- The disclosure of equity swaps continues to be a focus of contested M&A activity around the globe.
- A recent decision by the French financial regulator to fine LVMH Moët Hennessy-Louis Vuitton for the failure to disclose its stakebuilding in rival Hermès International through undisclosed cash-settled derivatives provides an interesting case study to consider how the Australian Takeovers Panel would apply its policy.
The use and disclosure of equity swaps continues to be an evolving and topical area of public M&A strategy and regulation.
Both in Australia and other major capital markets, we have seen a number of instances where the use of equity swaps has proven to be controversial. In 2012, Crown’s acquisition of an interest in Echo Entertainment through the use of swaps attracted recent commentary in this market, whilst overseas we have seen the use of swaps in battles for control of Volkswagen and Continental AG in Europe and CSX Corporation in the United States result in litigation.
Most recently, on 1 July 2013, the Enforcement Committee of the Autorité des Marchés Financiers (AMF), the French financial markets regulator, announced its decision to fine LVMH Moët Hennessy-Louis Vuitton (LVMH) €8 million over its failure to disclose its stakebuilding in rival luxury-goods maker Hermès International (Hermès) through undisclosed cash-settled equity swaps amended at the last moment to be settled in Hermès shares.
Since the publication of the Australian Takeovers Panel’s policy on disclosure of equity derivatives in 2008, the Panel has only had one opportunity to consider the issue and there is some uncertainty as to how the Panel would apply its policy in various situations.
The circumstances of LVMH’s swap transactions provide an interesting case study to consider how the matter would have been treated in this market.
LVMH’s raid on Hermès
In 2008, LVMH, which held 4.9% of the share capital and voting rights of Hermès, entered into numerous cash-settled equity linked swaps with three banks in respect of approximately 12.37% of the share capital of Hermès. The various swaps were divided between the three bank counter-parties which hedged their exposure by acquiring the underlying shares in Hermès.
The entry into the swaps was not disclosed to the market as:
- until October 2012 French rules on shareholding disclosure did not require cash-settled derivatives to be included in the calculation of the thresholds triggering shareholding disclosure obligations (unlike physically-settled derivatives which were required to be taken into consideration for the purpose of calculating these thresholds in 2009), and
- each bank built up an individual stake of less than 5% of the capital and voting rights of Hermès, which is the threshold for notification of interests that applies in France.
Whilst the swaps were initially structured to be exclusively cash-settled, by June 2010 two of the banks had orally agreed to the possibility of amending the swaps to provide for settlement via the physical delivery of the underlying shares. LVMH later explained that it had been concerned that there would be an overhang in the stock, forcing the price down and leaving Hermès exposed to an opportunistic bidder if the banks sold the shares into the market upon the swaps being cash settled.
On 21 October 2010, LVMH's Board of Directors approved the amendments to the arrangements and the unwinding in advance of the swaps via the physical delivery of the underlying Hermès shares acquired by the banks when hedging their exposure. On 22 October LVMH unwound the arrangement with the first two banks, thus raising its stake in Hermès from 4.9% to 14.2%. On 23 October LVMH took Hermès, the market and the AMF by surprise by announcing that it had built up a stake of more than 14% in Hermès, with an option to acquire a further 3% through the swap entered into with the third bank. That swap was unwound on 24 October, thus increasing LVMH's holding in Hermès to 17.07% and the corresponding threshold crossings notification was filed with the AMF on 27 October. In its notification, LVMH explained that it was not seeking control of Hermès or board representation but that it ‘considered pursuing, where appropriate, its acquisitions of Hermès shares according to market conditions’. LVMH subsequently announced that it had increased its interest in Hermès to 20.21%.
The appearance of LVMH on the Hermès register was not warmly received, either by the Hermès board or the Hermès family, which owned 62% of the company. On 5 December 2010, in reaction to LVMH's stakebuilding, the family announced it would establish a holding company to hold more than 50% of the share capital of Hermès and have a right of first refusal over any other shares held by family members, with a view to blocking LVMH from taking control.
LVMH’s use of the equity swaps proved immediately controversial amongst market participants, with many querying whether LVMH had complied with its disclosure obligations, in particular with regard to Article 223-6 of the AMF General Regulation which requires any person preparing a financial transaction that could have a significant impact on the price of the related security to disclose the characteristics of such transaction to the public as soon as possible. The AMF commenced investigation into the matter on 5 November 2010.
Should the stakebuilding have been disclosed as a financial transaction?
The first question was to determine whether LVMH's stakebuilding in Hermès could qualify as a financial transaction that must be publicly disclosed within the meaning of Article 223-6 of the AMF General Regulation. LVMH argued that, by entering into the swap, initially due to be settled exclusively in cash, it had merely sought financial exposure to the market of Hermès shares. However, the AMF found that the search for a financial profit alone did not explain the unusual circumstances in which the equity linked swaps were entered into. Adopting an ‘overarching approach’, the AMF took particular note of the following:
- the unusual amounts of the swaps,
- the division of the swap arrangements between three different banks so that no bank acquired a 5% stake in Hermès when hedging the exposure to LVMH, thereby avoiding shareholding disclosure under French regulations, which the banks would have otherwise had to make,
- that most of the shares acquired by the banks for the purpose of hedging their exposure had been identified in advance by LVMH who then provided this information to the banks,
- the entry into the swaps by two subsidiaries of LVMH located in Hong Kong and Luxembourg, which were not listed as consolidated companies until the 2010 annual report,
- the size of the guarantees granted by LVMH to the banks,
- the measures taken in the LVMH's consolidated financial statements to conceal the fact that its swaps were concentrated on a single security, and
- that most of the banks’ exposure under the swaps, and therefore the hedging, was due to be unwound within the same period of four months which created the risk of either a decrease in the price of Hermès shares or the sale of a block of Hermès shares to a LVMH competitor, which LVMH wanted to avoid.
Based on these facts, the AMF found that LVMH's stakebuilding in Hermès via the swap arrangements fell within the scope of Article 223-6 of the AMF General Regulation and, as such, LVMH was under the obligation of disclosing the characteristics of the intended financial transaction to the market.
When should disclosure have been made?
The second question concerned the date of such a disclosure. Considering that the swaps were initially due to be settled exclusively in cash, it was necessary to determine when LVMH had changed its intention in a way that attracted the disclosure requirement.
In the AMF's view, LVMH should have disclosed the revised characteristics of the swaps at the latest on 21 June 2010, when two of the banks orally agreed to the possibility of amending the swaps to provide for settlement via the physical delivery of the underlying shares. It was held that LVMH's stakebuilding in Hermès was, at this date, sufficiently precise to trigger the duty to disclose.
Furthermore, LVMH was found to have failed to comply with its disclosure obligations concerning the swaps under Article 223-1 of the AMF General Regulation in the preparation of its financial statements for 2008 and 2009.
All in all, the AMF fined LVMH €8 million. Moreover, it was recently reported that Hermès has sued LVMH over the use of the swaps seeking an order that LVMH transfers the shares acquired back to the banks, which would then be obliged to sell them into the market. A criminal complaint has since then been lodged by Hermès for insider dealing and market manipulation. This aspect of the case is still pending.
It is to be noted that LVMH is not the only company to have been fined for having used cash-settled derivatives in the context of a ‘creeping’ acquisition of control of a listed company. On 13 December 2010, French investment company Wendel and its former CEO were fined €1.5 million each for failing to disclose Wendel's stakebuilding in CAC 40 company Saint-Gobain through undisclosed cash-settled derivatives, although the facts were not strictly identical to those of the LVMH case.
The LVMH and Wendel cases led to a significant change in October 2012 to French rules on shareholding disclosure, which now provide for the aggregation of cash-settled securities for the calculation of threshold disclosure obligations. The purpose of this reform was to hinder creeping acquisitions of control of listed companies through cash-settled derivatives.
How would the Takeovers Panel view LVMH’s actions?
We have not seen a situation where the Panel has considered circumstances such as those of the LVMH swaps.
As under French law, an equity swap that provides for physical delivery of 5% or more voting shares in an Australian company must be disclosed under Australian law. It would give the investor a relevant interest in the underlying shares and potentially give rise to an association between the taker and the giver of the swap, each of which would need to be disclosed under the substantial holding provisions.
However, the more interesting aspect of the LVHM swaps relates to the period of time before LVMH and the banks agreed to physical delivery – when the swaps were cash settled.
Under Australian law, disclosure of cash settled equity derivatives is not always required. The Panel’s policy is that, where there is a ‘control transaction’, all long positions which already exist, or which are created, must be disclosed unless they are below 5%. This includes positions held under equity derivatives.
Under the Panel’s guidance note, a ‘control transaction’ is taken to have commenced when:
- a proposal that is likely to affect control or potential control of a company is announced,
- an acquisition of a ‘substantial interest’ occurs, or
- a proposed acquisition of a ‘substantial interest’ is announced.
The Panel states in the guidance note that an equity derivative can be a ‘substantial interest’ even though the derivative only gives rise to an economic interest. It is unclear whether a cash-settled swap over less than 5% could itself be considered to be a substantial interest as a result of being part of a broader ‘creeping acquisition’, particularly if there were no other significant stakes in the company.
One aspect of the Panel’s policy that has not been tested is its application in a scenario where an investor acquires an interest of 5% or more (via a swap or when combined with a physical holding of shares), but a ‘control transaction’ has not emerged.
It is not hard to envisage a scenario in which an investor takes out a swap over 5% or more of the shares in a company:
- with a view to providing price security if it undertook a bid, but at a time when its intentions in relation to the company are not certain, or
- with a view to merely achieving a financial return from the swap and with no strategic motivations for entering into the swap.
Usually, we would expect a passive investor to not disclose the swap at the time of entering into the swap, but it would need to do so later if a control proposal or acquisition of a substantial interest was announced.
If, however, the investor is considered to be a potential bidder for the company (such as LVMH) who has been sitting on an undisclosed interest via a swap, it is likely that the target will seek to challenge the prior non-disclosure as a breach of the Panel’s policy.
The Panel’s policy is not clear on when disclosure of the swaps is required prior to the commencement of a control transaction and there are different views on this point amongst market participants.
The difficultly faced by the investor when determining whether to disclose the swap is the need to continually reassess its disclosure obligations in light of changes in its intentions and consider how the Panel would view its actions and intentions retrospectively. Investors should be mindful of how steps taken to preserve the secrecy of interests acquired via swaps may be viewed if the non-disclosure is later challenged in the Panel. Heavily engineered arrangements may lend themselves to unhelpful inferences when defending alleged breaches of disclosure obligations.
Aside from the relationship between the swap and any control transaction, parties need to be mindful of the impact of associated hedging by the counter-party on the market in the underlying securities. The Panel’s policy specifically notes the impact of hedging on control (or potential control) of the company or the efficient, competitive and informed market for control of the company’s shares.
In the case of Hermès, the combined effect of the hedging of LVMH’s swaps and the Hermès family’s existing majority position was to reduce the free float in Hermès shares to 10%. The Panel has not had an opportunity to consider a similar reduction in free float in connection with an undisclosed swap in this market, but there is the potential for the Panel to consider that the failure to disclose such a swap gives rise to unacceptable circumstances as detracting from an efficient, competitive and informed market.
Finally, the French regulator’s decision to impose a fine on LVMH and the negative publicity for LVMH in connection with the matter brings into focus the potential consequences for breaching the Panel’s policy in regard to this issue. Though the Panel does not have power to impose fines, the Panel has wide powers to order the cancellation of any swap agreements and the disposal of any underlying securities.
More generally, market participants (both potential investors and counter-parties) need to carefully consider whether there are any potential reputational consequences if the Panel finds that a swap should have been disclosed. For potential bidders, an adverse finding by the Panel or negative publicity in connection with pre-bid activity could have a significant impact on the likelihood of success of any contemplated bid.