Dialogue: Market's shifting sands

The following is an edited version of a paper by former commercial lawyer STEPHEN FRANKS* on the implications of the Montana case for takeovers. The controversy accompanying the very first notice under the new takeovers code - involving the latest stage in the battle for Montana - has come as no surprise to him. Mr Franks, a former member of the Securities Commission who played a major part in drafting the Stock Exchange rules which have been replaced by the new regime, said he expected many more such problems.


The decisions of the standing committee on the Montana case call for clarification from the Stock Exchange or the Market Surveillance Panel. The market needs to know how far such decisions and rulings can be relied upon as precedents.

As it is entitled to, the standing committee has given the provisions a legalistic interpretation and expressly not followed earlier decisions. The exchange should now either change the rules to give earlier decisions more persuasive authority, or ensure that policy developed by decisions is embodied more promptly in specific changes to the rules.

The standing committee's decision was a careful interpretation of the words of the relevant provisions. It accords with my recollection of the original expectation of the rules. But experience modified the exchange objectives while the relevant rules were not materially modified other than through rulings.

The committee decision appeared to move a line that market participants were entitled to feel had been drawn by previous decisions. These had allowed prior lining-up of provisional acceptances or sell orders during a pause period to remain a feature of takeovers, as long as a real prospect remained of a competing bidder emerging during the notice period.

The pause is intended to allow parties and shareholders to explore alternatives and for the market to feel out bid prices and identify potential sellers. Getting set in market terms does not prevent an auction as long as the participants remain free to respond to the highest bid when the starter's gun is fired.

The auction possibility is what is important, not whether it occurs.

In the Montana case the number, nature, and timing of the arrangements meant that in practice, there was little prospect of an open auction.

Allied had told the market on the Thursday evening that it would not be competing, and the decision records a delay in completion for a couple of hours after midnight, so strictly the negation was theoretical, not actual.

But if Allied had changed its mind, and wanted to compete from midnight, it might have been too late, in practical terms. On that view perhaps all the decisions uphold the intent of the rule.

Accordingly, while I understand the dismay or even bewilderment of those who feel the goalposts have been shifted, they read into the earlier decisions more certainty than they could give. Now the concern must be that the market might misapply the Montana decision. These issues are not academic. The takeovers code raises the rewards for finding loopholes. Overseas markets with mandatory-offer laws show that the party with the best lawyers can defeat the party prepared to pay the most to the shareholders who want to sell.

The code does not use the defined term "transfer" to determine when control passes. But it cannot avoid the issue. It makes it unlawful to "become the holder or controller of an increased percentage of the voting rights in [a] code company" without complying with the code.

The new Takeovers Panel will have to decide whether conditional contracts, and sale orders to a buyer's broker, amount to a transfer of the control of the voting rights, or the creation of a right or option to acquire them.

They will draw on Australian and other case law, but market practice properly understood has always influenced the development of good business law.

The exchange should therefore try to ensure the new panel has a better understanding of sound existing practice. No one on the panel, other than Kevin O'Connor, has a demonstrated respect for sound research married to a deep knowledge of market practice. Yet that will be essential if the critical early decisions are to be sensible.

To discourage the Takeovers Panel from kicking for touch with unnecessarily restrictive early interpretations, the exchange should record now why preliminary contacts and arrangements are necessary if pricing is to be efficient when an offer opens.

Already New Zealand is going backwards in compliance cost and pricing-efficiency terms because the code does not permit on-market (electronic) auctions for control.

In securities markets, the discretions and uncertainties multiply as the rules become more ambitious. Simple rules against dishonesty and fraud, ruthlessly enforced, probably do the most for any market.

The exchange should strive to keep the rules as black-letter as practicable (the new panel is woefully reliant on administrative discretion). But codified market practice must leave breathing room for evolving ethical market practice.

Our new rules are ambitious. Precision cannot be obtained without creating pointless compliance costs and straitjackets, and loopholes for exploitation by the creative and motivated people who are drawn to securities markets.

* Stephen Franks is now an Act list MP.