Consultation Paper 155: ASIC'S proposed new guidance on prospectuses

Articles Written by John Keeves (Partner)

Introduction

On 12 April ASIC issued a Consultation Paper and draft Regulatory Guide concerning new proposals to give guidance on the 'clear, concise and effective' requirement for prospectuses, as well as on satisfying the prospectus content requirement.

Application

ASIC's guidance is intended to apply to a broad variety of disclosure documents, including a bidder statement for a scrip bid or a scheme booklet for a scheme with scrip consideration. Interestingly, ASIC also suggests that part of the draft Regulatory Guide relating to 'clear, concise and effective' should be applied to offer documents for 'low-doc' rights issues, despite the lack of clear legislative mandate for this. Moreover, ASIC is asking whether a 'loc-doc' offer document needs to have an 'investment overview' section, which may mean treating an offer document as if it was a prospectus - which it clearly isn't.

In this Update, we comment on a selection of ASIC's proposals.

Guidance on 'clear, concise and effective'

ASIC endeavours to provide guidance on the 'clear, concise and effective' requirement. For example, a prospectus should:

  • highlight key information - for example, use an investment overview as the first substantive section of the prospectus
  • use plain language - and avoid jargon
  • be as short as possible
  • explain complex information and technical terms
  • be logically structured and easy to navigate, with good sign posts within the document
  • balance disclosure of benefits and risks
  • avoid repetition
  • minimise use of definitions
  • use tables, diagrams and charts
  • use examples and case studies
  • omit extraneous or irrelevant information
  • comply with industry guidelines, such as the JORC Code and the Valmin Code.

Photographs should be used only after the investment overview, so as not to distract investors from key information.

Incorporation by reference

ASIC is trying to encourage shorter prospectuses, by in turn encouraging the use of the "incorporation by reference" provisions in section 712 of the Corporations Act. ASIC proposes a 'surprise' rule - in order to incorporate by reference, you must provide sufficient information so that an investor would not be taken by surprise, that a 'fair indication' of the document's character be given, along with highlighting any significant negative information. Unfortunately, the use of a 'surprise rule" may be subject to the 'hindsight bias' problem, because the level of surprise may well be measured with the benefit of hindsight, and the way event transpired, rather than merely what information was available to the issuer at the time.

To date, the incorporation by reference rules have been relied on quite rarely in practice, and we doubt ASIC's guidance, although well intentioned, will fundamentally change this. In our view law reform is required, so that, for example, specified categories of documents can be incorporated by reference without a summary, or there is some form of 'safe harbour' for incorporation by reference undertaken in good faith.

Investment Overview

ASIC's investment overview requirement is that there be an upfront 'meaningful' summary of key information, which provides a balanced disclosure of benefits and risks. The concern seems to be that the 'front section' of a prospectus tends to emphasise the positives and not deal with risks in the same way.

Business Model

ASIC expects a prospectus to explain the issuer's business model. To some extent, this may be stating the obvious, but perhaps some of the implications could be significant. For example, ASIC will expect 'significant dependencies' to be explained, and says section 710 - the central prospectus disclosure requirement - may require the disclosure of confidential information. Commercially confidential information would not usually be disclosed in a prospectus because investors would not typically expect such disclosure, in reliance on the qualifications to this effect in section 710(1)(a). However, it has to be acknowledged that withholding critical information on this basis could be problematic.

Finance

ASIC expects significant information in relation to financing, including details of covenant breaches during the previous two years, and comments on the prospects of refinancing or if there are no reasonable grounds for comment on those prospects, a statement to that effect. In the debt-finance environment since the GFC, comments on prospects of refinancing (or alternatives) are potentially fraught with danger, and this requirement may turn out to cause difficult problems in practice.

Contracts

With disclosure in relation to contracts, ASIC has similar requirements for disclosure around prospects of renewal, as for refinancing, with the attendant issues noted above.

Risk disclosure

ASIC's guidance on risk disclosure is extensive and fairly prescriptive.

One noteworthy point is that ASIC considers that even remote risks that might have a significant impact need to be disclosed, and that issues need to prioritise risks by their importance and order their disclosure accordingly. This could be another example where 'hindsight bias' comes into play, and the fact that a risk comes to pass might suggest to some that insufficient prominence was given to it. For example, it now seems pretty obvious that consideration should be given to refinancing risk, but this may not have been quite so evident pre-GFC.

Management

ASIC will expect explicit statements concerning director independence - either the director is free of relationships that might be expected to interfere with independent exercise of judgment, or notwithstanding such relationships, why the board considers the director to be independent. Relevant criminal convictions for directors or key management less than 10 years old need to be disclosed, and details where they have been involved with insolvent companies.

ASIC is mandating 'if not, why not' disclosure in relation to reporting against applicable corporate governance framework. This appears consistent with Condition 13 in ASX Listing Rule 1.1 requiring such statement as a condition of admission.

Allocations

ASIC will require disclosure of allocation policies in the event of oversubscription and details of allocation to underwriters, directors and officers and "friends and family".

Underwriting Agreements

Market practice has always been for an underwriting agreement to be summarised in a prospectus. ASIC is not seeking to change this practice, but interestingly will only require disclosure of 'significant' termination rights, and elsewhere suggests 'standard termination clauses' need not be copied out. Underwriting termination events are always potentially significant, although they might well be customary. However, it may not be reasonable to assume that the customs would be understood by a retail investor, so we query whether leaving out termination provisions is prudent, or whether reliance on an omitted termination event - even if it is standard - would cause 'surprise', along the lines of ASIC's proposed 'surprise' rule for incorporation by reference noted above.

Conclusion

Overall, ASIC's prospectus guidance on prospectuses is to be welcomed. The more issuers and advisers can understand ASIC's approach to reviewing prospectuses, the better, and this guidance has been a long time coming. On the other hand, the guidance is fairly prescriptive and tends to undercut the policy objectives underlying previous prospectus disclosure reform to have a "fuzzy" rather prescriptive test.

Whether ASIC's guidance will lead to simpler, better, and more comprehensible prospectuses is another matter, given a liability regime that will punish issuers and their officers for accidentally omitting something later regarded as significant. In our experience, retail investors read only part of disclosure documents, and tend to understand even less. Part of the purpose of producing and verifying a disclosure document is not necessarily to inform retail investors as such, but to ensure information is available to the market place, to promote transparency and market efficiency.

Moreover, retail investors should be encouraged to rely on appropriately expert financial advisers who are able to comprehend disclosure documents. Trying to meet the twin objectives of full disclosure of all material information and simple disclosure that can be understood by retail investors (without investment expertise) may simply not be possible. Investment decisions are inherently complex.

Submissions are due by 7 June, with a Regulatory Guide expected to be issued in December 2011. However, issuers should have regard to ASIC's proposed guidance now when preparing prospectuses.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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