On 18 October 2010, the Australian Securities & Investments Commission released two Consultation Papers setting out proposed changes to ASIC’s regulatory guidance on disclosures in related party transactions and expert reports and the independence requirements of independent experts. The Consultation Papers are the result of a twelve month review by ASIC of listed companies and registered managed investment schemes. The proposed changes will impact both companies and responsible entities of managed investment schemes.
Consultation Paper 142 Related Party Transactions
A) The arm’s length exception
Subject to a number of exceptions, Chapter 2E of the Corporations Act 2001 (Cth) (Act) requires a public company, or an entity that the public company controls, to obtain member approval in order to give a financial benefit to a related party of the public company.
One of the key exceptions is the “arm’s length terms” exception which provides that member approval is not needed to give a financial benefit on terms that would be reasonable in the circumstances if the public company or entity and the related party were dealing at arm’s length. Generally, the exception allows a public company to provide a financial benefit to a related party if the terms of the transaction are comparable to the terms that would have been reached had the two parties been unrelated to each other.
ASIC has stated that when considering whether a transaction falls within the arm’s length exception, companies must consider all relevant circumstances. ASIC has proposed changes to Regulatory Guide 76 to provide that companies should take into account all of the following factors in determining whether a related party transaction falls within the exception:
- How the terms of the overall transaction compare with those of any comparable transactions between the parties dealing on an arm’s length basis in similar circumstances.
- The nature and content of the bargaining process, including whether the company followed robust protocols to ensure that conflicts of interest were appropriately managed in negotiating and structuring the transaction. For example, if a director involved in negotiating a transaction has a material personal interest, this could be a relevant factor in the analysis.
- The impact that the transaction will have on the company, including the impact on its financial position and performance, and non-associated members.
- Any other alternatives available to the company.
- Any expert advice received by the company on the transaction. In some circumstances, directors may need to obtain professional expert advice to assist them to come to a view about a related party transaction. However, directors will still need to make their own independent assessment of the information.
ASIC also proposes to include guidance that if, after considering all relevant factors, there remains doubt as to whether the arm’s length exception applies, then member approval should be obtained.
B) Independent Expert Reports
Where a company seeks member approval to a related party transaction, the Act requires that members be given all relevant information in order for them to decide whether or not it is in the company’s interests to enter into the transaction.
ASIC has proposed to incorporate guidance in Regulatory Guide 76 to the effect that where a company seeks such member approval it may be necessary to provide members with a valuation from an independent expert in circumstances where:
- the transaction is significant form the point of view of the company
- the financial benefit is difficult to value
- the non-interested directors do not have the expertise or resources to provide independent advice to members about the value of the financial benefit, or
- the related party transaction is a component of a control transaction for which the company is commissioning an expert report.
ASIC has also proposed new guidance on how experts should assess related party transactions.
C) Disclosure about related party transactions
A key proposal raised by ASIC is that disclosure documents (including prospectuses, product disclosure statements, scheme booklets and bidder’s statements offering scrip consideration) should include details of all related party arrangements. Arguably, the current approach taken by most companies is to only disclose related party transactions that are considered to be material to an investor’s decision whether to acquire a security or financial product. ASIC’s current proposal would appear to place a greater onus on companies and their directors when preparing disclosure documents.
Specifically, ASIC proposes that disclosure documents should describe:
- all related party arrangements, including the value of the financial benefit if it can be quantified
- the nature of the relationship
- whether the arrangement falls within a permitted exception under Chapter 2E
- whether member approval was sought and, if so, when
- the policies and procedures that the company has in place in relation to entering into related party transactions and how compliance with these policies and procedures is monitored.
In its consultation paper, ASIC considers that the nature and extent of related party arrangements that exist for an entity or within a corporate structure is information that investors reasonably require because it can be indicative of aspects of an entity’s business model, its attitude to related party transactions and how they are managed and may reveal that some members have a different economic interest in an entity to others.
Consultation Paper 143 Expert reports and independence of experts: Updates to RG 111 and RG 112
ASIC has proposed a number of revisions to Regulatory Guide 111 and Regulatory Guide 112 dealing with the content of expert’s reports and the independence of experts respectively.
In relation to RG 111, ASIC is proposing to provide updated and revised guidance regarding the following matters:
- Analysing whether a transaction is fair and reasonable.
- The valuation requirements of a demerger.
- An expert’s choice of methodology.
- The requirement that an expert’s opinion be based on reasonable grounds.
- The obligations of a commissioning party when there is a change in circumstances.
- ASIC’s expectations for the preparation of expert reports.
- ASIC’s expectations for an expert’s working papers.
ASIC proposes certain clarifications regarding the “fair and reasonable” test used by experts in valuing a merger or other significant transaction. This includes clarifying that fairness should be determined assuming that both the vendor and the purchaser are knowledgeable and willing, but not anxious, parties and that they are acting at arm’s length.
ASIC has also proposed changes to RG 112 in relation to the independence requirements of experts commissioned by parties to significant transactions, including:
- a proposal that an expert should prominently disclose in its report if within the last two years it has valued an asset representing at least 30 per cent, by value, of the assets that it is valuing for the commissioning party, and
- a proposal that a commissioning party should ensure that the process by which an expert is selected is consistent with the concepts of actual and perceived independence.
Given ASIC’s renewed focus on compliance in this area, companies and responsible entities should now review and update their policies and procedures for dealing with related party transactions and engaging and instructing independent experts. Submissions to the proposed changes may be made to ASIC until 17 December 2010. Subject to the outcome of the consultation process, ASIC intends to release updated Regulatory Guides in March 2011.