Indecent disclosure – how much is reasonable in the current market?
31 March 2008- There is a trend towards increased disclosure in Australian M&A and equity markets.
- Details of margin lending arrangements over directors’ holdings may need to be disclosed, including the trigger points and whether the lender has the right to sell the securities unilaterally.
- ASIC has restated its view that disclosure requirements apply to covered short sales.
Late last year, the Takeovers Panel issued its draft guidance note reinforcing its view that cash settled equity derivatives must be disclosed to ensure they are not used to circumvent Chapters 6 and 6C of the Corporations Act.
More recently, the sale of substantial shareholdings by directors following margin calls in several high profile Australian listed companies has led to the ASX issuing an update which advises listed companies that their disclosure obligations extend to the financing arrangements underpinning the shareholdings of company directors. The ASX and ASIC have also issued warnings regarding disclosures surrounding short selling of securities, which has been blamed in part for some of the more dramatic falls in share markets.
The new Federal Treasurer, The Hon Wayne Swan, is also considering the need for further regulation to ensure transparency in these areas, and has called for a report by ASIC into the issue.
Margin lending
In February 2008, the ASX issued a release updating its view of the requirements under Listing Rule 3.1 and, in particular, the need for companies to disclose material information regarding the ‘existence and terms of any finance arrangements that may be in place in relation to directors’ shareholdings’ such as margin loans.
Listing Rule 3.1 requires a company to immediately tell the ASX of any information that a reasonable person would expect to have a material effect on the price of the company’s securities. The ASX observes that the expectations of a reasonable person ‘evolve over time’, leading to evolving responsibilities for disclosure.
The ASX notes that whether the terms of a margin loan arrangement under which a director holds shares is likely to be ‘material’ is a matter that must be decided by the company, taking into consideration the nature of the company’s operations and circumstances. However, the disclosure of the details of the funding arrangement may be required where a director holds a material number of securities subject to margin loans.
Details of the arrangement include the number of securities involved, the trigger points and whether the lender has the right to sell the securities unilaterally once the trigger points are reached. The ASX considers that the potential impact of the triggering term on the company’s financial position, performance and relationship with its bankers should also be disclosed. The ASX considers that where a company cannot immediately release that information, a trading halt may be required.
Short sales
The ASX and ASIC also released warnings in March 2008 in relation to disclosure obligations regarding the short selling of securities. ASIC’s stated view is that existing requirements to disclose substantial holdings of relevant interests apply to certain types of stock lending, usually termed ‘covered short sales’.
A ‘covered short sale’ refers to a sale where the seller has arrangements in place to deliver the shares before they sell them, usually by borrowing them from someone else (as opposed to a ‘naked short sale’ where the seller has no such arrangements in place).
The ASIC warning states that entry into a covered short sale type stock lending agreement is likely to attract the substantial holding notice provisions of the Corporations Act. ASIC recognises that compliance with the substantial holding notice provisions is likely to lead to an increased administrative burden on lenders, brokers and borrowers, and intends to issue a consultation paper investigating means of streamlining the notification procedures.
The ASX release reminded brokers of their reporting obligations in relation to short sales.
Observations
The updated position of the ASX suggests a broadening of the scope of required disclosure of investors’ financing arrangements. The circumstances under which directors and other shareholders finance their holdings has traditionally been considered a personal matter, not relevant to the company’s business affairs and operations.
There is much to be said in support of that view. The argument goes that disclosure to the market of the terms of margin lending agreements over material holdings, such as trigger points, could lead to deliberate actionsto artificially lower share prices to trigger point levels—for example, through short selling or (illegal) false rumour mongering. Once the trigger points are reached, the shares subject to the margin calls flood the market, further lowering the share price and allowing shares to be picked up cheaply before the share price re-stabilises.
Supporters of imposing stricter disclosure requirements on directors argue that other shareholders in the company ought to be aware of the company’s (and therefore, their own) exposure to potential calls on margin loans. Similar considerations to those outlined in the Takeover Panel’s guidance note regarding derivatives apply in relation to disclosure of margin lending—in some circumstances, where the terms of the lending are not disclosed, the identity of the persons exercising indirect control over the company may not be apparent to the market.
A middle road requiring the disclosure of the financing of directors’ material holdings through margin lending, without disclosing the triggers, may be a sensible compromise. However, this begs the further question of whether other persons with significant shareholdings who are not directors should be asked by the company to explain the terms under which they raised funding to acquire their shares and have significant terms of those agreements disclosed to the market. It is arguable that the considerations outlined above apply equally to substantial shareholders, whether or not they are directors. While the current disclosure requirements on substantial shareholders are relatively extensive, they are unlikely to be viewed as extending to disclosure of the terms of the funding arrangements under which the shares are held. As yet, neither the ASX nor ASIC appear to have addressed this issue.
As recent fluctuations in the market continue, it is likely that calls for further regulation and greater transparency will increase. Regulators should weigh the advantages of greater efficiency and transparency in the market against the potential for manipulation and the administrative burden that such measures may impose. Directors and other substantial investors should ensure they remain abreast of new developments in relation to disclosure as they arise.
Title : Partner
Office : Perth
Phone : +61 8 9211 7797
Fax : +61 8 9211 7878
Email : simon.reed@freehills.com
