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18-376MR ASIC to consult on measures to restrict offers to retail investors of stub-equity in proprietary companies
ASIC is concerned about recent control transactions where part or all of the consideration includes stub-equity in Australian proprietary companies. These offers of stub-equity have been made to a large and diverse group of target shareholders, including retail investors.
Proprietary companies are required to be closely held and are prohibited from making broad public offers of their shares. By structuring control transactions to avoid these restrictions, retail investors who accept scrip consideration miss out on the disclosure and governance protections that apply to public companies, but from which proprietary companies are exempt.
We intend to issue a consultation paper in early 2019 seeking views on a proposed legislative instrument to prevent these kinds of offers in control transactions.
We may also consider making individual instruments to prevent these offers where the control transaction is announced after the date of this media release but prior to the conclusion of our consultation.
An offer of ‘stub-equity’ occurs where scrip consideration is offered to target shareholders under a proposed control transaction (a scheme of arrangement or takeover bid). These offers provide an opportunity for target shareholders to retain an economic exposure to the underlying business of the target company through holding scrip in the bidding, or holding, vehicle (HoldCo). Generally, HoldCo is a newly incorporated special purpose vehicle set up by a private equity bidder.
Recent control transactions involving a proprietary HoldCo have been structured to avoid the two main restrictions placed on proprietary companies under the Corporations Act 2001 (the Act):
- proprietary companies must have no more than 50 non-employee shareholders (s113(1)); and
- proprietary companies are prohibited from fundraising activities which would require disclosure to investors (s113(3)).
The terms of these transactions have required certain shareholders to direct their scrip consideration be issued to a nominee or custodian to be held on the shareholder’s behalf, to ensure that HoldCo has fewer than 50 members and can therefore remain a proprietary company.
Proprietary companies are also not generally able to make broad public offers of their shares because such offers (fundraising activities) would require disclosure to investors. However, where an offer is made under a scheme of arrangement or takeover bid, section 708 of the Act provides an exception to this disclosure requirement.
Despite the general disclosure exception in section 708, ASIC considers that it is contrary to public policy, and the specific prohibitions and legislative intent of section 113, for a proprietary HoldCo to make a broad offer of scrip to more than 50 target shareholders, and to combine the offer with the contemplated use of a custodian arrangement to ensure HoldCo can remain a proprietary company.
ASIC considers it important that investors in widely held companies are afforded the safeguards that the law explicitly provides for shareholders of public companies, and from which proprietary companies are exempt, including:
- restrictions on related party transactions under Chapter 2E;
- restrictions on conflicted directors voting under section 195;
- rules for the appointment and removal of directors under section 201E and section 249H(3);
- Australian residency requirements for directors under section 201A; and
- the requirement to hold annual general meetings under section 250N.
Accordingly, ASIC will issue a consultation paper on a proposed legislative instrument to modify section 708, with the effect that offers of scrip in a proprietary company as part of control transactions will be prevented, or restricted to where that offer is made to only a small number of shareholders (for example, to existing substantial shareholders in the target as part of a separate class under a scheme).
Where control transactions involving the offer of proprietary scrip consideration are announced after the date of this media release, but prior to the conclusion of the above consultation, ASIC may consider making individual instruments modifying s708 to similar effect. Before making any such instrument, affected parties will be afforded procedural fairness, including the opportunity to provide submissions on the circumstances of their particular transaction.
ASIC notes that it appeared as amicus at the second court hearing for a recent scheme to raise the above public policy concerns: see Capilano Honey Limited (No 2)  FCA 1925 at -.