Proposed Takeovers Code Raises Issues for Fund Managers and Institutions

August 2000

By Charles Bolt, Senior Associate & Mark Todd, Partner

As with other legislation and rules relating to the sharemarket, the Takeovers Code seems likely to cast a wide net in order to achieve its objectives. This has the potential to impact on institutional investors, especially those with connections to the sharemarket through various business divisions. There is every possibility that the Code will require shares controlled through different divisions of the same corporate group to be aggregated when determining whether the Code's key 20% threshold is met or exceeded.

Introduction

The Takeovers Panel has been working through the submissions that were made on the recently-released draft of the Takeovers Code and will soon report back to the Minister of Commerce, Paul Swain, with its findings. While the final Code is expected to be introduced in September and to have effect some time later next year, it is not expected to vary significantly from the draft that was released in late July.

General comment

The Code should be of particular interest to fund managers and diversified institutions in New Zealand and Australia, particularly those with investment, trustee, custodial, banking and other business divisions with connections to the sharemarket. The wide net that is cast by the Code means that:

• it may be easier than you think to cross the key 20% threshold
  
  
• it has the potential to apply in situations that do not appear to contain the mischief that the Code is aimed at
  
  
• it could apply to companies that you expect to be exempt.

What does the Code say?

The Code contains two fundamental rules.

• First, a person who has "effective control" over less than 20% of the voting rights in a "Code company" may not obtain effective control over more than 20% of the voting rights except through a "compliance option".
  
  
• Secondly, a person who has "effective control" of more than 20% of the voting rights in a listed company may not obtain effective control over any more voting rights, again, except through a "compliance option".

"Code Company"

The Code applies to "Code companies". These are listed companies (those that are party to a listing agreement with the New Zealand Stock Exchange) and those that have been listed within a period of the previous 12 months.

The Code also applies to unlisted companies with assets of $20 million or more and at least 50 shareholders.

"Voting rights"

The Code focuses the extent to which a person and its associates can control a Code company by referring not to the number of securities held, but the number of substantive voting rights that are held or controlled.

In practice, this is likely to mean that the number of ordinary shares that are held or controlled will be relevant. Preference shares, options and convertible notes will not be relevant until they convert into ordinary shares.

"Compliance options"

The compliance options that allow a person to become the holder or controller of an increased percentage of voting rights can be summarised as follows:

• Full Offer
  A full offer may be made for all of the Code company's equity securities.
  
  
• Partial Offer
  A partial offer can be made on a pro rata basis. If the offeror holds 50% or less of the voting rights, the offer must be conditional upon the holder obtaining more than 50% of the voting rights. A partial offer for a lesser percentage can be made if a specific approval procedure is followed.
  
  
• Shareholder approval
  Specific issues and acquisitions can be made if the shareholders in the Code company give their approval.
  
  
• 5% Creep
  A person holding between 50% and 90% of the voting rights can increase their holding by up to 5% in a 12 month period.
  
  
• Compulsory Acquisition above 90%
  Compulsory acquisition provisions apply when the 90% threshold is met or exceeded.

"Effective control"?

Like the rules governing substantial security holder disclosures, the Code recognises that, to have any effect, it needs to drill down beneath beneficial holdings. For this reason, the Code focuses on how many voting rights (in reality how many ordinary shares) are under a person's direct or indirect "effective control".

And although the Code does not expand on the meaning of "effective control", it is reasonable to assume that all shares held within a corporate group, or which come under the management of a corporate group, would be under the parent company's indirect effective control for the purposes of the Code.

How could this affect your business?

Diversified institutions will need to take particular care to ensure that the investment and other activities of their various divisions do not, in aggregate, cause them to breach, perhaps innocently, either of the Code's fundamental rules. Some activities with the potential to do so are mentioned below.

Different funds holding shares in the same Code company

Various funds established and managed by the same manager are likely to have shareholdings in the same listed companies. For example, a fund with a New Zealand or Australasian focus and a growth and balanced fund run by the same manager are likely to hold shares in the same top 10 New Zealand companies.

As fund managers generally have control (although not legal title) of the shares in their various funds, the shareholdings of each fund will all be treated by the Code as being under the effective control of the one manager. The fact that those shareholdings are held within separate and distinct funds or legal entities that have different beneficial owners will be irrelevant.

Trustee division

Trustee divisions are likely to have holdings in listed companies in a variety of capacities. Personal estates are an obvious one, but these holdings may not add up to anything significant when compared with the Code's 20% threshold.

But what about group investment funds? How many are held in these and what level of control does the trustee exert over the voting rights attached to the listed company shares held by those group investment funds?

The ultimate parent company of the trustee is likely to be treated by the Code as having at least indirect control not only of the listed company shares that are controlled by the trustee division, but also those that are managed by the parent's investment or funds management division.

Australian affiliates

Australian affiliates from within the same corporate group may also hold shares in New Zealand listed companies, especially the larger ones. Once again, for the purposes of the Code, the ultimate parent company (which could be incorporated in Australia) could be regarded as having indirect control over not only the shares that are controlled through the Australian investment division, but also those that are controlled through the New Zealand division.

Corporate banking

Margin trading is not as popular as it once was, although there has been some increased institutional interest recently in resurrecting these types of products.

Nevertheless, institutions with corporate banking divisions may have corporate loans secured over listed company shares.

Again, the Code is relevant to this kind of activity and financiers will need to ensure that exercising their security over shares in a listed company, when combined with all of the group's other connections with the shares of the listed company involved, does not cause either of the fundamental rules to be breached.

Management agreements

And what about listed shares that are managed under contract on behalf of another fund manager?

Does the management contract allow you to decide how to exercise the votes attached to the shares that you manage?

If it does, the Code is likely to treat that level of management as amounting to "effective control". Consequently, the number of shares managed on behalf of another institution or fund may have to be counted when assessing whether the thresholds in the Code are met or exceeded.

Domicile of company may not be relevant

The Code focuses on companies that have listing agreements with the New Zealand Stock Exchange. In that sense the Code is also broad because it does not specify what type of listing agreement a company must have.

It seems, therefore, that the trading of shares in a company such as Goodman Fielder, which may have only a secondary or "courtesy" listing on the New Zealand Stock Exchange and a primary or "home" exchange listing in Australia, could be covered by the Code. The fact that the shares are acquired through the Australian Stock Exchange, by an Australian entity, and are held on the Australian register may be irrelevant.

Consequently, the exposures of an institution's Australian division to such a company will also be relevant, particularly if the New Zealand division is also investing in that company through the New Zealand Stock Exchange.

For the purposes of the Code it may be necessary to aggregate the shares that are controlled from the New Zealand division with those that are controlled from the Australian division of the same group.

Inadvertence is not a compliance option

A number of circumstances could cause a threshold to be crossed inadvertently. For example, a poorly supported rights issue (in which you participate), or a well supported pro rata buy back or a selected buy back (in which you do not participate) could cause your shareholding in a listed company to move above the 20% threshold, without you doing anything and without your knowledge or consent.

And for those institutions with corporate banking divisions, the exercise of a security over shares in a listed company, when combined with the other shares in that company that are "effectively controlled" through the group's other divisions, could cause one of the fundamental rules to be breached, albeit inadvertently.

There were no exceptions in the draft Code for these types of seemingly innocent activities. And while submissions on this point have been made to the Panel, there is nothing to suggest that any specific exemptions will be included when the final draft is released.

The Panel

Like the Securities Commission, the Takeovers Panel will have the power to grant exemptions. As yet, however, we know nothing about the Panel's policies or its approach to exemptions.

The experience of Brierley Investments with Mount Charlotte in the United Kingdom under a similar takeover regime (which also requires compulsory bids when the 20% threshold is crossed) should serve as a reminder of the potential impact the Code could have.

What can you do?

Bell Gully is looking to conduct a series of seminars on the Code once the final version is released. If you would be interested in attending a seminar, please complete and return the fax back form. We will be in contact when the Code has been finalised and promulgated.