ANNUAL REPORT 2005

John King

Chairman's Review

The over-riding value of the New Zealand Takeovers Code is that it allows parties to compete for control of code companies while giving all shareholders the opportunity to take part in the takeover process. The Code encourages and facilitates takeovers on the basis of equal treatment and full disclosure which benefits competing bidders and target company shareholders.

The operation of the Code prevents changes of control of a code company from occurring without the approval and participation of its shareholders. A person wishing to acquire more than 20% of the voting securities of a code company can only do so in compliance with the Code. Broadly this means an offer to all shareholders or an acquisition approved by non-associated shareholders.

The Code applies equally to all market participants involved with code companies. All market participants are obliged to conduct their affairs on the basis of the Code, and conversely, they and investors are entitled to rely on the protections contained in the Code.

Because the Code applies equally, regardless of whether the bidder is a New Zealand company or a company from overseas, bidders and code companies have certainty as to how changes of control can occur. This contributes significantly to the integrity of the markets making them more attractive to a wide range of investors.

Before it was introduced some critics suggested that the Code would discourage takeover activity. This has not occurred. In the past year the Panel has received 19 takeover notices relating to New Zealand code companies. This volume of takeover activity, the biggest since the Code came into force, has made 2004- 2005 an extremely busy year for the Panel. This year there were some significant developments in the enforcement and exemption activities of the Panel.

ENFORCEMENT

One of the Panel’s functions is to investigate any act or omission relating to a takeover of a code company in order to enforce the Code. One issue in particular that has led to a number of investigations and enforcement actions in the past year is the concept of “association”.

The Code’s fundamental rule is triggered when a person or associated parties acquire ownership of, or control of, voting rights above 20% in a code company. The concept of “association” is included as an antiavoidance provision as the Code could easily be circumvented if it concentrated only on voting rights held or controlled by any one company or individual.

Market participants need to understand the concept of association so that they do not risk breaching the Code. Enforcement actions which the Panel has had to take in the past year suggest that the two aspects of association - when parties are associates and the consequences that can result from being associates - are not well understood.

Persons who act jointly or in concert are associates. If one person acts or is accustomed to act in accordance with the wishes of another person they are associates. Related companies are associates.

Parties that have a business, personal or ownership relationship will not necessarily be associates for the purposes of the Code. To determine whether such parties are associated the Panel considers all facets of the relationship and all the circumstances surrounding the relationship. A relationship is likely to be considered an association for Code purposes where it concerns the future control of voting rights of the code company.

In one meeting held by the Panel this year under section 32 of the Takeovers Act the parties were held to be associates; in another section 32 meeting parties were held not to be associates.

The first section 32 meeting concerned Dorchester Pacific Limited where the Panel determined that Bridgecorp Capital Limited and Brent King were associates because they had an ongoing contractual relationship relating to the future control of voting rights in Dorchester. Bridgecorp acquired 19.99% of the voting rights in Dorchester from a number of parties including Brent King. Mr King retained 5.05% of Dorchester. Bridgecorp and King considered that they did not breach the Code on the basis that they were not associates and neither held more than 20% of Dorchester. However, the Panel determined that they were associates because the agreements between them created ongoing relationships respecting the control of Dorchester. As associates their combined holdings exceeded the permitted threshold of 20%.

This was quite different from the situation considered by the Panel in the Calgary Petroleum Limited determination. A number of shareholders increased their voting rights in Calgary by taking up an overacceptance facility of a pro rata offer. Another shareholder complained to the Panel that these shareholders were associates because they had personal and business relationships, and had voted the same way on a resolution to remove a director of the company. The Panel decided that a number of shareholders agreeing to exercise their votes in a particular way does not necessarily make them associates. The Panel considered the nature of the relationship between the shareholders and determined that they were not associated.

Although many of the shareholders had personal and business relationships, in contrast to the Dorchester case, their relationships did not involve the control of voting rights in Calgary.

The second aspect of association is that associate status of itself is not a breach of the Code. It is only if an associate becomes the holder or controller of voting rights, and together the associates hold, or will hold, more than 20% of the total voting rights in the code company, that the Code will be breached. In the case of Dorchester the fact that Bridgecorp and King were associates did not breach the Code. It was the acquisition that took their combined holding to more than 20% of Dorchester when they were associates, that breached the Code.

Code Word No 14, published in April 2005, gives a detailed explanation of the associate issue to assist market participants to understand this aspect of the Code. The Panel considered, and issued press releases, in relation to the associate issue in two other matters which did not need to be dealt with by a formal meeting under section 32 of the Act. These involved the acquisition of shares in Powerco Limited and Northland Port Corporation (NZ) Limited.

Although section 32 meetings are the most high profile of the Panel’s enforcement activities, enforcement work is carried out on a day-to-day basis. The Panel’s executive reviews offer documents, target company statements and notices of meeting for all takeover transactions. The executive also follows up issues arising from company announcements and shareholder complaints. Issues arising from these sources often require further action. In some cases non-compliance can be avoided or remedied if the parties amend documents, dispose of shares or issue correcting statements. This is an important part of the Panel’s work and is essential for an efficient takeovers market.

In some instances, parties providing incomplete or incorrect information have hindered the Panel’s ability to investigate takeover activity or consider applications under the Code. It is an offence to mislead the Panel. The Panel has needed to remind some market participants of the importance of candour in their dealings with the Panel.

EXEMPTIONS

The Panel’s decisions on some exemption applications attracted some controversy during the year. A number of applications related to the treatment of overseas shareholders in the case of scrip offers.

Scrip offers are an important part of the takeovers market. However the cost of making a scrip offer for a code company is increased by the need to comply with securities laws in every country where shareholders reside. The Panel’s policy is to grant exemptions which enable different treatment of overseas shareholders under scrip offers but only if it is satisfied that the number of overseas shareholders in the jurisdiction in question is extremely small and the offer documents cannot be used in that jurisdiction. As a condition of the exemption, the Panel generally requires that overseas shareholders be offered a cash equivalent which is the net proceeds of the sale of the scrip they would have received. This puts overseas shareholders in the same position as a New Zealand shareholder who immediately sold the scrip received under the takeover offer. Unfortunately with the takeover offer for Powerco Limited the exemption granted in accordance with this principle was able to be exploited in an unexpected manner because of the unusual terms of the offer.

However, the Panel’s policy is valid and the conditions of future exemptions will ensure that the problem does not arise again.

The second type of exemption application which attracted some comment during the year related to upstream acquisitions. The Code was deliberately constructed to capture the change of control of voting rights in code companies by means of a transaction upstream from the direct holder of the voting rights in the code company. However, shareholders can approve upstream transactions under the provisions of rule 7(c).

The Panel’s stance on exemptions for upstream acquisitions was made clear in its rejection of an application made by Vector Limited. Vector wished to acquire 64.25% of the voting rights in NGC Holdings Limited by purchasing a holding company of The Australian Gas Light Company. AGL did not wish to sell the NGC shares held by its holding company into a direct takeover because it would have had tax disadvantages for AGL, and did not wish to go through the shareholder approval process under rule 7(c). However, the Panel’s exemption power is not intended to enable market participants to structure a transaction in a manner that does not comply with the Code to achieve a particular commercial outcome or benefit. There was no reason why the alternatives provided by the Code could not be utilised and accordingly the exemption application was declined.

This year the Panel received more exemption applications than usual. The volume and nature of these applications indicate that the purpose of, and limitations on, the Panel’s exemption powers are not fully understood. There will be cases where the Code may have unintended consequences or may not adequately provide for unexpected or unusual circumstances. It is to deal with these situations that the exemption power is required to ensure that the Code operates effectively and efficiently and fulfils its objectives.

The Panel issued a guidance note in January 2005 to clarify the Panel’s exemption power and to assist market participants in their appreciation of when exemptions are likely to be granted.

HARMONISATION WITH AUSTRALIA AND INTERNATIONAL LIAISON

Harmonisation of the New Zealand Takeovers Code with Australian takeovers law was addressed when the New Zealand Code was formulated. At that time section 24 of the Takeovers Act provided that:

“In formulating a takeovers code the Panel shall have regard, as far as practicable, to the principles applying to the harmonisation of business law contained in the Memorandum of Understanding between the Governments of Australia and New Zealand on the Harmonisation of Business Law signed at Darwin on the 1st day of July 1988”.

The Panel’s approach to the formulation of the Code was to produce a Code which was appropriate for the New Zealand takeovers market, taking into account the requirements of section 24.

The legal framework governing takeovers in Australia is very different from the framework provided by our Takeovers Act. There are differences in the legislation and in the roles of the Panels. The Australian Securities and Investments Commission fulfils some of the functions performed by our Panel. Furthermore, the Australian Panel has a much wider jurisdiction in that it can deal with situations which are described as “unacceptable circumstances”.

Harmonisation does not require either country to follow blindly in the footsteps of the other. The aim is to have a common purpose and similar principles. Differences in approach arise for historical reasons and because of the particular requirements of each jurisdiction.

It is in this sense that there is “harmonisation” between the takeovers regimes in New Zealand and Australia. They both seek to place a framework over takeover activity to ensure an orderly process where shareholders are treated equally and, on the basis of proper disclosure, are able to make informed decisions. In particular we have adopted a common threshold of 20%.

For Australian investors interested in New Zealand companies the introduction of the New Zealand Code meant that the basically uncontrolled nature of the takeovers market in New Zealand had come to an end. Australian investors now participate with all other shareholders in the takeover process in a manner that in principle produces outcomes similar to the outcomes under Australian law.

An aspect of harmonisation is being addressed by the Securities Legislation Bill now before Parliament. At present the New Zealand Panel has no power to deal with situations where the Code has been complied with but the parties in the takeover contest engage in misleading or deceptive conduct. The new law will amend the Code to prohibit, and give the Panel powers to deal with, such conduct.

We continue to maintain a close relationship with the Australian Panel. In May 2005 the Minister of Commerce, Hon Pete Hodgson, reappointed Denis Byrne, a member of the Australian Panel, to the New Zealand Takeovers Panel. My appointment to the Australian Takeovers Panel was also extended. These appointments are extremely helpful in keeping each Panel well informed about takeovers matters in the other jurisdiction. Liaison with other takeovers regulators from around the world is important to ensure an understanding of current issues and the approaches to them. Deputy Chairman David Jones and Counsel to the Panel Marion Hemphill attended a meeting of representatives of Takeovers Panels from around the world held in Johannesburg during the year.

LAW REFORM

We expect to see our recommended technical amendments to the Code come into force later in the 2005 calendar year. We have been concerned at the time taken to achieve changes to the Code, most of which were first recommended more than 18 months ago. We need to find ways in which improvements to the Code, identified from our experience with the takeovers market, can become law more quickly.

The Securities Legislation Bill, currently before the House, makes significant changes to the Code and the Act. Among other things, the Bill removes the $20 million asset test for a code company that is unlisted and broadens the scope of the Code to cover misleading or deceptive conduct, not just misleading or deceptive statements in the offer documents and the target company statement. On the other hand the Code will no longer apply to companies that are listed only in respect of non-voting securities.

This year has seen the passage of the Crown Entities Act. Significant Panel resources had to be diverted to ensure that the Panel’s independence was preserved and its processes accommodated during the consultation on this legislation.

PANEL RESOURCING

The Panel’s income is divided between a Government grant and third party income received under the Takeovers (Fees) Regulations 2001. It is difficult to estimate the Panel’s income because third party payments depend on the level of takeover activity and the outcome of enforcement action.

For the last two years the Panel has met its deficits from accumulated funds, but warned in the 2004 annual report that surpluses were not at a level to absorb continuing deficits. This year a loss of approximately $160,000 was avoided by an additional Government grant. Government has also increased funding for the new financial year which will put the Panel in a good position to carry out its current and new responsibilities under the Securities Legislation Bill. However, it may well be appropriate to consider an increase in the size of the Panel itself to cope with the increased workload expected from the anticipated law changes.

CONCLUSION

The Panel continued to keep market participants well informed during the year by face to face meetings and via the website www.takeovers.govt.nz. Two issues of Code Word addressed the specific matters that we thought needed clarification for market participants and their advisers.

Panel Members have made significant contributions to the Panel’s work, often at times and for periods that were personally inconvenient. I am grateful to them. Their willingness to make themselves available enables the Panel to respond to market issues in a timely way. I am also grateful to the highly skilled Panel executive for their dedication and hard work which makes a significant contribution to a well-regulated takeovers market in this country.

J.C. King
Chairman