ASIC releases paper on collective action by institutional investors

In brief

ASIC has released its consultation paper on collective shareholder actions, which calls for feedback on a draft update to Regulatory Guide 128. The consultation paper illustrates ASIC's current (albeit preliminary) views on the tension between fostering increased investor engagement, on the one hand, and maintaining the integrity of the takeover and substantial holdings provisions in Chapter 6 of the Corporations Act, on the other. The draft updated RG 128 provides a timely reminder that both investors and relevant entities active in this context (such as companies and funds) need to be particularly conscious of the limitations placed on investor engagement by Chapter 6. Partner Tim Lester and Senior Associate Alex Purtill report.

Background

Since RG 128 was issued in 1998 there have been significant developments in corporate governance thinking around the world. Leading advocates of corporate governance now recommend increased and broader engagement by entities with their stakeholders to enhance the long-term performance of the entity and as a means to avoid the costs of expensive and distracting shareholder activism and increased regulatory scrutiny. However, there is a balance that needs to be struck between embarking on broader engagement and ensuring that investors who participate in such engagement do so in a manner which complies with the takeover and substantial holding provisions in Chapter 6 of the Corporations Act.

Chapter 6 of the Corporations Act places limits on, and requires certain disclosures from, investors holding a 'relevant interest' in an entity, in order to promote the orderly passage of a change in control of an entity so that the market is fully informed and all investors treated equally throughout the process. For purposes of determining the 'relevant interest', investors concerned about common issues may be regarded as 'associates' or as having entered into a 'relevant agreement' (for simplicity, in this article we refer to these concepts as the collective action triggers) and the aggregate voting power of such group of investors is attributed to each investor in the group as its relevant interest. Depending on the size of the relevant interest attributed to them, investors may be required to lodge substantial holding notices, may be prohibited from acquiring additional interests in the entity, or may even breach the takeover provisions.

The consultation paper recognises the tension between good corporate governance and the takeover and substantial holding provisions of the Corporations Act, and provides guidance on ASIC's views as to what types of behaviours investors undertake in the name of corporate governance that may attract enforcement action by ASIC under the Corporations Act. The consultation paper uses the phrase 'collective action' to describe the full range of behaviours covered by an investor's interaction with other investors. The draft updated RG 128 then provides illustrative examples of such collective action and indicates which are more likely, and which less likely, to enliven the collective action triggers.

What has changed?

More examples of collective action

The draft updated RG 128 undertakes a broad review of the takeover and substantial holding provisions of the Corporations Act, and this review frames the consideration of collective action throughout the draft updated RG 128. As in the current RG 128, the draft updated RG 128 discloses ASIC's views on where the line between acceptable and unacceptable circumstances should be drawn by providing examples of collective action that fall on either side. In addition to the illustrative examples in the current RG 128 (which are treated consistently in the draft updated RG 128), new examples of collective actions that are less likely to enliven the collective action triggers are addressed. These are examples that involve:

• discussing possible matters to be raised with the relevant entity's board; and
• making representations to the relevant entity's board about the entity's policies, practices or particular actions that the entity might consider taking.

Conversely, the following examples of collective actions that are more likely to enliven the collective action triggers are provided in the draft updated RG 128:

• jointly signing a s249D notice or s249N notice relating to the composition of the board or the relevant entity's affairs; and
• investors formulating joint proposals relating to the composition of the board or a particular strategic issue.

These additional examples of collective action signal ASIC's increased focus on circumstances where shareholder activists working together to nominate directors or cause the relevant entity to undertake strategic transactions may enliven the collective action triggers and hence may need to lodge substantial holding notices and, possibly, comply with other provisions of Chapter 6.

Better guidance on which activities ASIC will examine

This theme is also evident in the extension of the types of potential collective action that ASIC indicates will receive closer scrutiny. The narrow, control-purpose test that is set out in the current RG 128 is replaced with a broader test that appears to be directed at practices commonly adopted by activist shareholders, including conduct that evidences a history or pattern of consistent actions between investors.

In the draft updated RG 128, ASIC goes out of its way to point out that it will not examine collective action aimed at good corporate governance only, effectively endorsing the following corporate governance principles:

• better disclosure to the market;
• more comprehensive board evaluation processes;
• more sophisticated risk management systems;
• improved sustainability or corporate social responsibility reporting; and
• changes to executive remuneration structures.

This focus on the exercise of good corporate governance by entities faced with proxy solicitation contests is evident in the recommendations that the draft updated RG 128 makes for investors and for relevant entities to consider when engaging with investors.

What other matters investors should consider when engaging with other investors?

The current RG 128 reminds investors that the mere existence of a voting agreement is likely to be price-sensitive information and may need to be disclosed before any person with knowledge of that voting agreement trades securities. The draft updated RG 128 reiterates that guidance, and encourages investors to also consider whether they are acting as shadow directors (with liability for the full scope of directors' duties) through the exercise of influence over the management of the relevant entity, and to ensure that any public statements are not misleading or deceptive.

What other matters relevant entities should consider when engaging with investors?

The draft updated RG 128 also provides some additional guidance to relevant entities when engaging with investors. Relevant entities are encouraged to consider, in this context:

• the duty to act in the best interests of the entity as a whole, and not to favour the interests of any particular investors;·
• the duty to act for a proper purpose, in particular, to expend entity funds in the interests of the entity only and not to advance personal interests (such as retaining their position as director);
• the treatment of confidential information disclosed through selective engagement of investors; and
• any potentially misleading or deceptive interpretation of public statements made in response to investor communications.

What happens next?

ASIC has called for submissions in response to the consultation paper by 20 April 2015. In particular, ASIC is seeking quantitative information regarding the compliance costs, effect on competition and any other benefits of the draft updated RG 128.