On 30 March 2011, the Australian Securities and Investments Commission issued updated Regulatory Guides on Related party transactions (RG 76), Content of expert reports (RG 111) and Independence of Experts (RG 112). In our December 2010 Acumen we reported on the Consultation Papers and draft Regulatory Guides previously issued by ASIC on these topics.
ASIC has modified some of the proposals about which we expressed some concern in our previous update, in particular in relation to the "arm's length" exception and the relevance of the bargaining process and the availability of comparable transactions. ASIC has stated in revised RG 76 that if the parties have dealt at arm's length it is more likely that the outcome can be considered to be arm's length terms, while recognising this is not strictly necessary. Similarly, in relation to comparable transactions, ASIC states that an absence of comparable transactions may mean that other factors become more important in deciding if the exception applies in contrast to the statement in the Consultation Paper that such an absence "raises the issue of how directors can conclude that the transaction is on arm's length terms".
ASIC's guidance in relation to whether member approval is required is now headed by "certainty" instead of "doubt" and states that directors should only rely on the exception where they are persuaded that it applies - in contrast to being arguable - but then says member approval should be obtained unless it is "clear" that the transaction falls within the exception. This still implies a demanding threshold for directors to satisfy.
ASIC has not withdrawn from its position in the Consultation Paper that all related party transactions should be disclosed in prospectuses and other disclosure documents, regardless of materiality. This position is expressed to be on the basis that information about related party transactions is material information, whether or not the transaction itself is material to the issuer, because it might "be indicative of certain aspects of an entity's business model, its attitude to related party transactions and how they are managed". That is true in some cases, if, for example, the related party transactions have actual or potential economic significance to the issuer, but cannot be true if they are not significant - after all - if the transactions cannot have a material economic effect on the issuer they should not enter into the calculus of an investment decision by a rational investor. If the rationale is that all related party transaction to date should be disclosed regardless of materiality because they might indicate some likelihood of future related party transactions, neither is this compelling as matter of investment analysis. In the United States, the test of materiality in the securities law context is whether the omitted fact would change the overall mix of information about the issuer. It is hard to see how information about immaterial transactions would satisfy that test of materiality, and ASIC (and the Courts) should be cautious about setting the materiality benchmark in Australia too low.
Revised RG 111 is broadly in line with the draft Regulatory Guide issued along with Consultation Paper 143. ASIC has maintained its overall approach to the "fair and reasonable" test for expert's reports, with some refinements. The "fairness" limb essentially relates to value, while "reasonableness" takes in a broader range of factors, and a transaction can be "not fair" but reasonable."
One key change (although said by ASIC to be minor) is that ASIC has moved away from a requirement in the Consultation Paper that an expert value "reasonableness factors" (ie the factors that might make an offer "reasonable" even if it is not fair) now requiring only that such factors are "quantified" to the extent reasonably practicable and where the expert can do so with sufficient precision to assist security holders.
ASIC has maintained the view that "fairness" should be determined without reference to the "financial distress" of a target - this might go to "reasonableness - but, in line with the Takeovers Panel decision in Target Energy, says that funding requirements for a target not in financial distress should be taken into account in determining fair value. ASIC's view about generally ignoring the financial position of the target when determining fair value seems little theoretical, because if the target's financial position is known (which it ought to be through continuous disclosure), willing but not anxious bidders (provided they are rational) will all take that into account in setting an arm's length price. But if such factors can be taken into account by way of "reasonableness" then the approach should be workable in practice.
ASIC has also decided not to pursue a requirement that an expert values the advantages and disadvantages of a demerger, but - in line with "reasonableness factors" above - requires them to be quantified to the extent reasonably practicable and where the expert can do so with sufficient precision to assist security holders.
ASIC has amended a critical paragraph of RG 111 in relation to the extent to which experts can rely on the information given to it, to ensure that an expert must satisfy itself that it is reasonable to rely on the information on which the report is based (absent exceptional circumstances).
In relation to the discounted cash flow (DCF) valuation methodology, ASIC will not now require that DCF is only used for projects that are generating cash flow, but if DCF is used for early stage projects the expert with be put to the test as to whether the forecast financial information used in the DCF is based on reasonable grounds, consistent with ASIC's RG 170 stance on forecast financial information.
Importantly for energy and resources companies, RG 111 will now require an expert's report to comply with any normally applicable standards and guidelines for valuing a particular class of assets, using the Valmin Code for mineral and hydrocarbon assets as the example.
Finally, ASIC has adopted its proposal in relation to requiring experts to carefully document their work and maintain detailed working papers, among other things, making ASIC surveillance and review an easier task.
In line with the Consultation Paper and draft Regulatory Guide, RG 112 now contains a section on commissioning an expert. The commissioning party will need to be satisfied that the expert is independent and has adequate resources and expertise to undertake the engagement. Further, ASIC says that it may be appropriate to have the engagement overseen by a non-executive director if management might be conflicted.
Also in line with the Consultation Paper and draft Regulatory Guide, ASIC has made it clear that, in ASIC's view, an expert's conclusion should not be released in advance of, and in isolation from, the report with its explanation of methodologies and material assumptions.
Download RG 76
Download RG 111
Download RG 112
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