Dorchester report an interesting read for securities cops

By Shoeshine

Friday 1st October 2004

A significant part of the securities law industry seems to have got its knickers in a tangle over the question of associates and lock-ups.

From the panel's point of view the most damaging allegation is that it has "changed its mind," a claim that makes it look like it capriciously thrusts a spanner into deals built on what lawyers thought was the bedrock of precedence.

The panel's defence is that there is no precedence.

The code's basic principle is clear and simple. You can't go over 20% of a code company without making a bid for all the company's shares at the same price you paid to get over 20%.

"You" here includes two parties who are associated under the code's rules.

The problem is with "lock-ups" an agreement to buy and sell at some future point and what people who become associated through a lock-up agreement can and can't do.

The code has never had an argument with lock-ups in themselves. But, as paragraph 112 of the Dorchester decision says, they must have four essential features to be code-compliant.

There must be a commitment to make a code-compliant offer; a commitment to accept the offer when it is made; a relatively short time frame; and no shares must actually change hands until the code offer is made.

Looking across the Tasman, by the way, doesn't help here.

Our code may look on the surface similar to Australia's but this is an area of fundamental difference.

Australia leans heavily toward the auction principle for changes in the control of code companies, and doesn't allow lock-ups at all.

Australian critics have argued that places an unnecessary restriction on the way the holders of major stakes could dispose of their shares. The writers of our code agreed.

Lock- ups are therefore allowed here, subject to the four criteria above being met.

Another red herring is that the panel has changed its attitude to associates.

This is the line Prime Infrastructure seems to want to pursue when it says it dumped the Powerco shares the panel required it to sell for expediency's sake, but didn't accept it was associated with the council sellers.

This is missing the point.

In both the Dorchester and Powerco cases, the code was breached when the parties on the "buy" side of the lock-up bought shares, either on-market or privately, before a code offer had been launched.

In Dorchester's case, there were two other code-breaching factors.

There was never a commitment by Bridgecorp to make a code- compliant offer.

And the lock-up agreement stretched out ten-and-a-half months.

In fact, the panel has argued, because there was an accompanying agreement to actually buy and sell shares, the 5.05% "lock-up" wasn't a lock-up at all.

Reading the panel's investigation it's hard to form an opinion on whether Dorchester managing director Brent King and Bridgecorp thought they could circumvent the code, whether they had bad advice, or whether they refused to take good advice.

Certainly they were aware there were code issues.

"We've discussed the possibility of trying to bring Baker and Green into the transaction somehow, but our view is that such an arrangement is almost certain to trigger the Takeovers Code," one email reads.

But they appear to have thought that just calling something a "lock-up" would get them past the takeover cops.

That would be amazingly optimistic.

King got $4.04 for the first 15% of his shares, and Bridgecorp paid the same to other shareholders to get it to 19.99%. The "lock-up" was supposed to get Bridgecorp to 25.04% by agreeing, some time before June 30, 2005, to buy a further 5.05% King held.

But the lowest price Bridgecorp was to pay in any code offer it made was $3.30.

King was paid $600,000 for the "option" to sell 5.05%. The panel found that effectively topped up his payment for his entire previous 20.14% holding to $4.40.

In short, a takeover bid by Bridgecorp could have seen the largest shareholders exit with $4.40 a share, and everyone else with $3.30.

You don't have to be a legal genius to see that is precisely the sort of outcome the code was designed to abolish.

All this is a long-winded way of coming to a simple conclusion; by all means do lock-ups, but bear in mind that the lock-up creates an association between the parties. In no circumstances can they then buy shares if that will take their joint holding beyond, or further beyond, 20%.

There are important further implications of this for people who find themselves associated for whatever reason.

Two holders of stakes of 15% each might, for example, decide they don't like a board of directors, and agree to vote to sack them.

Even though no control over shares has actually changed hands, their association in effect means each is deemed to hold 30%.

So for as long as their agreement exists they can't buy a single extra shares without making a bid for the whole company.

Shoeshine suspects this means in future such agreements will be made in the back of a bar with no written records.

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