Takeovers Panel

CLASS EXEMPTIONS FOR BUYBACKS

A CONSULTATION PAPER ISSUED BY THE TAKEOVERS PANEL

May 2009

PROBLEM IDENTIFICATION

Background

  1. Under a buyback a company acquires its own shares. A company may undertake a buyback in a number of ways, including:
    • by the company making an offer to each shareholder to buyback a uniform percentage of each shareholder's shares (a pro-rata buyback)
    • by the company entering into an agreement with 1 or more shareholders to buyback their shares
    • by the company buying its shares on-market
  2. The Takeovers Code is relevant to buybacks because shareholders who are (together with their associates) near to or over the 20% threshold of rule 6 of the Code may have their control percentage increased as a result of a buyback and therefore potentially breach rule 6 of the Code. While acquisitions and allotments occur as the result of a conscious decision and positive action, buybacks can potentially result in inadvertent breaches of the fundamental rule because the increase in voting control is a result of non-action (i.e., non-participation in the buyback) on the part of the person needing to rely on the clause 4 class exemption. Provided the conditions of exemption are complied with, the person who increases, as a result of a buyback, over the 20% threshold in the fundamental rule will not breach the Code.

Status quo

  1. The fundamental rule of the Code contained in rule 6 is that no person can:
    • increase their control percentage to more than 20% (together with their associates) of the voting rights in a Code company; or
    • increase an existing control percentage of 20% or more (together with their associates) of the voting rights in a Code company.
  2. Rule 7 of the Code provides for various exceptions to the fundamental rule. The exceptions that are relevant for the purposes of this review are those contained in rule 7(c) and rule 7(d).
  3. Under rule 7(c) a person may become the holder or controller of an increased percentage of the voting rights in a Code company by an acquisition of voting securities approved by ordinary shareholder resolution in accordance with the Code. Rule 15 sets out the requirements for the notice of meeting containing the proposed resolution in respect of the acquisition (i.e., sets out the information that the notice of meeting must contain, or be accompanied by, including disclosure of the number of shares in the company that may be acquired and the percentage of shares that that number represents).
  4. Rule 7(d) and rule 16 which relate to allotments rather than acquisitions are almost identical to rule 7(c) and rule 15.
  5. Rule 7(c) and rule 7(d) reflect a key principle of the Code that an increase in voting rights, that would otherwise breach the fundamental rule, should be permitted with the approval of the Code company's shareholders by ordinary resolution.
  6. Prior to the Code's coming into force on 1 July 2001, the Panel granted the Class Exemptions. These cover a range of situations that, in the absence of an exemption, could lead to inadvertent breaches of the fundamental rule. Among the Class Exemptions are 2 which relate to buybacks by Code companies of their own shares. These 2 exemptions are the clause 4 class exemption for buybacks approved by shareholders and the clause 5 class exemption for buybacks not approved by shareholders. The clause 4 class exemption was drafted to mirror the shareholder approval mechanism contained in rule 7(c) and rule 15 of the Code.1
  7. Clause 5 of the Class Exemptions provides an exemption for buybacks that are not approved by shareholders under clause 4. It is a condition of the exemption that the exempted person whose control percentage increases as a result of a buyback eliminates the excess control percentage within 6 months and the additional voting rights are not exercised before that decrease.
  8. Buybacks where clause 4 is being relied upon by a shareholder whose voting control would increase under the buyback require the appointment of an independent adviser to prepare an independent adviser's report. The number of independent adviser approval applications received by the Panel over the last 8 years indicates there has been approximately 1 company buyback per year requiring shareholder approval for the purposes of clause 4 (i.e. utilising the clause 4 exemption).
  9. The Panel does not hold statistics for the number of buybacks where clause 5 has been utilised because no application or notification is required to be given to the Panel under clause 5.
  10. The clause 4 class exemption (which is the focus of this review) provides a mechanism for a person to increase their control percentage in a Code company above the 20% threshold of the fundamental rule by not selling into a buyback. The clause 4 class exemption allows the person relying on it to achieve that increase (that is, they are exempted from the rule 6 prohibition against increasing above the 20% threshold) with the approval (by an ordinary resolution) of the shareholders of the company, who are not associates of the exempted person.
  11. The shareholders make this decision on the basis of disclosure in the notice of meeting of the details of the potential maximum of the increase in the exempted person's voting control that could occur as a result of that person not participating in the buyback. In addition, an independent adviser provides a report on the merits of the buyback from the perspective of the shareholders who will have to consider whether or not to accept the offer (if it is not a "special offer" to just 1 or a few shareholders). The independent adviser also opines on the merits of the buyback in terms of its impact on voting control in the company, from the perspective of shareholders who can vote to approve or reject the buyback for the purposes of the exempted person's proposed voting control increase.
  12. The clause 5 exemption has no equivalent in the Code. It provides a method to eliminate, over a reasonable period (i.e., 6 months), an increase in voting control that has not been sanctioned by the Code company's other shareholders and that therefore cannot be retained. The clause 5 exemption can be relied upon even if shareholder approval has actually been sought but it has not been given, under the clause 4 exemption. Thus, clause 4 enables an increase in voting control that occurs as a result of the buyback to be retained, while clause 5 exempts the increasing person from complying with the fundamental rule of the Code, but requires the inadvertent increase in voting control to be eliminated within 6 months. The Panel is not aware of any issues with the clause 5 class exemption, therefore this paper focuses on the clause 4 class exemption only.
  13. The clause 4 class exemption is set out in full in Appendix 1.

Exemptions from rule 15(b) and rule 16(b) of the Code

  1. The clause 4 class exemption is drafted so as to be consistent with and to closely mirror rule 7(c) and rule 15(b) of the Code which relate to acquisitions of Code company shares by a new or existing shareholder. As noted above, rules 7(d) and 16 (which relate to allotments of Code company shares) are substantially identical to rules 7(c) and 15(b). We refer to the rules 7(c) and 15(b) and 7(d) and 16(b) provisions as the "Rule 7 Requirements".
  2. The Rule 7 Requirements mandate the disclosure of the exact number and percentage of shares to be acquired or allotted. If the exact number and/or percentage of shares to be acquired or allotted cannot be specified under rule 15(b) or rule 16(b) (as the case may be) rule 7(c) and rule 7(d) will not be able to be relied upon in the absence of an express exemption from the Panel. The Panel has granted a number of exemptions that allow maxima to be stated in the notice of meeting for shareholder approval of acquisitions or allotments where this situation arises.
  3. For example, exemptions from rule 16(b) have been granted in respect of:
    1. underwriters of share issues who do not know how many shares they will subscribe for under the allotment as this is dependent upon whether, and to what degree, others subscribe;
    2. persons subscribing to rights to acquire shares under a rights issue who do not know what percentage of voting rights in the Code company they will hold as a result of the allotment as this is dependent upon whether, and to what degree, others subscribe;
    3. persons exercising rights to convert convertible securities into voting securities who do not know the total voting rights that will be on issue at the time of their conversion and allotment because there are other holders of the convertible securities who may or may not also exercise their conversion rights;
    4. persons exercising options to be allotted voting securities who do not know the total voting rights that will be on issue at the time they may elect to exercise their options because there are other holders of options who may or may not exercise them.
  4. Exemptions from the Rule 7 Requirements are usually made subject to the following conditions (modified as necessary for the specific situation) in respect of the acquisition of voting securities by, or allotment of voting securities to, the person seeking to rely on the exemption:
    1. all relevant voting control maxima are disclosed in the notice of meeting;
    2. all relevant voting control maxima have been calculated on the basis that there is no change to the number of voting securities on issue between the date of the notice of meeting and the completion of the allotment (or acquisition) except those that are issued under the allotment;
    3. full particulars of the acquisition/allotment are disclosed in the notice of meeting;
    4. the notice of meeting contains a summary of the terms and conditions of the exemption;
    5. the notice of meeting displays a disclaimer that the Panel is neither endorsing nor supporting the accuracy or reliability of the contents of the notice of meeting nor implying it has a view on the merits of the acquisition/allotment;
    6. the form of the notice of meeting is approved by the Panel;
    7. the proposed acquirers/allottees can only increase their voting control as a result of the transaction approved under the exemption;
    8. there is no effective change of control of any corporate acquirer/allottee for the time period specified in the exemption;
    9. the proposed acquirers/allottees cannot increase their voting control at any time during the duration specified in the exemption to a percentage above the maximum percentage of voting securities that they could hold or control as disclosed to shareholders in the notice of meeting;
    10. in cases where shareholder approval is obtained for a series of allotments occurring over several years, disclosures are also made about the control positions of the exempted persons, in the Code company's annual reports.
  5. The Panel has stated in its statements of reasons for the granting of these exemptions that it considers the particular exemptions to be appropriate and consistent with the objectives of the Code because disinterested shareholders have an opportunity to vote on the acquisition/allotment and if they approve that acquisition/allotment on the basis of the maximum number of voting securities that could be acquired/allotted then, by implication, they can be taken to have approved the acquisition/allotment of a lesser number and percentage of voting securities.
  6. The policy behind the conditions is to ensure that shareholders have the necessary information to make a fully informed decision when deciding whether to approve any increases in voting control.

Other legislation and rules

  1. Other legislation that is relevant to a buyback is briefly described below.

Companies Act 1993

  1. Buybacks by New Zealand registered companies are governed by sections 59 to 66 of the Companies Act 1993.
  2. There is no requirement under the Companies Act that a buyback be approved by the shareholders of the company (except if the buyback constitutes a major transaction or if a "special offer" is made to buyback a particular shareholder's shares).
  3. Other than in the case of special offers, a buyback may be undertaken by a company in 1 of 3 ways:
    1. A pro rata offer made to all shareholders (section 60);
    2. An on-market offer, subject to prior shareholder notification. The offer must be made in the period between 10 working days and 12 months after sending the notification to the shareholders (section 63);
    3. An on-market offer, for up to 5% of the shares in a class. Shareholders must be notified of the acquisition within 3 months after the shares are acquired, and the stock exchange notified within 10 working days after the shares are acquired (section 65).

Securities Markets Act 1988

  1. Under section 23 of the Securities Markets Act a substantial security holder (being a person that has a 5% or more relevant interest in a listed company's shares) must disclose by way of notice (an SSH Notice) to the listed company and the NZX any movement of 1% or more in their relevant interest. The NZX posts SSH Notices on its website, so any such change to a substantial security holder's interest in the company is publicly available. Hence, when a listed Code company undertakes a buyback, any 1% or more increase to its substantial security holders' control of voting rights would be disclosed to the market.

Listing Rules

  1. Under the NZX Listing Rules, before a listed company acquires its own shares it must give notice to the NZX. This notice must specify the period of time within which the company will acquire the shares (which must be within 12 months from the date of the notice) and the maximum number of securities to be acquired in that period.
  2. The Listing Rules also require post disclosure of certain details of the shares acquired (e.g. class and number of shares acquired, share price and the reason for acquisition).
  3. Unlike the clause 4 class exemption the Listing Rules do not provide a mechanism whereby the maximum potential voting rights increases of specific persons are required to be disclosed.

Issues with clause 4 of the Class Exemptions

  1. The Panel has identified several issues with the clause 4 class exemption and these are set out below. Market participants are invited to identify other issues with this exemption, and to give their views on the extent to which they agree or disagree with the problems that the Panel has identified.

Issue 1: Changes in ownership of exempted corporates

  1. Buybacks (especially on-market buybacks) can occur over an extended period of time. In some cases a company will have a buyback programme in place so that it can buy back its shares on-market over a period of several years.
  2. A corporate person (and those who control it) may rely on the clause 4 class exemption to obtain shareholder approval for its (and their) increase in voting control under a buyback. The ownership of that corporate person may change during the life of the buyback. However, the fundamental rule catches those who "control", as well as those who hold. Accordingly, due to the breadth of the fundamental rule, any substantial change in the ownership of the exempted corporate person could not occur without breaching the Code. This means that if there was to be a change of ownership of a corporate shareholder who (together with associates) controlled more than 20% of a Code company, regardless of whether the corporate shareholder itself could continue to rely upon the clause 4 class exemption, the new person proposing to acquire the shares in the corporate shareholder would have to comply with the Code or obtain an exemption from the Panel before acquiring his or her or its position in the corporate shareholder. Accordingly, the Code already regulates changes of control upstream of a Code company, so the change of control itself is not really a problem.
  3. The greater problem with exempted corporate shareholders, however, is that, although shareholder approval would need to be obtained for an effective change in the control of the corporate shareholder, the Code would not require the notice of meeting to disclose information about the potential future increases in control of the Code company by the corporate shareholder (or its controllers) under an ongoing long-term buyback programme. Accordingly, in this situation shareholders make their decision on whether to give their approval on a less than fully informed basis.

Issue 2: Shareholder approval given under "point in time" disclosure

  1. Shareholder approval under the clause 4 class exemption is given under "point of time" disclosure (i.e. under those disclosures contained in (or accompanying) the notice of meeting for the approval resolution). Because a buyback may take place over several years, new shareholders coming in may be unaware of the maximum voting rights increases permitted to a person under the clause 4 exemption, as disclosed in the notice of meeting. Accordingly, to a certain extent, shareholders in the secondary market make investment decisions on a less than fully informed basis.
  2. The shortcomings of point of time disclosure in the context of buybacks over an extended period are not remedied by the disclosure requirements under the Companies Act, Securities Markets Act or the Listing Rules, because none of these require disclosure of the maximum voting control increases permitted to a person under the clause 4 class exemption.

Issue 3: Basis for calculating disclosures not defined

  1. The clause 4 class exemption is subject to the condition that the notice of meeting containing the proposed resolution to approve the acquisition contains particulars of the maximum number of voting securities that may be acquired by the Code company. It also requires that the notice of meeting sets out the percentage of all voting securities of the Code company that the maximum number represents, and the potential maximum aggregate of the percentages of all voting securities that the exempted person (and that person's associates) would hold or control if the maximum number of voting securities were acquired. The above percentages can only be calculated with reference to the number of shares of the company on issue as at a specific date (and in the case of a buyback undertaken over a long period of time, on the assumption that there is no change in the number of voting securities on issue over that period, other than as a result of the buyback).
  2. Many companies have convertible securities on issue that can be converted into shares at the holder's election. Accordingly, shares can be allotted (thus increasing the total number of shares on issue) at frequent intervals. The clause 4 class exemption does not define the assumptions for making the calculations, such as the date at which the number of shares of the company on issue should be calculated, and therefore there is lack of clarity surrounding the percentage calculation. Different percentages will be obtained depending on when the calculation is made. Some Code companies specify in the notice of meeting for a clause 4 shareholder meeting that the calculation date is the date that the notice of meeting is sent. Others specify a particular date in advance of the notice of meeting. Others may state that the calculation is based on the number of shares that will be on issue as at the date of the shareholders meeting (this might be appropriate where, for example, mandatory convertible notes will convert into shares on or before that date).
  3. The lack of prescribed assumptions such as regarding the date for making the calculation means that the company must decide for itself the basis for the disclosure calculations. While this may be seen as positive for some (i.e. by allowing flexibility), for others it may cause confusion or anxiety as to whether the disclosures are Code compliant. The Panel would be interested in the market's views as to the extent to which this issue causes problems.

Issue 4: Wording of clause 4(2)(a) unclear

  1. Under clause 4(2)(a) of the clause 4 class exemption, the exemption is subject to the condition that "the acquisition is approved by an ordinary resolution of the shareholders of the code company".
  2. It is not clear on its face that the shareholder "approval" referred to in clause 4(2)(a) is approval only for the purposes of the Code (i.e., only so that the exempted person can increase without breaching the fundamental rule), not for the purposes of the Companies Act. Given that the Companies Act does not impose a shareholder approval requirement for buybacks (except, in certain circumstances, for a buyback that constitutes a "major transaction" or a "special offer" to buyback shares from only 1 or a few shareholders in the company), the Code company can still proceed with the buyback regardless of whether shareholder approval is obtained for the purposes of clause 4(2)(a).2
  3. In the early years of the Code's operation an exemption was sought (and granted by the Panel (the Takeovers Code (Designer Textiles (NZ) Limited) Exemption Notice 2002)) on the basis that the directors of the company had announced a decision to undertake a buyback before shareholder approval was sought for Code purposes. This seems to indicate a narrow interpretation of the clause 4 class exemption, as though the requirement of shareholder approval was to authorise the buyback itself to occur, rather than to enable persons wishing to increase their voting control to do so.

Issue 5: Uncertainty over whether multiple resolutions permitted

  1. There have been some instances that the Panel is aware of where there has been uncertainty over whether multiple resolutions are permitted in respect of the shareholder approval required by the clause 4 class exemption.
  2. Whether multiple resolutions are permitted can be important because under clause 4(2)(b) the person seeking to rely on the exemption cannot vote in favour of the resolution. This means if there is a single resolution for the buyback and there is more than 1 person seeking to rely on the exemption, none of the exemption seekers could vote in favour of the resolution to approve the buyback. However if multiple resolutions are permitted each person would be entitled to vote in favour of the buyback on the resolutions relating to the other exemption seekers (provided they are not associates of the exemption seeker named in that resolution).
  3. It is not clear on the face of the wording of the clause 4 class exemption that a separate resolution for each exemption seeker is allowed. The Panel's view is that multiple resolutions are permitted.
  4. Neither of issues 4 and 5 is a very big problem, in the sense that legal practitioners can, and do, discuss with the Panel executive how clauses 4 and 5 of the Class Exemptions work. However uncertainty creates unnecessary compliance costs, and it is sensible to have regulations drafted in a manner that is clear and accessible to those regulated by them.

Issue 6: Incomplete disclosure of maximum voting control of exempted person

  1. The clause 4 class exemption requires (by subclause (2)(c)(ii)(C)) that the notice of meeting in respect of the buyback contain, or be accompanied by, a statement of the maximum aggregate percentage of all voting securities that could be held or controlled by the exempted person and the exempted person's associates if all voting securities were acquired by the Code company under the buyback.
  2. The clause 4 class exemption does not require the notice of meeting to disclose the maximum percentage of voting securities that could be held or controlled by the exempted person alone. Shareholders are left to determine for themselves, unless the disclosure is voluntarily included in the notice of meeting or is included in the independent adviser's report, what the exempted person's potential maximum control percentage might be. Such a statement in relation to the exempted person alone is required under the Rule 7 Requirements that the clause 4 class exemption is intended to mirror.
  3. The absence of a requirement (in the clause 4 class exemption) of such a statement means that the clause 4 class exemption is inconsistent with the Rule 7 Requirements. It also means that shareholders make their decision on whether to provide their approval to the buyback on a less than fully informed basis.

Footnotes

  1. The Statement of Reasons for the clause 4 exemption states: "the exemption is appropriate and is consistent with the objectives of the Code because it closely mirrors the shareholder approval mechanism, which is an exception to the fundamental rule, set out in rules 7(c) and 15 of the Code."
  2. If the buyback proceeds and shareholder approval is not obtained, the shareholder that had wanted to increase its control position in the company by not participating in the buyback would now either have to participate in the buyback or rely on the clause 5 class exemption (under which it would have 6 months to eliminate any control increase that had occurred as a result of the buyback).