- ASIC turns back the clock on the on-sale provisions in Chapter 6
- Taking options as consideration for a loan and the onsale provisions
- War and impacts for issuer and underwriters
- Insider trading and OTC derivatives post FSR
ASIC turns back the clock on the on-sale provisions in Chapter 6D*
*Conditions apply
By Peter Tillman, Senior Associate
The good news for participants in the equity capital markets is that ASIC has reinstated the pre-FSR position for the on-sale of securities (including units in listed trusts) by granting permanent class order relief to allow institutional investors to sell securities within 12 months after their issue without a disclosure document. The bad news is that the relief, which replaces the interim relief granted last March, still comes with a number of conditions attached.
Pre-FSR
Prior to amendments made to Chapter 6D of the Corporations Act 2001 (Cth) by the Financial Services Reform Act 2001 (Cth) (the FSR), s 707(3) provided that an offer of securities for sale within 12 months after their issue required disclosure if:
- the securities were issued without disclosure to investors; and
- the issuer issued the securities with the purpose of the person to whom they were issued selling or transferring the securities, or granting, issuing or transferring interests in, or options over, them,
and s 708 did not say otherwise. Thus, under the pre-FSR s 707, issuers had the flexibility to raise capital in a timely, cost effective and relatively straightforward manner by issuing securities to professional and sophisticated investors without lodging a prospectus in accordance with the disclosure carve-outs in s 708(8) and (11), respectively. Indeed, such was the streamlined nature of the 'institutional placement' under the old s 707, that issuers (through their advisers) could go to the market one day, and be counting the proceeds of the offer the next.
It was also market practice back then for underwriters/lead managers to obtain representations and warranties from the issuer as to 'purpose' - for example:
The Company hereby states that it will not be issuing the Placement Shares for the purpose of the investors selling or transferring them (or granting, issuing or transferring interests in, or options or warrant over them) and it believes that it can establish this if required to do so. The purpose of the issue of the Placement Shares is to raise the capital needed to [*]. It is the Company's desire that investors acquire the Placement Shares and remain as investors in at least the medium term and that the Company broaden its shareholding base as a result of the issue of the Placement Shares,
and for institutional investors to confirm in their acceptance letter that:
- no disclosure or offering document has been prepared in connection with the sale and offer of Placement Securities, and
- it is our present intention to be investors in the Placement Securities and to remain so in at least the medium term. This confirmation is understood to be a statement by us of present intention only but not an undertaking not to sell, particularly where our investment objectives or market conditions change.
Post-FSR
All this changed when the FSR introduced an additional element into s 707(3)(b) - namely, the intention of the investor. Under s 707(3)(b)(ii), securities cannot be on-sold without a prospectus if the person to whom the securities were issued acquired them for the purpose of selling or transferring the securities, or granting, issuing or transferring interests in, or options over, them, notwithstanding the issuer's purpose in issuing the securities (there is a similar provision in respect of financial products issued under a product disclosure statement: s 1012C).
Understandably, this amendment rattled the cages of issuers and underwriters alike and was generally seen as sounding the death-knell for institutional placements.
ASIC response
As a stop-gap measure, ASIC granted interim class order relief on 7 and 15 March 2002, and reserved its position going forward. For a discussion of the interim class orders, see MJ Greig, 'A place for placements - institutional placements post-FSR (11/3/02)'.
ASIC has now formalised its position in relation to the on-sale provisions by issuing Class Order 02/1180 on 29 November 2002 and following it up with Policy Statement 173 'Disclosure for on-sale of securities and other financial products' on 3 December 2002.
Class Order 02/1180
With Class Order 02/1180, s 707(3) is conditionally restored to its pre-FSR state (ie, the section focuses on the issuer's purpose, but not the investor's purpose). Moreover, relief is available in respect of the following categories:
- Category 1: Securities - disclosure of previously withheld information.
- Category 2: Securities - prospectus disclosure at or after time of issue.
- Category 3: Managed investment products - disclosure of previously withheld information (the interim class order did not apply to interests in managed investments).
- Category 4: Managed investment products - PDS disclosure at or after time of issue.
- Category 5: Employee share schemes.
- Category 6: Share purchase plans.
- Category 7: Options, convertible securities or other financial products.
- Category 8: Dividend reinvestment or bonus plans.
- Category 9: Compromises and arrangements (under the insolvency provisions of the Corporations Act).
- Category 10: Takeovers.
- Category 11: Securities of exempt public authorities.
- Category 12: Executive officers - transitional relief.
For the purposes of this article, the discussion of Class Order 02/1180 will be confined to 'Category 1' and 'Category 2' relief (which is largely the same as the relief given to the on-sale of units in a listed trust under Categories 3 and 4), being the 'substantive' relief for institutional placements.
Category 1 and Category 2 Relief
In Policy Statement 173, ASIC states that any significant relief from the on-sale provisions can only be justified if a comparable level of protection is otherwise available to retail clients who acquire financial products by way of transfer within 12 months after their issue. Accordingly, the 'Category 1' and 'Category 2' relief is conditional, among other things, on the issuer having made some sort of disclosure to the market whether it be by way of the continuous disclosure regime, by special announcement to the ASX (known as the 'Dump' category) or by relying on a disclosure document prepared in respect of similar securities of the issuer (the so-called 'Same Class Prospectus' category).
The conditions for obtaining Category 1 or Category 2 relief are set out in the table below.
| Condition | Category 1 Relief | Category 2 Relief |
|---|---|---|
| The relevant securities must be in a class of securities that were continuously quoted securities of the issuer (ie, ED securities). |  1 |
|
|
The class of securities must have traded on the ASX during that period without being suspended from trading for more than 5 trading days. |
|
|
|
There must be a completed contract for the securities (i.e, investors must have paid full consideration). |
|
|
|
If the securities are debentures - the issuer must have a trust deed that complies with s 283AB of the Corporations Act, and have appointed a trustee that complies with s 283AC. |
|
|
|
ASIC must not have determined in writing that the issuer cannot rely on the special prospectus content rules for continuously quoted securities. (Under s 713(6) of the Corporations Act, ASIC has the power to exclude an entity from relying on the special content rules if the entity has contravened Part 2M (the financial reporting and audit provisions), ss 674(2) or 675(2)(the continuous disclosure provisions), s 724 (options available to an issuer where the disclosure document is defective) or s 728 (misstatements in, or omissions from, a disclosure document)). |
|
|
|
The issuer must notify the ASX at or about, but not later than 2 business days after, the time of issue that:
|
|
|
|
A prospectus has been issued in relation to securities of a class of securities which are now being offered at or after the time of the issue of the securities but before any on-sale of the securities.
|
|
|
| The offer for sale must not occur until after the issuer has notified the ASX that all information relevant to the offer of the securities that has been withheld from the ASX in accordance with the ASX Listing Rules, but would have been required to be disclosed in a prospectus, has been disclosed to the ASX, or that there is no such information to be disclosed. |
|
X |
Analogous relief is also available in respect of managed investment products (ie, Category 3 and Category 4).
What this means for issuers and underwriters
In reality, the interim relief granted by ASIC back in 2002 meant that it was 'business as usual' for most institutional placements, provided the issuer was in the ASX/S&P 200 index.2 Under the new class order, relief is available for all listed entities provided they satisfy the conditions in Category 1 or Category 2, as the case may be. Moreover, relief is now available in respect of units in a listed trust whereas under the interim class orders it was not (see Categories 3 and 4). So in these respects, Class Order 02/1180 should be welcomed by issuers and underwriters alike.
However, it is to be expected that arrangers, managers and underwriters of institutional placements will require additional representations and warranties from issuers - namely, that:
-
the relevant securities are in a class of securities that were:
-
ED securities listed on the ASX during the past 12 months;
-
quoted on the ASX during that period without being suspended from trading for more than 5 trading days;
-
-
the relevant securities have been issued for full consideration;
-
in the case of debentures - the issuer has a compliant trust deed and has appointed a trustee;
-
the issuer has not breached Part 2M, ss 674(2) or 675(2), s 724 or s 728 of the Corporations Act;
-
the issuer has notified the ASX as required by Class Order 02/1180; or
-
the securities will be issued at or about the time of an issue to persons who applied for securities under the prospectus.
Issuers (and underwriters) may also require an acknowledgement from institutional investors that:
- a prospectus has been issued in relation to
securities of a class of securities which are now being offered at or after
the time of the issue of the securities but before any on-sale of the
securities;
- the offer for sale must not occur until after the issuer has notified the ASX in accordance with Class Order 02/1180.
References
- In the case of Category 1 only, the relevant securities must be in a class of securities that were continuously quoted securities of the issuer on the ASX at all times in the 12 months before the date of issue.
- Under the previous class order, there were in effect 3 possible categories (called Categories 4, 5 and 6) which an issuer would try to fall within: Catgory 4 was the Big Listed Company exception (where the issuer is in the ASX/S&P 200 Index); Category 5 applied where the listed issuer made a 'dump' of the information previously withheld from the market or confirmed that there was no such information (called here the 'Dump' category - which has been retained in CO 02/1180); and Category 6 which applied where there had been a prospectus for the same class of securities but not the actual securities issued under the placement) (called the 'Same Class Prospectus' category - which has been retained in CO 02/1180).
Taking options as consideration for a loan and the on-sale provisions
By Julian Donnan, Lawyer
The amendments to the anti-avoidance provisions for disclosure in Part 6D.2 of the Corporations Act generates new issues for financiers who accept options over unissued shares as part of the consideration for providing the loan.
No onsale without a prospectus
As you will be aware, s 707(3) of the Corporations Act was amended in March 2002 to provide that an offer of a body's securities for sale within 12 months after their issue needs disclosure to investors if the body issued the securities without disclosure to investors and either:
- the body issued the securities with the purpose of the person to whom they were issued selling or transferring the securities; or
- the person to whom the securities were issued acquired them with the purpose of selling or transferring the securities.
Deemed purpose
Prior to March 2002, s 707(3) may not have constituted an obstacle for lenders who took options as consideration for a loan because the provision focused on the purpose of the issuer rather than the acquirer. Now, the provision also focuses attention on the purpose of the acquirer. Additionally, acquirers might be deemed to acquire securities for the purpose of on-sale if any of the securities are subsequently sold, or offered for sale, within 12 months after issue, unless it is proved that the circumstances of the issue and the subsequent sale or offer are not such as to give rise to reasonable grounds for concluding that the securities were acquired with that purpose.
Corporate lenders will be attracted to options as a form of consideration for the provision of finance because the loan may result in an increase in the value of the company's stock, eg, if the injection of capital permits a mining company to engage in production or a construction company to complete a building project. However, once the value of the options becomes attractive, it is often preferable for the financier to exercise the option, obtain the issued shares and sell-off their stake, rather than remain as an equity holder over 12 months in what could be a speculative enterprise (noting that their debt exposure would ordinarily rank ahead of any equity holders). On a 'reasonable grounds' test, therefore, a bank may have difficulty in establishing that the deemed purpose provisions do not apply following a sale.
What does this mean for lenders?
If lenders receive options over unissued shares and those options are exercised (and shares issued), then their ability to sell those securities in the market without a prospectus is limited. A financier may seek to convert its equity stake into cash but it will wish to avoid being exposed to the potential liability and costs associated with preparing a disclosure statement in accordance with Part 6D.2 of the Corporations Act.
What can lenders do to avoid selling the shares without a prospectus?
When structuring the loan
Prior to accepting consideration in the form of options of unissued shares, financiers should consider the implications of s 707 and whether it may apply. Financiers may decide, for example, to seek a representation and warranty from the borrower that the shares are freely transferable without requiring disclosure under Part 6D.2. They may also seek an indemnity for any costs associated with a subsequent sale.
Alternatively, financiers may query whether the options can be granted pursuant to a prospectus and ensure that at the time of exercise of the option, there is no further offer. In this case, Policy Statement 173 released by the Australian Securities and Investments Commission in December 2002 provides relief from s 707.
When selling the shares
If a financier intends to sell the shares following exercise of the option, it may avoid the ambit of s 707 altogether by offering the shares for sale under an exemption contained in s 708 such as:
- structuring the sale so that the minimum amount payable for the shares being sold is $500,000;
- selling to a professional investor, such as a financial services licensee (eg, a broker); a bank; a superannuation trust; a listed company; or a person who controls at least $10 million; or
- where the aggregate amount is less than $2 million, making a personal offer to 20 investors.
If no exception is available under s 708, financiers may also have regard to the categories of relief contained in Policy Statement 173. Of particular note are Categories 1 and 2 of the Policy Statement which are discussed in the preceding article. Essentially these disclosure-based exemptions permit on-sale in prescribed circumstances where the sale takes place at a price that should ordinarily have factored into it all the publicly available information that has been disclosed about the company, eg by way of periodic reports, continuous disclosure or a prospectus.
War and impacts for issuers and underwriters
The conflict in Iraq has had a major effect on the world's capital markets. These recent events, of undeniably international consequence, have significantly changed how issuers and underwriters need to approach the uncertainties presented by war and acts of terrorism.
There are significant issues for companies seeking to raise capital particularly with regard to satisfying disclosure requirements in a prospectus. Careful consideration needs to be given to the impacts of war on the issuer's material contracts, the underwriting agreement, business prospects and general market conditions and how these impacts are disclosed in the prospectus. The issuer also has to consider carefully whether there will be an impact on its business and profitability which could trigger a market disclosure obligation under the relevant listing rules.
For arrangers and underwriters the issues revolve around the adequacy of termination events in underwriting agreements. It is time to assess these and the heightened risks for underwriters.
In an article 'War and Capital Markets' partner, Warwick Painter and lawyer, Mary-Jane Harvey advise on these issues and examine the strategies that can be adopted now to cope with current uncertainties.
Insider trading and OTC derivatives post FSR
This article by Julian Donnan examines the application of insider trading laws in Australia to over-the-counter (or OTC) derivatives as a result of the implementation of the financial services reform amendments to the Corporations Act 2001 (Cth) on 11 March 2002. OTC derivatives are essentially bilateral derivative contracts entered into by parties off an exchange.
The article contends that OTC derivatives should not be subject to the insider trading regime contained in the Corporations Act in the same way as other Div 3 financial products because of:
- the nature of OTC derivatives;
- the sophisticated character of trading participants; and
- the economic function of the OTC derviatives market.
These features, it is argued mandate different treatment for such products. Further anomalies in the current insider trading regime in relation to derivatives, including legislative inconsistencies, the inappropriateness of Chinese wall defences and the inability to meet regulatory objectives, augment the case for removing OTC derivatives from the ambit of the insider trading regulation.
(Source: J Donnan, "Insider trading and OTC derivatives under the Financial Services Reform Act", March 2003, Volume 14, Number 1, Journal of Banking and Finance Law and Practice, 32)
Julian Donnan is a lawyer in the AAR Capital Markets group.
