O'Sullivan: Short shrift for old order

By FRAN O'SULLIVAN

The Stock Exchange - and the broking industry - need to take a good, sharp look at their practices in the wake of last week's Montana ruling.

The Montana standing committee, comprised of Sir Duncan McMullin, Sir Ian Barker and Bill Wilson, QC, ruled that Credit Suisse First Boston broke NZSE rules when it lined up institutional shareholders on February 8 - in advance of the kick-in time for an exchange waiver - to sell their Montana shares to Lion Nathan.

The standing committee rejected CSFB's argument that its calls to brokers on February 8 were simply "book building" and that share transfers did not take place until the next day.

To most New Zealand brokers, CSFB's actions - including the selective scaling of share acquisitions - are simply normal market practice in this country. If the brokers are correct, by deduction Lion Nathan will not have been the only company whose strategies are at risk through loosely written Stock Exchange listing rules.

The exchange must now act urgently if it is to avert market chaos. There are several matters to confront.

First, the NZSE must urgently rework the definition of "transfer" under listing rule 4.1.

As the Montana debacle - and sharebrokers' testimony to the inquiry and later - have exposed, the industry has commonly taken the view that a transfer of shares does not occur until a deal is completed.

Brokers have tended to rely on the general definition laid down under listing rule 4.1, which says "transfer" in relation to an equity security includes sale of that security and the grant of rights or interests, whether conditional or not, which are intended to create for the recipient benefits which are substantially equivalent to ownership of that security.

Using this broad definition, CSFB argued that its dealers' approaches to institutional and other large shareholders in Montana before midnight on February 8 was within the listing rules as sales had not yet occurred and the broker could have walked away at any time before midnight.

Not so, said the committee, relying on an expanded definition provided by subsections such as 4.1 (a), which in summary includes within the general definition a transaction whereby one party disposes of, alienates or proposes to dispose of any equity security.

The reference to "proposal" contemplates that a decision where the intention of the parties need not be binding or irrevocable fell within the general transfer definition, said the committee.

Conclusion: The committee and the market cannot both be right.

Secondly, the NZSE must urgently decide whether standing committee rulings should be binding on subsequent committees or made subject to appeal in the event of widely differing interpretations.

The Montana committee's blanket decision to overturn or disregard precedents by previous NZSE standing committees which dealt with the "transfer"' issue - even when made by respected market players - is deeply worrying for market participants.

The committee dismissed a previous ruling on the Power NZ case, saying that that standing committee - "which had a majority of non-lawyer members" - seemed to have taken a narrow view of "transfer" and had ignored the detailed and expansion definition of "transfer" in the listing rules.

The Power NZ committee was loaded with market heavyweights or experienced players such as Robert Dobson, QC, who frequently acts for the NZSE and its market surveillance panel, Tower Corporation's Paul Bevin, who is also a market surveillance panel member, and sharebroker Peter Brook.

Nevertheless, while the Montana committee conceded that decisions such as the Power NZ committee's "might and no doubt on occasions do provide valuable guidelines for the market," it said they were not binding on subsequent committees.

Further, said the Montana committee, to the extent that such views were contrary to ours, "we must disregard them."

Ironically, it would appear from the committee's viewpoint that even the NZSE's own chief executive cannot give market players reliable advice.

In February, Bill Foster said there was nothing in the rules that said you could not talk to people about whether they might be interested in selling their stock, but binding contracts could not be completed before the notice period expired.

Conclusion: market players are in a very sticky position if they place reliance on standing committee rulings which can be disregarded at will by subsequent panels.

The next major issue for the exchange is whether transactions based on "proposals" before the pause period expires - even if they fall short of binding agreements - could be challenged using the committee's analysis.

If the upshot of the Montana ruling is that any proposal to dispose of shares constituted a transfer - regardless of whether parties could walk away - several recent deals could have arguably been challenged.

At issue is whether those filing restricted transfer notices which include references to proposed transfers or proposals breach the listing rules if they have clearly already had discussions and negotiations regarding the proposed deals, reached broad agreement on the terms but have not taken the deal through to the stage of being contractually bound before a restricted transfer notice is filed.

By definition, that is before the expiry of the required pause period.

As one broker argued last week, if the Montana ruling is taken to its logical conclusion, deals such as the recent Cedenco Foods/SK Foods transaction might have been challenged.

In that case a restricted transfer notice was made detailing the proposed transfer of 8.54 million Cedenco shares. Simultaneously, Brierley Investments disclosed it had granted a call option over a 19.9 per cent holding in Cedenco shares to Sky Foods.

As the broker argued, the call option substantially lessened the opportunity for other players to contest for Cedenco.

Another deal cited as challengeable relates to INL's strengthening of its hold on Sky Network - where a restricted transfer notice, detailing an intention to acquire 5.26 per cent on-market and/or by private treaty and an 11.02 per cent stake from Todd Capital by private treaty, was accompanied by an attached agreement.

In each of those examples, the market players were simply following accepted practice in accordance with the common understanding of the rules.

Conclusion: the reality is that the confusion now present in the market opens the way for some large-scale mischief - if not outright greenmail.

For Lion Nathan, the standing committee's ruling has serious consequences: it is now judged a defaulter. It faces the loss of all or part of its 62 per cent holding in Montana, and must pay for Montana's and Allied's expenses in relation to the NZSE inquiry.

For Credit Suisse First Boston - one of the world's top four investment banks - the Montana ruling presents another severe credibility blow.

CSFB was already under huge pressure over various allegations of sharemarket malfeasance, including a US investigation into allocations for initial public offerings.

CSFB's chairman and chief executive, Lukas Muhlemann, told the bank's Zurich annual meeting that he had made improving the bank's controls and processes a top priority.

Days later the Montana ruling came out at the very time that a ban on CSFB's Indian broking arm was upheld after an investigation into price-rigging.