Disclosures made by David Jones Limited concerning an unsolicited, apparently dubious, private equity merger proposal at the end of June 2012 again pose the question of whether Australia’s continuous disclosure regime properly serves the interests of the market and sets an appropriate liability balance for listed companies and directors. 

Directors are right to be closely interested in the lessons that can be learned from this situation. 

What happened?

Before the Australian Stock Exchange opened for trading on Friday 29 June 2012 David Jones surprised the market by announcing that it had received an unsolicited letter from a “non-incorporated UK entity about which no usual public information is available,” indicating an interest in making an offer for the company.  David Jones suggested that shareholders treat any related market comment cautiously.  David Jones subsequently advised the market that it had made this announcement because it had become aware that several third parties including financial market participants were likely to know that information.  David Jones subsequently advised that an entity known as EB Private Equity had previously contacted the company expressing an interest in making an offer for the firm, most recently on 28 June 2012.

At 1:50pm on 29 June 2012 David Jones made a further announcement advising that the approach had been made by EB Private Equity and that the proposal was $1.65 million for a 100% acquisition based on $850 million of equity, $450 million of bank debt and $450 million in residual equity for existing shareholders.  The second announcement again stressed that the details available to David Jones in relation to the proposal were limited.  David Jones subsequently advised that it had made the further announcement as it had become aware that details of the proposal had been posted to a UK blog site and that international media outlets had details of the proposal.

On 29 June 2012 David Jones share price increased by almost 15%. 

On Monday, 2 July 2012 David Jones placed itself in trading halt and subsequently advised the market that EB Private Equity had advised David Jones that it had decided to withdraw its proposal as “recent publicity around this proposal has made it difficult to proceed”. 

The David Jones share price subsequently declined to its pre-announcement level. 

Regulatory enquiries continue in relation to the circumstances that existed in this period.  It seems fairly clear that the events resulted in confused market trading.  Nothing in this note should be interpreted to suggest that any person has breached any regulatory requirement.

The Australian regime

Australia boasts some of the toughest continuous disclosure requirements of any jurisdiction in the world.  Under the Australian Stock Exchange listing requirements, listed entities have an immediate obligation to disclosure all information that a reasonable investor would require in assessing the price or value of securities.  That, of course, is similar to the stock exchange rules of many markets.  There is a specific exemption from the disclosure requirement to the extent that a reasonable investor would not expect disclosure if the material is confidential and, among other things, the circumstances relate to an incomplete proposal.  ASX can also require disclosure if it forms the view that a false market exists. 

What sets Australia apart from many jurisdictions is that the disclosure requirement is linked to a comprehensive enforcement pyramid in the Corporations Act.  Violation of the continuous disclosure regime potentially imposes criminal liability consequences, civil penalty consequences, civil liability consequences including class actions and the power for ASIC to levy a fine of up to $100,000 per violation.  Directors and others involved in the contravention may also face accessory liability subject to the availability of a due diligence defence based on reasonable grounds for believing it was in  compliance.

Enforcement of continuous disclosure violations through class actions has been a rapidly growing feature of Australian law in recent years – voluntary settlements of class actions in Australia now exceed $700 million, most of those relating to alleged continuous disclosure violations. 

In addition, ASIC has become an enthusiastic supporter of the fining power with 19 fines now levied against companies, including a landmark $300,000 fine levied against Leighton Holdings Limited in 2012 for alleged delays in disclosing earnings downgrades.

Shifting Sands

It is clear that potential liability under the enforcement pyramid is having a significant impact upon the attitude of listed entities and their directors in Australia, as illustrated by the events surrounding the David Jones disclosures.  The regulatory enforcement record suggests that listed entities have little latitude to delay an immediate disclosure obligation when a confidential and incomplete control transaction begins to leak to the public domain. 

One of the particular challenges of the Australian continuous disclosure regime is the requirement to “immediately” disclose information.  This requirement is also linked to a definition of when a listed company becomes ”aware” of relevant information for the purposes of disclosure based on the state of knowledge of any director or executive director that they have or ought reasonably have come into possession of.  That feature of the regime can place significant pressures upon normal corporate governance structures in a listed company.

Good illustrations of the shifting regulatory emphasis in the area of the disclosure of merger negotiations are the fines levied against Promina in 2007 and Rio Tinto in 2008.  It should be remembered that acceptance of a fine is not acceptance of liability.  One of the significant issues with the fining remedy is that it does not represent a finding of fact or law and frequently the circumstances surrounding the acceptance of the fine will be opaque.

In the Promina situation Promina Group agreed in March 2007 to pay a $100,000 fine for failing to disclose a merger approach from Suncorp-Metway in October 2006.  Promina had been approached by Suncorp-Metway with a cash and scrip merger proposal by target company scheme of arrangement at 6pm on 10 October 2006.  On the morning of 11 October a number of newswires ran stories speculating that a control transaction may occur and at noon Dow Jones ran a newswire article that Suncorp-Metway was looking to buy Promina at $7.50 per share “according to talk circulating amongst hedge funds”.  Disclosure of the approach was not made until 8:30am the next morning when morning newspapers also reported the rumours.  The period of alleged failure to disclose was less than 24 hours and covered only 4 hours of trading on ASX.  Promina had not at that time made a formal decision to proceed with merger negotiations.

In the Rio Tinto situation Rio Tinto agreed in June 2008 to pay a $100,000 fine for failing to disclose a merger approach it had made to Alcan in July 2007.  In 2007 Alcan was defending an unsolicited tender offer and it was well known that Alcan was looking for alternative offers.  At 2:30pm on 12 July 2007 Dow Jones ran a newswire article reporting that Rio Tinto was “in the closing stages” of the purchase of Alcan at a price approaching $100 per share “according to people familiar with the transaction”. Two similar newswire articles were run by Dow Jones and Reuters shortly after.  On 10 July 2007 Rio Tinto had sent a letter of offer to Alcan of $101 per share and at 8am on 12 July 2007 Alcan had notified Rio Tinto it was the preferred bidder, subject to the negotiation of final agreements.  In response to an ASX inquiry at 3pm Rio Tinto requested a trading halt at 3:40pm.  An announcement of the making of the proposal was made by Rio Tinto at 4pm.  The period of alleged failure to disclose (until the trading halt) was less than 75 minutes.

There was no strong evidence of the share price moving as a result of the newswire releases in these situations (indeed the Promina share price was falling from an intra day trading high after the release of the Dow Jones newswire article, admittedly from a price higher than the prior day’s closing price) and, in the case of Rio Tinto, it’s likely interest in Alcan was reasonably well known.

Market integrity

A real question must be asked as to whether hair trigger disclosure of this nature is always in the interests of the market. 

The relevant ASX guidance note on continuous disclosure (Guidance Note 8) itself acknowledges that it is critical to strike a balance between encouraging timely disclosure of material information and  preventing premature disclosure of incomplete or indefinite matters and recognises that premature disclosure can prejudice an entity’s commercial interests (at paragraph 13).  Unfortunately vigorous enforcement of immediate continuous disclosure obligations as illustrated in the circumstances described above encourages a disclose first / think later attitude by listed entities to market disclosure.

In the David Jones situation David Jones itself noted that in making the announcements it was concerned not to give more credibility to the approach than was necessary pending receipt of more details from EB Private Equity.  With the benefit of hindsight it is clear that market integrity was not advanced by rushed disclosure of an approach that would seem to have little substance.  Market integrity would be better served if a listed entity was allowed sufficient flexibility to assess the veracity of information it is receiving. 

As noted above, in the Promina and Rio Tinto situations it can be argued that if the company were monitoring the share price it might not be entirely clear whether or not the share price was being impacted by the undisclosed information.  Clearly there is a policy basis to argue that disclosure must be made where the share price is being affected by trading based on non-public information.  In the absence of those circumstances the policy imperative is less clear.

Australia also has some of the strictest insider trading laws in the world and, in particular, the insider trading prohibitions are triggered by the mere existence of material price sensitive information without any requirement that the insider have some relationship to the disclosing entity or that the trading occur on the basis of the information.

In the merger context it is inevitable that many persons will know of an incomplete and confidential proposal before it is consummated.  Some of these persons may be loose lipped.  Others may have strategic reasons why they might prematurely leak details.  From a policy perspective it is perverse that the listed entity and its officers (and indirectly its shareholders) potentially suffer in the circumstances of a leak rather than a person seeking to obtain a possible advantage from the leak.  The first David Jones disclosure was said to have been triggered by the knowledge that several third parties had access to the information.  Is that kind of leak really a loss of confidentiality that should trigger immediate disclosure obligations in the absence of a price movement?

Stock markets trade on information.  However, stock markets are also driven by speculation, rumours and herd behaviour.  The Promina newswire was attributed to hedge fund talk.  It would seem that the critical feature of that newswire report that drove a disclosure obligation beyond other newswire speculation of a merger on that day was a price reference – even though that price was not correct.  Similarly the Rio Tinto price speculation was not entirely correct.  However in both cases ASIC commented that it considered the reports to be “reasonably specific”.  To the extent there is incorrect rumour and that rumour is not sourced to the listed entity, in circumstances where an incomplete merger transaction is being negotiated behind closed doors, it again seems harsh to reward inaccurate speculation with a requirement that the listed entity comment on that speculation.

The Role of Trading Halts

The David Jones facts also illustrate the necessary interaction between the obligation of immediate disclosure and the use of trading halts pending further enquiry by a company. 

The continuous disclosure requirements themselves do not recognise a trading halt as a means of managing a situation where a listed entity is assessing a developing situation.  As noted above an immediate disclosure obligation can cause normal governance processes and board review mechanisms to be overridden.  Listed entities should be encouraged to adopt prudent governance structures and to seek and obtain appropriate professional advice when making important announcements that affect market integrity.  For that reason it would be appropriate to recognise a clear safe harbour from liability when trading has been halted in order to expeditiously satisfy disclosure obligations.

True it is that a loss of liquidity through a trading halt may not be in the interests of investors.  However if that choice has to be made where a company has a good reason to manage a legal risk for liability for an immediate disclosure obligation that may be material surely the interests of the listed entity should be respected.

A further difficulty with the current ASX trading halt mechanism is that it is only available from a maximum 2 business day period, where in many circumstances issues may take longer than that to resolve.  The alternative to a suspension from trading is rarely palatable because of potential event of default consequences under financing facilities for many companies.

There is a good case for reconsidering the current trading halt mechanism to allow a company a period longer than 2 business days to assess and respond to a continuous disclosure issue, if required.

Where to?

For all these reasons it is appropriate that there be a debate over the appropriateness of the hair trigger requirements of Australia’s continuous disclosure rules and the protections afforded to listed entities and boards that act in a responsible manner dealing with a developing disclosure issue. 

With further uncertainty caused by the pending High Court decision in Fortescue Resources and the subsequently proposed release of a proposed new ASX Guidance Note on continuous disclosure the debate is not going to be resolved any time soon.