity swaps are derivative instruments entered into between investors and bank counterparties, generally on standard international documentation.

Banks pay investors the return they would have received by holding a particular share (dividends and any share price increases).

In return, the investor pays the bank a financing return and any share price decrease. The bank is not required to, but will often hold the underlying shares to hedge its obligations to the investor. This is particularly so (ie, the "market reality") where the underlying share is illiquid, has small market capitalisation, cannot be matched by a similar share and has a history of price volatility.

The investor has no right to acquire any shares held by the bank, or to direct how those shares may be voted.

In the GPG/Perry case, the banks acquired from Perry the Rubicon shares they held to hedge their obligations to Perry. When the swaps terminated 15 months later they sold the Rubicon shares to Perry.

The Court of Appeal considered whether an arrangement or understanding existed requiring disclosure by Perry Corp of an interest in the shares held by the banks as a hedge.

It found there was neither an actual arrangement or understanding that Perry Corp would be able to acquire shares in Rubicon held by the banks, nor was there a disclosable interest arising from the near inevitability that Perry could do so.

It was found that it was market reality that the banks would hedge an equity swap over Rubicon by holding Rubicon shares, and that the shares would be highly likely to be available for purchase by Perry Corp on termination of the swaps, if it wished to do so.

But consensus and communication are also required for there to be an arrangement or understanding. The mutual expectations of two parties, based on market reality, are not enough. Perry Corp would also have needed to be able to "control" the banks' shares. It had no such control.

The Court of Appeal decision means that an interest in equity swaps of the type held by Perry Corp are in New Zealand treated consistently with other jurisdictions such as Australia, Britain and the United States (which do not require market disclosure).

* Rachel Taylor, who acted for Perry Corp in this litigation, is a partner in the Wellington office of the Australasian commercial law firm Phillips Fox.

THE BACKGROUND


Two weeks ago, the Government confirmed plans to change the Securities Markets Act after litigation between Guinness Peat Group and US hedge fund Perry Corp.

GPG had sued Perry, claiming the US fund illegally concealed a substantial shareholding in Fletcher Challenge spin-off Rubicon.

Perry had emerged as a shareholder after GPG bought a 19.9 per cent stake in Rubicon.

GPG said Perry had used an "equity swap" arrangement with investment banks to hide its Rubicon stake, later unwinding the swap when it desired a direct shareholding. GPG won in the High Court, but lost on appeal. GPG sought leave to appeal to the Privy Council, but was refused.

The Government plans to change the law so that arrangements like those between Perry and its banks must be disclosed to the market.