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Well-intended rules stymie free market

By Mike Ross

Thursday 17th April 2003

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PDL, Richmond, then Rubicon: all examples of the law of unintended consequences.

Naive politicians claiming to regulate for the common good by requiring disclosure of nominee shareholdings in listed companies have instead created private benefits for the strong and powerful.

Judges have a wide discretion in imposing penalties for failing to disclose. They can tip the balance in a contested takeover battle.

Described in Parliament as a measure to assist small shareholders worried about insider trading, nominee disclosure rules enacted in 1988 have proved a godsend for the big boys fighting for control of listed companies.

Legal battles over nominee shareholdings in PDL, Richmond and Rubicon have been little more than tactical fights for management control, having nothing to do with either protecting small shareholders or controlling for insider trading.

Arguments over disclosure of nominee shareholdings bear comparison with America's Cup racing ­ unsettle rival syndicates by claiming they have committed technical breaches of the rules. Winning off the water makes for an easier battle on the water.

In the battle for control of PDL two years ago, Schneider took out rival Clipsal once the High Court reduced Clipsal's PDL holding as a penalty for hiding part of its shareholding through nominees. This share forfeiture dropped Clipsal's holding in PDL below a viable blocking minority interest.

As a result, the decision of one High Court judge had the effect of deciding who would be the winner. What started as a contested takeover was decided by judicial fiat.

Late last year, the High Court declared Dunedin-based PPCS a defaulter in its use of nominees to disguise the extent of its holding in rival meat processor Richmond. The penalty imposed: forfeiture of 6.8 million Richmond shares and disenfranchisement in respect of 14.6 million shares.

Justice Willy Young then set about crafting an outcome that would see PPCS either making a complete takeover of Richmond or divesting itself of all shares in the company.

Capital market dynamics soon overran the judge's best endeavours. Arbitrageurs, other meat processors and speculators were soon in and out of the market exploiting uncertainties following from the judge's order and the operation of the Takeovers Code. Both the Takeovers Panel and Justice Young have been kept busy trying to bring their own senses of order to the chaos.

PPCS has been making little headway in its various bids seeking full control of Richmond. With the risk of its controlling stake in Richmond evaporating, PPCS is appealing the High Court ruling.

Earlier this year, GPG took aim at US-based Perry Corporation in its battle for control of Rubicon. In the High Court, Justice Judith Potter ruled Perry Corporation had failed to fully disclose an economic interest in Rubicon created through the use of equity swaps.

The penalty this time: forfeiture of 12 million Rubicon shares and the forced sale of the balance of its holding, another 24 million shares. With $8 million of forfeited shares at stake, Perry Corporation is off to the Court of Appeal.

Disclosure of interests in listed companies is forced by 1988 legislation, now renamed the Securities Markets Act 1988. Any investors with a beneficial holding of 5% or more in a listed company must disclose their interest. Further movements of 1% must similarly be disclosed. Penalties for failing to disclose can be severe, ranging from an order that full disclosure be made through to outright forfeiture.

The disclosure rules were pushed through by a Labour government smarting from the 1987 sharemarket crash and desperate to be seen to do something.

The then minister of justice, Geoffrey Palmer, said, "A nominee shareholding disclosure law will not only complement remedies against insider trading but in itself go a very long way to inhibit that kind of trading."

It is difficult to find any evidence to support this view. It reads as a facile political justification for further regulation.

Challenged by opposition members that it would offer no solace for small investors but instead become a weapon in corporate manoeuvrings during takeovers, the minister retorted: "It will certainly be used in takeover battles. People will know what is going on ... and that will help small investors, not hinder them."

Hands up all those small shareholders in Richmond and Rubicon who consider themselves "helped" by recent litigation.

The confusion and uncertainty surrounding ongoing legal battles have the effect of depressing share values, not boosting them.

It is the management of companies locked in battles for corporate control who are making tactical use of the nominee disclosure rules. The rules are not helping small investors and have no discernable impact on insider trading.

Mike Ross teaches commercial law at Unitec Business School

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