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Securities Commission Bulletin No.3 - Preparing to "go public" [1984] NZSecCom 3 (5 July 1984)

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OFFICE OF PO BOX 1179

SECURITIES COMMISSION TELEPHONE 729-830

_{LEVEL 6 GREENOCK HOUSE 102-112 LAMBTON QUAY –39 THE TERRACE WELLINGTON 1 NZ}

_{5 July, 1984}

SECURITIES COMMISSION BULLETIN NO. 3

_{PREPARING TO “GO PUBLIC”}

1. Arrangements for the benefit of existing shareholders, directors and promoters are often made as part of the preparations for a public issue. This bulletin describes some of the disclosures that are required under the First Schedule to the Securities Regulations 1983 in such cases. Additional requirements that apply where listing on the Stock Exchange is sought are contained in the Listing Manual of the New Zealand Stock Exchange. Attention is also directed to the law about pre-prospectus publicity which is discussed in Bulletin No.2.

2. The law certainly does not discourage promoters and directors from acting under the stimulus of self-interest. In such cases, the law requires full and frank disclosure of the interest, and insists that undisclosed profits taken by those persons be paid to the

company. The leading case is Gluckstein v. Barnes [1900] UKLawRpAC 21; [1900] A.C. 240, a decision of the

House of Lords. Members of a syndicate agreed to purchase a property for 140,000 pounds, and to resell it for 180,000 pounds to a public company promoted by them. Before settlement of the purchase, they bought up mortgages on the property at a discount of 20,000 pounds. On settlement, having paid 140,000 pounds to the vendor, they received from the vendor the full amount of the mortgages thus realising a profit of 20,000 pounds. In the prospectus for the public company, the syndicate expressly referred to the profit of 40,000 pounds, being the difference between the buying and selling prices for the property, but did not refer to the profit of 20,000 pounds on the mortgages. After the company failed, a member of the syndicate was held liable for the 20,000. Perhaps there is room for argument as to the precise nature of the liability established by the case. In some of the judgments it is said that liability rested on the statement in the prospectus that the syndicate had paid 140,000 pounds, when in fact, allowing for the discount, they had paid only 120,000 pounds. Other commentators have suggested that it was a simple case of a secret profit taken by fiduciaries which they could not be allowed to keep. Whatever technical basis might be taken, the robustness of the view of the Law Lords that such conduct would not be tolerated is indicated by the concluding sentences of the speech of Lord Macnaghten. On the question whether the member of the syndicate was entitled to contribution from the others, his Lordship said, “He can bring an action at law if he likes. If he hesitates to take that course, or takes it and fails, then his only remedy lies in an appeal to that sense of honour which is popularly supposed to exist among robbers of a humbler type.” In the Antipodes, it has been necessary so far to apply this case only in New South Wales (Hermann v. Charny [1976] 1 NSWLR 261).

3. Part I of the Securities Regulations 1983 contains general and specific provisions requiring disclosures in these kinds of cases. The important specific provisions relate to:-

3.1 The financial statements that are required under clauses 8 and 23 to 38 of the First

Schedule;

3.2 The disclosures regarding a business or subsidiary, acquired by the issuing group within the preceding 2 years, or proposed to be acquired, that are required under clause 11 of the First Schedule;

3.3 The disclosures regarding the interests of directors in material transactions that are required under clause 15 of the First Schedule;

3.4 The disclosures regarding the interests of promoters in material transactions that are required under clause 16 of the First Schedule.

There are also three relevant general requirements:-

3.5 Statements regarding material contracts made within 2 years are required under clause

17 of the First Schedule, in addition to the requirement to lodge copies of the contracts with the registered prospectus.

3.6 Particulars of “any material matters relating to the offer of securities” that are not elsewhere contained in the prospectus (except contracts entered into in the ordinary course of business) are required under clause 40 of the First Schedule.

3.7 If a statement required to be included would be misleading if additional information were not also included, the additional information must be included (Reg. 5.(1)).

4. The particular requirements of the Schedules do not constitute an exhaustive or complete specification of the information that should be contained in a prospectus. That is made clear by the requirements of clauses 17 and 40 of the First Schedule, and of Regulation 5(1). It is good practice to begin the preparation of a prospectus by assembling all the information specified in the Schedules and drafting the disclosure statements, but when that has been done, it is necessary to stand back from the detail and ask two questions:-

4.1 Are the draft statements misleading in the absence of further information? (Reg. 5(1))

4.2 Do the draft statements cover all the material matters relating to the offer of securities? (Clauses 17 and 40, First Schedule)

These are questions of judgment and degree. An example will illustrate them. Where a public issuer buys assets from a director or promoter, relative or a company described in clauses 15 and 16, specific disclosures are required under these clauses.

That is not to say that in all other cases in which a director or promoter has an interest, disclosure is not required. It depends on the question whether the interest is material

to the offer of securities. Where the assets are items of stock acquired at market prices, the interest will usually not be material to the offer of securities, and no

particular disclosure will be required. But where the assets are substantial items of property, or the assets and undertaking of a business including goodwill, the details,

including the nature of the directors’or promoters’interest, could well be material and require disclosure under clauses 17 and 40. So far, the Commission has

intervened under s.44 of the Act in two cases after the registration of the prospectus to consider whether additional disclosure should have been made, and in one case

additional disclosures were required.

5. One can approach the matter of disclosure with reference to the method of entry that is offered to the public. Four methods of entry are commonly offered:-

5.1 An existing company may increase its capital and offer the new shares for public subscription. (Section 7)

5.2 The shareholders of an existing company may offer to sell shares to the public, sometimes after a bonus issue, sometimes after receiving a special distribution, and usually at a price exceeding par. (Section 8)

5.3 A new public company may be formed which acquires the share capital of an existing company or companies and makes a public issue of securities to meet the cost or to repay bridging finance. Each existing company becomes a subsidiary of the public company. (Section 9)

5.4 A new public company may be formed which acquires some or all of the assets and undertakings of an existing company or companies and makes a public issue of securities to meet the cost or to repay bridging finance. In these cases, existing companies remain in the ownership of their existing shareholders. (Section 10)

Many refinements are possible. Indeed, sometimes a chain of transactions is constructed involving numerous companies created for the purpose of arranging

affairs in the manner desired by the promoters. It is clear that promoters and directors can arrange matters to take benefits and profits in a variety of ways.

6. This bulletin does not attempt to discuss the advantages and disadvantages of the methods of introducing the public. The choice of method is left to the promoters. It may be noted, however, that the choice of method may be influenced by reasons other than commercial simplicity and convenience. The impact of income tax is, in many cases, decisive as to the method chosen. (An excellent analysis of the relevant income tax provisions has recently been made by John Prebble, “The Taxation of Companies and Corporate Investors”, Butterworths 1984.) For present purposes, it is sufficient to note that the legislation mentioned in this bulletin covers all the methods.

7. Increase of capital

7.1 The simplest and most direct method for a company to “go public” is to increase its share capital and make a public offer of the new shares. This process entails striking a balance between the interests of the existing shareholders and the new public investors. Various methods are available to do it.

7.2 The issuer may declare a special dividend or distribution or make a bonus issue of securities to existing members before making the public offer. If that is done within the accounting periods referred to in clauses 8 and 23 to 38 of the First Schedule, the facts will be disclosed in the statements required under those clauses; if it is done after

the close of the latest accounting period, the information should be disclosed as a material matter under clause 40.

7.3 Before making the public offer, the issuer may grant options to take up additional securities on terms settled when the options are granted. Where the option price is set at a premium over par, it may be taken as an indication of confidence on the part of

the grantees of the options. Disclosures regarding options are required under clause

13 of the First Schedule.

7.4 The public offer may be made at a premium, which becomes locked into the share premium account of the issuer for the benefit of new and existing shareholders alike. Disclosures of the terms of the offer are required under clauses 1 and 21 of the First Schedule, and of the terms of other material contracts and offers under clauses 17 and

40. In a recent issue of 12.5 million 20 cent shares, 7.5 million shares were allotted at

par to the promoters and nominees, and 5 million shares were allotted to the public at the price of 50 cents per share (i.e. at a premium of 30 cents per share). The resulting premium of $1.5 million paid entirely by the public and held by the company, is thus attributable pro rata to the shareholdings, i.e. $900,000 to the promoters and nominees, and $600,000 to the public shareholders. Terms of this kind should be carefully explained in the prospectus.

8. Members’Offer to Sell Shares

8.1 New Zealand statute law has 2 provisions about offers by shareholders to sell all or part of their holdings to the public. They are section 6 of the Securities Act 1978, and section 457 of the Companies Act 1955.

8.2 Section 6 of the Securities Act applies where the shares were allotted with a view to being offered by the allottee for sale to the public. Where the shares are so offered within 6 mo nths after the original allotment or where the shares are so offered before they are fully paid up, there is a presumption that the original allotment was made with a view to offering the securities for sale. In England, this is a common method of marketing an issue. The issue is taken up by an “issuing house” for resale to the

public. The procedure has been used in New Zealand, but here the offers have usually been made by a parent company wishing to introduce New Zealand shareholders to its New Zealand subsidiary. A notable recent example was the offer by Australia and New Zealand Banking Group Limited (the Australian parent company) of 6,674,500 ordinary shares of $1 each fully paid up in the capital of ANZ Banking Group (New Zealand) Limited made on 1 February 1980 at the price of $1.75 per share. In these cases, the full requirements of the Securities Act relating to the prospectus and advertising now apply.

8.3 Section 457 of the Companies Act 1955 applies where an existing shareholder makes

a public offer of part or all of his holding which he had taken up otherwise than with a

view to resale. The Securities Act does not apply to such a case (section 6), but the offer must be made in conformity with section 457 of the Companies Act 1955, and must be accompanied by a statement in writing of the matters mentioned in that section, or by a prospectus that complies with the Securities Act.

8.4 Vending shareholders often take benefits from the company before reselling their shares to the public offerees. Such benefits may take the form of a bonus issue of

securities or a special dividend (not infrequently distributing capital profits). Moreover, the vending shareholders usually fix their selling prices at a figure greater than the consideration received by the company for the shares.

8.5 The facts of the matters mentioned in para. 8.4 will usually be apparent from the accounting information required under the First Schedule to the Securities Regulations, especially clause 23 (balance sheet, 24 (capital and reserves), 37 (comparative figures) and 1 and 21 (terms of the offer and securities), but if the facts are not thus disclosed, particular attention should be given to the question of disclosing them under clause 40 (other material matters).

9. Holding company’s offer after acquiring a subsidiary

9.1 The requirements of the First Schedule that apply where a public issuer has recently (i.e. within the past 2 years) acquired a subsidiary, or discloses in the prospectus that it intends to acquire equity securities that will result in a company becoming a subsidiary, are directed towards securing disclosure in the prospectus of:-

(a) the prescribed financial information about the subsidiary where it is material

(clause 11); and

(b) the considerations paid by and accruing to, and the profits accruing to, the directors and promoters (clauses 15(4) and 16).

9.2 Disclosure of financial information under clause 11 is required where the consideration for the acquisition of the subsidiary (or proposed subsidiary) is more than one-fifth of the amount of the total tangible assets shown in the balance sheet of the issuing group that is included in the prospectus under clause 23(1). Where the subsidiary or proposed subsidiary is itself a holding company, each company in the subsidiary’s group becomes a subsidiary of the public issuer. In that respect, the regulations adopt the definitions contained in section 158, Companies Act 1955 – see Reg. 2, definitions of “ho lding company” and “subsidiary”. Nevertheless, the relevant clauses (11, 8 and 23 to 38) require the disclosure of information about the group (defined in Reg. 2) being the group that has been or is proposed to be acquired by the public issuer.

9.3 A difficulty arises in cases where such a group has only recently been assembled, with the consequence that the accounts for that group (as defined) will not cover the accounting periods mentioned in clause 11. In those cases, the Commission considers that clause 40 requires disclosure of the pre-acquisition figures for those accounting periods in respect of each subsidiary where they are material.

9.4 The Commission is keeping the operation of clause 11 under review, welcomes enquiries in cases of difficulty, will consider making use of the exemption power under section 5(5) of the Act in appropriate cases, and will consider proposals for amendments to the clause in the light of experience.

9.5 Disclosures under clauses 15(4) and 16(2) are required in respect of material transactions within the previous 5 years, or which are to be entered into, between the public issuer or a subsidiary and a director or promoter, his relatives or companies in which he and his relatives held a majority of the shares. Disclosures are required

about the property, its cost, and the price paid or payable. It should be noted that, to avoid overlap, the definition of a promoter in the Regulations excludes a director.

9.6 A material transaction is defined in Reg. 2 as a transaction whereby real or personal property is acquired by a person from another person – being property the value of which is material to any of the parties to the transaction.

9.7 Clauses 15(4) and 16(2) are narrowly drawn to cover the plain cases and to avoid a multiplicity of immaterial information in complicated cases, as where a company is formed to acquire a number of businesses or divisions from existing companies, or as where companies with common directors have many transactions with each other.

9.8 It is possible to avoid the terms of clauses 15(4) and 16(2) by careful construction of a series of transactions. Thus, where a promoter or director acquires shares in a company which sells assets to the issuer, disclosure of the cost of the shares is not required by these clauses. Similarly, where a third party (other than one described in the clauses) is interposed who acquires an asset from the promoter or director and on- sells it to the issuer, disclosure of the cost to the promoter or director is not required

by these clauses. But in each of these cases, and in any other where promoters or

directors take a profit, directly or indirectly, from transactions culminating with the issuer, whether or not clause 15 or 16 applies, careful consideration should be given to the question whether disclosure is required under clause 40. Thus, where directors of the issuer had purchased the shares of a company which sold substantially the whole

of its assets to the issuer, the Commission considered that disclosure of the cost of the shares should be made under clause 40.

10. Company’s offer after a Purchase of Assets

10.1 The requirements of the First Schedule relating to the purchase of a business by a public issuer are also contained in clauses 11, 15(4) and 16, which have been briefly reviewed in section 9 above.

10.2 Where the business is being purchased from a company, it is undesirable to include corporate items in the disclosures. Where, for example, an existing company sells its assets and undertaking including goodwill as a going concern, it is not appropriate to show shareholders’funds and reserves. Those are corporate items relating to the affairs of the vending company – they do not relate to the items being sold. A simple statement of assets sold and liabilities assumed, that reconciles with the consideration, is required. Similarly, corporate items should not be included in the profit and loss accounts. The results of the business transferred, rather than the profits of the vending company, are the required disclosures.

10.3. Disclosures of directors’and promoters’interests in respect of the sale of assets are required under clauses 15 and 16. These have been outlined in paras. 9.5 to 9.9 above.

_{11. Conclusion}

Promoters and directors are placed by the law under a duty to make full and frank disclosure of all matters that are material when securities are offered to the public.

The detailed clauses in the Schedules are not an exhaustive code. The general duty of

disclosure is especially strict when a promoter or director has a material interest in any aspect of the matter. In such cases, the conflict of duty and interest should be recognised and the interest should be fully exposed in the prospectus.