In recent weeks, two significant developments of relevance to Australian equity capital markets have taken place.
On 12 April 2011, ASIC commenced a consultation process to finalise its policy concerning 'clear, concise and effective' prospectus disclosure and has published a draft regulatory guide which contemplates a number of changes to current market practice.
In March 2011, Origin Energy Limited's (Origin) capital raising utilised for the first time a new form of accelerated renounceable entitlement offer structure, which potentially overcomes some of the perceived disadvantages previously suffered by retail shareholders.
ASIC's proposed changes to prospectus disclosure
ASIC's draft regulatory guide, which is open for public comment until 7 June 2011, provides guidance about how to word and present prospectuses and other documents in a 'clear, concise and effective' manner and also about how to prepare prospectuses that satisfy the content requirement of section 710 of the Corporations Act 2001 (Cth) (Act). ASIC aims to publish the final guide in December this year.
Even though ASIC states that none of its recommendations are prescriptive, it expressly states its goal is to change market practice and we believe this is likely to happen since ASIC has the power under the Act to issue stop orders for prospectuses that it considers are misleading and deceptive or are not 'clear, concise and effective' (section 739 of the Act). The guidance will also be relevant to other documents provided to shareholders, such as transaction-specific prospectuses, bidder's and target's statements, scheme booklets and notices of shareholder meetings.
We suggest that issuers and underwriters need to have regard to ASIC's recommendations now even though the regulatory guide will not be settled until after public consultation has ended.
ASIC's recommendations aim to overcome a number of shortcomings that ASIC considers are preventing prospectuses from assisting retail investors to make informed investment decisions:
- prospectuses have become too long, jargon-heavy, repetitive and confusing for retail investors;
- front sections do not contain key information about the offer because they are dominated by photographs and marketing statements;
- risks disclosure is too generalised and in the front sections isn't balanced with the attention given to the benefits of the offer; and
- inadequate explanation of the business model of the issuer is provided.
'Clear, concise and effective'
ASIC's draft regulatory guide provides a much needed steer for issuers about what ASIC considers is necessary for a prospectus to be 'clear, concise and effective'. It is proposed that a prospectus will generally be found to satisfy these requirements if it highlights key information, uses plain language, is as short as possible, explains complex information (including any technical terms), is logically ordered and easy to navigate.
Summary of key recommendations
- Introduction of an 'Investment Overview' in the front section
ASIC proposes that the first substantive section of the prospectus be an investment overview which sets out all key information about the offer and provides balanced disclosure of the benefits and risks of the offer.
This would replace the current approach of including upfront investment highlights, summaries of the offer and frequently asked questions. ASIC suggests that the overview would usually need to include information about the business model of the issuer, all of the key risks, key financial ratios and other financial information, the experience of the board and management (for IPOs), the interests of those involved in the offer and related party transactions, and the key terms of the offer and use of offer proceeds. It is suggested the overview should take the form of a table with cross references to parts of the prospectus containing more information. It should not summarise the whole prospectus.
- Putting the brakes on marketing
The Investment Overview is intended to promote balanced disclosure in the front part of the prospectus, which currently is usually the "marketing section". ASIC also wants all front sections to be balanced in disclosing benefits and risks, including the Chairman's letter. ASIC considers that photographs upfront are "problematic" and makes a number of recommendations about their use (including that they be excluded until after the Investment Overview).
- More incorporation by reference
ASIC encourages greater use of section 712 of the Act to incorporate by reference into the prospectus any documents lodged with ASIC that are not key to a retail investor's assessment of the offer (e.g. contracts, trust deeds and detailed corporate governance policies). Traditionally, this right has been infrequently used because the section requires the issuer to determine whether the lodged document is primarily of interest to investment analysts or retail investors, with different disclosure requirements depending on the answer.
Helpfully, ASIC has also urged issuers to avoid lengthy summaries of terms from documents like underwriting agreements and constitutions when they are market standard.
- More substantive disclosure
In some respects, ASIC's recommendations may have the effect of imposing more onerous disclosure obligations on issuers, for example: recommended inclusion of the gearing, interest cover and working capital ratios, a summary of the past 3 years' audited accounts (in addition to any pro forma financial information), a subjective analysis of the issuer's business model (including its strategy and future plans) and summaries of all contracts that are critical to the issuer's ability to make money or which contain significant obligations or restrictions. There is increased focus on disclosure of all related party arrangements (and whether they have received shareholder approval). To assist retail investors, all key financial terms used should be adequately defined and explained.
- Better risk disclosure
Rather than setting out a long list of risks, the issuer will need to evaluate their materiality and explain the implications of the risk being realised. There is more pressure to evaluate the "key risks".
The fairest of them all? Features of the new "PAITREO" entitlement offer structure
Origin adopted the PAITREO (Pro-rata Accelerated Institutional, Tradeable Retail Entitlement Offer) structure in its $2.3 billion capital raising in March 2011. The PAITREO represents another attempt to refine the accelerated renounceable entitlement offer structure (AREO) to mitigate concerns about disadvantages posed by dual bookbuilds on retail shareholders.
Features of the PAITREO
The PAITREO retains the key features of an AREO, including a dual bookbuild, but is unique in that it allows trading of retail entitlements on the ASX (or by way of an off-market transfer) following completion of the institutional bookbuild.
Having 'Tradeable Retail Entitlements' means that, for the first time in an accelerated entitlement offer, eligible retail shareholders have the opportunity to get liquidity for their entitlements up-front. Entitlements not taken up by retail shareholders are sold through a back-end bookbuild process, in which only institutional investors may participate.
Institutional entitlements are not tradeable. Accordingly, under a PAITREO, the only return which renouncing eligible institutional shareholders may receive for their entitlements is through a premium generated in the institutional bookbuild at the front end of the offer.
Why would you consider a PAITREO?
In an AREO, heavy institutional selling of shares which typically occurs after the institutional bookbuild means that retail holders typically receive much less than institutional investors for their renunciations. The PAITREO innovation of allowing retail investors to trade their entitlements is seen as being fairer. This is because the structure is likely to reduce the price differential between the premia realised by renouncing retail and institutional shareholders since it enables trading of retail entitlements immediately after the institutional offer and prior to the opening (and close) of the retail offer. This results in a smaller retail bookbuild, and minimises the effect the prevailing share price has on renouncing retail holders.
Although the single bookbuild used in the SAREO structure was also aimed at reducing this price differential, the PAITREO will not face the same resistance from institutional investors unwilling to risk waiting approximately 4 weeks to find out the price they will receive for their entitlements.
Both ASIC and ASX provided novel regulatory relief to facilitate the PAITREO structure. This regulatory support is necessary to conduct a PAITREO offer. Based on the success of Origin's offer to date, we would expect future raisings adopting a PAITREO structure to be accommodated by ASIC and ASX. From a legal documentation perspective, there are very few other differences between an AREO and a PAITREO.
Is the PAITREO viable for future entitlement offers?
The PAITREO was suitable to Origin, given its high proportion of retail shareholders. However, it has been suggested that the PAITREO may result in a higher discount to the Theoretical Ex-Rights Price (TERP) imputed in the offer price (so as to create a viable market for entitlements trading). It is possibly for this reason that Leighton Holdings Limited chose not to adopt a PAITREO structure for its $757 million renounceable entitlement offer announced on 11 April 2011. As a result of the downward impact of its announcement of substantial write-downs, the discount to TERP implied by the offer price may have been too small to make the PAITREO offer workable.