Last November the UK Takeover Panel regulated the secret building of stakes in takeover targets through the use of derivatives. On 20 May, the Takeovers Directive Implementation Regulations put the panel on a statutory footing while attempting to protect it from attack by judicial review.
The Australian Takeovers Panel has recently struggled with similar issues. The result, for now, is that the Australian rules on disclosure of derivatives are uncertain, and the Australian panel’s powers have been seriously undermined by judicial review.
The Australian panel declared three times that industrial supply company Glencore International’s use of derivatives to build a secret position in a takeover target was unacceptable, but Glencore twice persuaded the Australian Federal Court that it was the panel that had behaved unacceptably.
How did this happen? What will be done about it? And what does it mean for players in the Australian market today? Hopefully, the recent Australian experience does not foreshadow what is in store for the UK panel now that it is a creature of statute.
Takeover regulation in both the UK and Australia is based on statements of general principle followed by detailed rules. Each set of principles is similar and is intended, among other things, to ensure that share markets are informed and all shareholders of a target are treated equally.
The UK Takeover Code states that its principles and rules must be interpreted to achieve their underlying purpose. The UK panel polices the code and the new Takeover Appeal Board was established in an attempt to reduce the likelihood of judicial review challenges against the panel. The panel’s code committee is able to develop the rules of the code.
The Australian general principles are given effect by its Takeovers Panel having the power to declare – on application by the corporate regulator, the Australian Securities and Investments Commission (ASIC), or an aggrieved market participant – that there are ‘unacceptable circumstances’ in relation to the affairs of a company by reference to the general principles. The panel can then make orders to protect the rights or interests of people affected by unacceptable circumstances or to ensure that a bid proceeds as far as possible, as it would have done if the circumstances had not occurred. During a bid period, market participants cannot conduct court proceedings in relation to the bid.
The Australian Takeovers Panel functions as a form of administrative tribunal, with its members drawn from Australia’s takeovers and business communities, who work on a part-time basis. Its decisions form a body of authority supplemented by the panel’s guidance notes on key topics, which alert the market to matters that the panel would generally consider as constituting unacceptable circumstances.
The panel has a rule-making power, but has not exercised it due to concerns about the constitutional validity of the power. However, the body has made known its willingness to develop case authority by making decisions in novel situations and to develop policy through guidance notes.
The clampdown on derivatives
By 2005 both panels were concerned that derivatives were making markets uninformed and distorted. Under a long derivative, a bank would agree to pay an investor any increase in the price of a share. The bank would often hold actual shares to hedge against any price increase. The investor would have no ownership in the shares and thus avoid the then stake-building disclosure rules in each country. Yet the derivative trading and hedging still affected the market.
In a current UK takeover offer period, an investor must promptly disclose to the market “interests” that exceed 1 per cent of a particular class of the target company’s securities, and likewise in relation to a bidder offering share consideration. Interests arise by owning, controlling or holding options over shares and, due to the changes to the UK Takeover Code made last November, by having a long derivative referenced to them.
In Australia, the disclosure threshold is reached when an investor and their associates (broadly defined to include anyone acting in concert with an investor to own shares) have a “relevant interest” in 5 per cent of the overall voting power of a public company. A relevant interest is a legal or beneficial interest in shares, or control over the voting or disposal of shares, even if control is remote, unenforceable or conditional. Disclosure is required the following day during a bid period.
In early 2005, the Australian panel prepared a draft guidance note requiring disclosure of derivatives as if they were actual shares. Before the note was published, Glencore secretly built a ‘combined holding’ of shares and derivatives in miner Austral Coal, while considering launching a takeover bid to rival an existing bid. Glencore failed to disclose its presence until two weeks after its combined holding reached 5 per cent.
The Australian Takeovers Panel ruled against Glencore and made orders forcing it to divest Austral shares. A review panel ruled similarly, so Glencore sought judicial review. Federal Court judge Arthur Emmett ruled that the panel had erred by failing to find, as a precondition to its declaration, an effect on control or potential control of a company or of a substantial interest in a company – the panel said there was an effect, but did not describe it.
Emmett J provisionally rejected a challenge to the constitutional validity of the panel, but future challenges on this point are possible.
The case was remitted back to the panel, which again made a declaration against Glencore, this time ordering it to compensate market participants affected by the uninformed market Glencore had caused, but without requiring divestiture.
Glencore sought further judicial review by Emmett J, who held that the panel had again failed to find, based on evidence rather than conjecture, that Glencore’s conduct had an actual effect on control. It is insufficient for the effect to be merely that the market is uninformed and for this to have potentially ill effects – there must be proven effects. Emmett J also held (although this may be strictly obiter dictum), that a long derivative does not constitute a relevant interest in shares.
The need for reform
There are calls for reform of Australian takeover legislation so that the panel can make rulings consistent with the policy objectives of the legislation, as was intended when the current panel was conceived in 1997. The panel has dealt with more than a dozen applications since Glencore, but its authority has been weakened considerably and is likely to be tested in further hard cases involving litigants with deep pockets.
Derivatives in Australia now
Despite the Australian Takeovers Panel’s defeat, there is uncertainty as to whether derivatives can be used to avoid disclosure rules. With careful drafting, derivatives can be written so that they do not give rise to a disclosable interest.
There is, however, scope for the panel and the ASIC, which had to pay Glencore’s court costs, to try attacking derivatives by investigating conduct, emails and telephone tapes that might betray relevant interests through a reality of control over the disposal of banks’ hedging shares. Where there is ongoing stake building, insider trading laws also come into play.
Australian market participants are entitled to expect more certainty in the rules governing the disclosure of derivatives.
Bill Koeck is joint head of M&A and Matthew Dobson is a senior associate at Blake Dawson