Takeover Documents - Compliance with the Code
Published 1 November 2005
The Panel’s executive routinely checks takeover notices, takeover offer documents and target company statements for compliance with the Code.
From some recent examples it appears that companies and their legal advisers treat compliance with the Code as an option rather than a legal obligation. This is not the case and the Panel will take appropriate enforcement action if documents do not comply.
Some areas where compliance with the Code has raised difficult issues, mostly for target companies, are discussed below. This article does not discuss the ongoing issues relating to Oyster Bay.
Disclosure of assumptions underlying forecasts
Schedule 2 of the Code sets out the requirements of the target company statement, i.e. the statement that a target company must issue in response to a takeover offer. The target company must send to the offeror and to every offeree … a statement containing, or accompanied by, the information specified in Schedule 2 … (Rule 46).
The target company statement must include … the identity of the independent adviser who has provided a report under rule 21 and a copy of the adviser’s full report or a summary of the full report prepared by the adviser. (Clause 19 of Schedule 2)
Clause 21 of Schedule 2 states that If any information provided in the target company statement refers to prospective financial information, the principal assumptions on which the prospective financial information is based.
The Panel interprets Schedule 2 as meaning that the independent adviser’s report on the merits of an offer (as required by Rule 21) is part of the target company statement for the purposes of clause 21 of Schedule 2.
Independent adviser reports often give prospective financial information, comprising financial forecasts of the target company for one or two years ahead. Invariably, given the short time which advisers have to prepare their merits reports, these forecasts will be based on information provided by the target company management.
If an incumbent board or management is resisting a hostile takeover there is an incentive to exaggerate the value of the target company to make the bid appear low. This may appear to be in the interests of shareholders if it pushes up the offer price, but it may not be in the company’s interests if it frustrates a much-needed change of control.
Where an incumbent management supports a takeover offer, possibly one made by an existing majority holder for the shares it does not already hold, there is less incentive for management to inflate the value of the company. In these circumstances information about the target company’s future prospects that is given to the adviser may be relatively conservative.
Partly because of these varying possibilities the Code requires the target company statement (including the independent adviser’s report) to state the principal assumptions on which any prospective financial information is based. It is expected that the assumptions will directly accompany the prospective financial information in the document.
The Panel executive has seen instances where the principal assumptions underlying prospective financial information have either not been stated or have been stated in such a bland way that they disclose little information that is useful or relevant.
When considering the adequacy of disclosed assumptions the Panel notes this advice from the New Zealand Institute of Chartered Accountants:
Prospective financial information will be based on many assumptions about future conditions and events which may or may not occur. The quality of the information will be dependent largely on the appropriateness of these assumptions. Therefore, users are to be provided with these assumptions so as to make their own informed judgement on the quality and reliability of the assumptions. For users to make their own informed judgement, it is necessary to provide information which assists them in assessing the sensitivity of prospective financial information to changes in assumptions which are subject to high degrees of uncertainty. (FRS-29 Prospective Financial Information issued in 1996 paragraph 5.6)
Where target company statements and independent adviser reports do not include an adequate description of the principal assumptions underlying any prospective financial information that they contain, the Panel has generally required the target company to issue a correcting statement. This has to be distributed to all target company shareholders to mitigate the effect of what is, in essence, a breach of the Code.
If the correcting statement is distributed to target company shareholders without delay the Panel is unlikely to take any further enforcement action.
Those who prepare target company statements and independent adviser reports should ensure that the principal assumptions underlying any prospective financial information are adequately described.
Information about asset valuations
The Code states that the target company statement must include:
If any information in the target company statement refers to a valuation of any asset, (a) the date of the valuation, the identity of the valuer, and a summary of the valuation, that discloses the basis of computation and the key assumptions on which the valuation is based; and (b) an address or addresses where copies of the valuation are available for inspection and a statement that a copy of the valuation will be sent to any offeree on request. (Clause 20 of Schedule 2)
This requirement applies whether the independent adviser’s report or another part of the target company statement refers to the valuation of the asset. The disclosure required by clause 20 can be in the body of the independent adviser’s report and/or in the directors’ part of the target company statement. Disclosure in either place will comply.
Where a target company is a property development company, with a significant number of investment properties which are included in the company’s financial statements at market value, this reference in the financial statements will not generally constitute a reference to the valuation of an asset for the purposes of clause 20. Specific reference to valuations of one or more individual assets would be needed for the disclosure requirements to be triggered.
If a target company commissions its own expert opinion on the value of its shares and refers to this value in the target company statement (in addition to the independent adviser’s report) then the Panel is likely to consider that this is the valuation of an asset (being the value of the target company itself). This should be summarised in the target company statement to the extent required by clause 20 and be available to any shareholder who requests it.
Information about material changes in the financial or trading position of the target company
The target company statement must include:
All material changes in the financial or trading position, or prospects, of the target company since the annual report referred to in subclause (1) [being the most recent annual report] or a statement that there are no known material changes. (Clause 18(4) of Schedule 2)
Sometimes quite a long time may have elapsed between the company’s last annual report and the target company statement. Interim financial statements may have been published in that time. An independent adviser’s report will usually include prospective financial information. However, clause 18(4) requires all material changes in the financial position or prospects of the target company since the last annual report to be identified.
Subsequent interim financial statements or the independent adviser’s report are not enough for compliance, unless the independent adviser’s report specifically identifies the material changes that have occurred since the last annual report.
Approval of Target Company Statement
The target company statement must include:
(1) A statement that the contents of the target company statement have been approved by the board of directors of the target company: and
(2) If any of the directors of the target company do not approve of the statement, their names and their reasons for not approving.
(Clause 25 of Schedule 2)
It is common for a target company board to establish a committee of independent directors to handle all aspects of a takeover. This is particularly likely where an existing major shareholder is bidding to increase its stake, or an existing major shareholder has entered into a pre-bid lock-up arrangement with a new external party. This committee normally has fully delegated authority from the board of directors.
The Panel considers it is acceptable for a committee of independent directors to approve the contents of the target company statement for the board of directors. However, all other directors must explicitly not approve the statement and explain why in the target company statement.
A problem can arise if the target company statement includes information relating to the interests of directors and officers of the target company in material contracts with the bidder (as required by clause 13 of Schedule 2). In particular, officers or directors of the target company who are also officers or directors of the bidder, will probably have contractual arrangements with the bidder. However, the independent directors of the target company, who have to approve the statement, may not be privy to information about the interests of directors and officers unless those persons tell them. Non-independent directors are obliged to disclose information about any contractual arrangements with the bidder to the independent directors who are to approve the statement.
For their part, independent directors should ensure that non-independent directors verify information in the target company statement about the interests of directors and officers in any material contracts they have with the offeror or its related parties before they (the independent directors) approve the statement.
Signing of certificates for Offer Documents and Target Company Statements
The Code prescribes the certificates that must be signed for the offeror in the offer document and the target company in the target company statement. The certificates require a combination of executive and board level responsibility to be taken for the contents of the offer document and target company statement. (Clause 19 of Schedule 1 and clause 26 of Schedule 2)
The executives who must sign the certificate in the offer document and the target company statement respectively are specified in clause 19(2)(b)(i) of Schedule 1 and clause 26(2)(a) of Schedule 2. These clauses state that the certificate must be signed by:
The Chief Executive Officer and the Chief Financial Officer of the offeror [the target company] or their respective agents authorised in writing, or if there is no Chief Executive Officer or Chief Financial Officer, the person or persons fulfilling those roles respectively, or their respective agents authorised in writing.
In several instances takeover notices reviewed by the Panel executive indicated that the subsequent takeover offer document would not be signed by a person in one or other of the executive capacities. In these instances the Panel executive usually talks to the offeror’s legal advisers to ascertain who is filling the executive roles. In one or two instances the offeror’s advisers have overlooked that there are incumbent executives filling these roles although they don’t have the job titles. In other instances the offeror has been a small investment holding vehicle with only one or two directors and no executive staff. In these cases the directors must be filling the executive roles and should sign the certificates. The issue is the role and not the titles. Those who fulfil the roles have to sign the certificates.
Where target company statements have been issued without being signed by the responsible executives the Panel has acted swiftly to have the matter remedied. In one case the target company had overlooked the need to have the chief executive sign the document while the chief financial officer (a secondee from an accounting firm) had not signed because he thought that the contractual arrangements between the accounting firm and the target company prevented him from doing so. It was only after the Panel had called a section 32 meeting to deal with the non-compliance that the chief financial officer signed (by way of an addendum) the target company statement.
The requirement for the chief executive officer and the chief financial officer (or the persons fulfilling these roles) to sign the target company statement is a legal obligation that must be complied with. The only exception would be if the Panel granted an exemption. See Practice Note – Exemptions from Clause 26 of Schedule 2 on page 4 of this issue of CodeWord
The requirements for “particulars” in Offer Documents and Target Company Statements
The offer document or target company statement must include the particulars of agreements or arrangements entered into, or of interests in contracts, or of restrictions in company constitutions that are relevant to the takeover transaction. (Clauses 10, 11, 12, 15 and 16 of Schedule 1 and 10, 11, 12, 13, and 16 of Schedule 2) There is a tendency in takeover documents for responses to the requirements of these clauses to be general rather than particular.
In the Panel’s view, particulars means names and amounts.
Clause 12 of Schedule 2 covers the circumstances where a target company has entered into certain arrangements with its directors and/or senior officers. These arrangements relate to payments or other benefits for compensation for loss of office, or remaining in or retiring from office. These payments may be quite modest and reasonable. Or they may be poison pills, i.e. very large payments that entrench existing management by having a significant adverse effect on the value of the target company if a takeover succeeds.
The Panel expects the names of the people concerned and the amounts of the prospective payments to be disclosed. The amounts may be disclosed in terms of multiples of salary (e.g. 3 months’ salary, one year’s salary) in some instances.
If the amounts are modest and reasonable, disclosure should not cause any embarrassment or discomfort. If the amounts are large, disclosure of the amounts and the names of the recipients is very important. If the names and amounts are not disclosed, the offerees and the market will not know if there is reason for concern.
The offeror must disclose details of any agreement or arrangement, made or proposed, under which the target company or its related companies will give direct or indirect financial assistance in connection with the offer. (Clause 12 of Schedule 1)
In some instances where takeovers are virtually bound to succeed (e.g. a majority owner increasing its stake with prebid agreements in place) the response to this clause has been a vague statement about existing financing arrangements possibly being extended to cover the assets of the target company if the takeover succeeds. This does not comply with the requirement to disclose particulars of arrangements under which the target company will give financial assistance in connection with the offer. The Panel will insist on supplementary disclosure that identifies the parties with whom the financing arrangements have been made and the nature of those arrangements.
We’re here to help
The Panel appreciates that the form of takeover documents is evolving as the market gains experience with the Code. The Panel executive is happy to discuss takeover disclosure issues with the legal advisers to offerors and target companies before documents are finalised. This advice is without prejudice to the Panel’s position if a document is later challenged, but many potential problems can be averted ahead of time by a call to the Panel executive.