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29 March 2000
Areas Targeted by CLERP Reforms
'Plain English' Rewrite and Policy Reforms
Purpose of the Changes
When is a Disclosure Document Required?
Types of Disclosure Documents
When is a Disclosure Document not Required?
Liability for Fundraising Activities
The Corporate Law Economic Reform Program Act 1999 (CLERP Act), which commenced operation on March 13 2000 comprehensively rewrites and reforms Australia's Corporations Law in the following key areas:
This article covers the fundraising rewrite and reforms. An earlier article covered the takeover reforms (see Government Overhauls Takeover Law) and briefly commented on the background to, and policies behind, the CLERP Act. A further article to be published shortly will cover reforms in the areas of directors' duties, corporate governance and accounting standards.
The CLERP Act involves a complete 'plain English' rewrite of the fundraising provisions. The rewrite involves a number of policy reforms as well as many changes of detail, some of which are a substantial departure from the previous law. The policy reforms are aimed at facilitating and reducing the costs of fundraising, especially for small and medium-sized enterprises (SMEs). The changes also update and rationalize the law in certain key areas in need of reform. The most significant policy changes are:
Policy changes aside, plain English rewrites, so enthusiastically promoted by Australian politicians in recent years, are greeted with bemused resignation by many within the legal profession.
The heralded benefits of plain English legislation, (namely that it is simpler to understand and administer, and therefore involves lower costs in compliance, administration and enforcement), must be weighed against the substantial loss of certainty. Rewrites are susceptible to errors and points of confusion. Much of the judicial consideration of the previous provisions and the established practices of the ASIC, is rendered redundant upon a rewrite. Pending the building up of a new body of precedent, companies are forced to raise funds within a less certain legislative framework.
The reforms are designed, in line with the overall policy behind the CLERP Act and its mantra of 'economic efficiency, producing economic growth, and international competitiveness', to allow SMEs to more easily and cheaply raise funds. This in turn helps them to grow and contribute to the economy. Whilst the desirability of these outcomes is accepted, the role of the legislative framework in achieving them is questionable on two levels.
Firstly, an appropriate balance between those objectives and the more traditional objective of investor protection must be achieved. The government claims to have achieved this balance. But the package of reform made by the CLERP Act aimed at facilitating fundraising by SMEs comes at a significant cost of reduced protection for investors. The appropriateness of the government's new balance must be assessed having regard to the generally higher-risk profile of SMEs, at least compared with larger companies whose financial position and performance tend to be less volatile. It also has to take into account the risks of abuse of the reforms by both large and small fundraisers.
Secondly, there is a question as to whether the CLERP fundraising reforms will achieve their objectives. While the legislative framework is a factor in the ability of SMEs to raise funds, other factors are perhaps more important. These include:
If a specific exemption is not available, a disclosure document complying with the legislation must be lodged with the ASIC before commencing with the offering. An offer of securities for issue or sale includes invitations to make applications or offers for those securities.
Meaning of 'security'
The fundraising provisions apply to offers of "securities of a body". A 'body' is any body corporate or unincorporated body, whether incorporated in Australia or elsewhere.
Securities do not include futures contracts or exchange traded options.
Each of the categories of securities referred to above is largely unchanged, except that the definition of debenture has been recast. Furthermore, new rules apply in relation to offers of options, the effect of which is that an option over an unissued security will be subject to the fundraising provisions at the time of grant. It is intended that warrants and similar financial instruments offered by third parties will be subject to the fundraising provisions at the time of grant. The subsequent exercise of the option by the holder is then not intended to be regulated. This marks a significant change from the previous regime under the Corporations Law, which did not regard an offer of options to subscribe for unissued securities as an offer of securities (as defined).
Primary and Secondary Offerings
The fundraising provisions extend to primary or initial offerings (as offerings of securities for issue). Secondary offerings (as offerings of securities for sale) are also regulated if:
Disclosure by prospectus
The primary disclosure document for the fundraising regime is a prospectus, which must contain all information that investors and their professional advisers would reasonably require to make an informed assessment of (i) the rights and liabilities attaching to the securities offered, and (ii) the assets and liabilities, financial position and performance, profit and losses and prospects of the body that is to issue (or has issued) the securities.
The general disclosure test is subject to a number of qualifications, including the fact that disclosure is only required in a prospectus to the extent to which it is reasonable for investors and their professional advisers to expect to find the information in a prospectus. Previously, this 'reasonableness' requirement was part of the general test rather than a separate qualification. The explanatory memorandum circulated in Parliament prior to the enactment of the CLERP Bill 1999 (CLERP Explanatory Memorandum) suggested that the previous formulation expanded rather than limited the general disclosure test, contrary to the intention of the legislature. It suggested that the reformulation as a qualification, will better realize this intention. In practice, the reformulation is not likely to have a significant impact on the scope of the matters disclosed, although a prospectus can no longer omit information previously disclosed to the market (as was the case under the previous law).
A number of specific disclosure requirements also apply, including a requirement to disclose certain interests and information in relation to stock exchange listing. As under the previous law, prospectuses for the offering of listed securities are subject to a reduced disclosure test, which is largely unchanged.
Reform of 'incorporation by reference' provisions
Prospectuses may identify documents that are lodged with the ASIC and thereby incorporate into the prospectus information contained in the document. Incorporation can extend to documents not otherwise required to be lodged with the ASIC (in contrast to the position under the existing legislation), which increases the usefulness of the provision and its potential to facilitate shorter prospectuses.
Where a document is incorporated into a prospectus by reference, it is taken to be included in the prospectus and must be available free of charge during the securities application period.
The prospectus must contain a description of the contents of the documents, if the information is primarily of interest to professional analysts or advisers, or investors with similar specialist information needs, together with a statement that this is the case. In other cases, the prospectus must contain sufficient information about the contents of the document to allow the person to whom the offer is made to decide whether to obtain a copy.
Offer information statements
The CLERP Act introduces the offer information statement (OIS), a new fundraising document, designed for use by SMEs. An issuer may elect to use an OIS, rather than a prospectus, to raise up to A$5 million. The funds may be raised in tranches but A$5 million is a lifetime limit for each issuer. Proprietary companies may not use the OIS regime since they are not permitted to raise funds in a manner requiring a prospectus or other disclosure document.
Disclosure obligations under an OIS are narrower and more specific in scope than the general disclosure obligation applicable to prospectuses. The liability regime states that lack of knowledge of misleading and deceptive statements or omissions is a defence.
This suggests that disclosure under an OIS is likely to be more limited in scope than under a full prospectus, and less extensive enquiries are required to be made by those involved in its preparation. The CLERP Explanatory Memorandum states that external enquiries are not expected to be undertaken to ascertain information about matters on which disclosure is required. However, separate from their obligations under the fundraising regime, the directors of an issuer are subject to a duty of care, skill and diligence, which necessitates inquiry into the affairs of the issuer and monitoring of its business. The existence of these requirements suggests that the benefits of the OIS may be overstated.
It remains to be seen whether the level of disclosure in OISs is, in practice, significantly lower than for prospectuses. Certainly, all material information known to directors should be disclosed and, provided directors are enquiring into the affairs of the issuer and monitoring its business correctly, the knowledge of directors is likely to be substantial. Nonetheless, to the extent that the scope of disclosure in an OIS and enquiries undertaken in the course of preparing it are more limited than in the case of a prospectus, investors bear a greater risk.
The CLERP Act also introduces profile statements, pursuant to which capital may be raised, in circumstances approved by the ASIC. A prospectus will still need to be prepared and lodged with the ASIC.
It appears from the CLERP Explanatory Memorandum that the use of profile statements is primarily contemplated where offers are to be made to retail investors, and the use of a profile statement would give investors the ability to make comparisons between similar products.
When it is used, the profile statement will be the primary source of information for retail investors and must:
The profile statement attracts liability for any inadequately addressed matters required to be disclosed in it. However, in an attempt to ensure full disclosure in the prospectus lodged in association with the profile statement, a person will be assumed to have acquired securities in reliance on both a profile statement and the prospectus. Reliance on the prospectus in fact need not be established.
Under the changes made by the CLERP Act, disclosure documents are still required to be lodged with ASIC. However, the requirement that certain prospectuses be registered with the ASIC is removed.
The disclosure document may be distributed immediately after it has been lodged with the ASIC but, in relation to the offer of non-quoted securities, applications by investors may not be accepted until seven days after lodgment of the disclosure document with the ASIC. The ASIC may extend this 'cooling off' period to a maximum of 14 days. The 'cooling off' period is designed to give the ASIC and the market an opportunity to consider the disclosure document before subscriptions may be processed. The extended seven to fourteen day period will not apply to an offering of quoted securities, on the basis that these securities already have an established market price and are subject to the continuous disclosure regime.
Under the CLERP Act, there are various exemptions from the obligation to prepare and lodge disclosure documents. These are based on the previous regime but have been substantially simplified (with some additions). Two of the exemptions facilitate small-scale offers and offers to sophisticated investors.
Small-scale offerings exemption
A disclosure document will not be required if a person makes an unlimited number of personal offers that (i) result in securities being issued to 20 or fewer persons in any 12 month period, and (ii) do not result in any more that A$2 million dollars being raised in any 12 month period.
The requirement that the offer preceding an issue must be 'personal' prevents the exemption extending to offers being made to retail investors at large. A personal offer is defined as one that may only be accepted by the person to whom it is made, and is made to a person who is likely to be interested in the offer. Consideration must be given to previous contact between the person making the offer and the person to whom it is made, professional or other connection, or statements or actions by the offeree that indicate that they are interested in offers of the relevant kind.
The A$2 million cap is arbitrary and without a clear policy basis. However, it may serve to limit potential loss to investors not receiving the benefit of full disclosure. This may be appropriate as the exemption does not require the persons to whom securities are issued to have a particular level of investment or financial resources. In calculating the A$2 million limit, the amounts paid on issue (as well as any amount payable in the future by way of a call on partly paid securities, or on the exercise of an option, or on exercise of a right to convert the securities into other securities) must be taken into account.
Sophisticated and professional investor exemptions
A disclosure document will not be required if a person falls within one of three 'sophisticated' or professional investor exemptions, namely where:
The second sophisticated investor exemption is ambiguous. It is not clear how a dealer can be satisfied that an investor can assess the merits, value and risks of an offer without proper disclosure. The requirement of 'reasonable grounds' involves a legal risk for a dealer seeking to rely on the exemption, and it is to be expected that dealers will require suitable disclosure to be made to an investor before they will allow offers to be made through them. Exactly what constitutes appropriate disclosure in the circumstances will be the issue requiring determination.
The former underwriting exemption no longer applies, but other exemptions may still assist, such as those described above, or that applying to licensed dealers acquiring as principals.
Significant relaxation of prohibition
In a sensible reform, the previous advertising restrictions, which have always caused difficulties, have been substantially rewritten and relaxed.
The primary prohibition prevents a person from advertising an offer (or intended offer) of securities that requires a disclosure document, or from publishing a statement that directly or indirectly refers to the offer (or intended offer), or is reasonably likely to induce people to apply for the securities.
A number of exemptions qualify this prohibition. Broadly, a distinction is drawn between securities being offered which are in a class which are already quoted and those which are not.
If the securities to be offered are in a class already quoted before lodgment of the relevant disclosure document with the ASIC, there is no restriction upon advertisements or publications. This is provided they include a standard warning statement that a disclosure document will be made available when the securities are offered and that anyone who wishes to apply for the securities will need to complete the application form in the disclosure document.
If the securities to be offered are in a class not already quoted before the relevant disclosure document is lodged, any advertising is restricted to:
Following lodgment with the ASIC of the disclosure document, an advertisement or publication may be issued. Again, this is provided it contains statements that offers will be made by way of a disclosure document and anyone wishing to acquire the securities must complete the application form in the disclosure document.
The distinction between quoted and unquoted securities is a sensible one, as the policy behind restrictions on advertising (ie, encouraging investors to rely on the disclosure document rather than contents of an advertisement) does not apply equally to quoted and unquoted classes of securities. Information about quoted securities and the relevant issuer is already publicly available, known to the market and reflected in the listed price of securities, which provides a basis for investors to assess the merits of acquiring the securities.
By contrast, little information in relation to securities of an unquoted class is likely to be available to potential investors, as the issuer will not have been subject to the continuous disclosure regime. Accordingly, restrictive advertising provisions in connection with the offer of these securities have a sound policy basis. They are designed to minimize the potential for individuals, seeking to raise funds, to generate expectations among potential investors about the desirability of the offer, before all relevant information reaches the market and investors are able to make an informed investment decision.
As offers must be 'personal' for the 20 issues in 12 months exemption to apply, advertising is not permitted in circumstances where reliance is placed on this exemption.
Pathfinder documents permitted
Pathfinder documents are now permitted, in another exemption to the primary prohibition on advertising. This allows draft disclosure documents to be sent to individuals who would fall within the sophisticated or professional investor exemptions (described above).
This reform is welcome. The circulation of a pathfinder document is a standard and useful procedure that assists an issuer in pricing an offer and finalizing the contents of a disclosure document, and has not in practice caused detriment to investors. The reform means that it will no longer be necessary to obtain case-by-case ASIC discretionary relief to distribute a pathfinder.
Image advertising position clarified
The status of image advertising and, in particular, whether it breaches the advertising restrictions, has often involved difficulties and uncertainties in Australia. Image advertising can be influential on investors by presenting the company in a favourable light without expressly referring to a pending public offer. The extent of image advertising has increased markedly.
Under the previous regime, the ASIC expressed the view that image advertising which, when read in conjunction with the surrounding circumstances, would call the attention of the average person to the proposed offering or induce the average person to apply for securities, is prohibited.
The new provisions are intended to clarify the law on image advertising. In deciding whether a statement indirectly refers to an offer or an intended offer, or is reasonably likely to induce people to apply for securities, regard should be had to whether the statement:
Whilst this provision does clarify the law, an express reference to the surrounding circumstances of the advertising would have been a further sensible inclusion. There remains a gap between the ASIC position outlined above and the legislative provision which focuses on the statement in question.
The prohibition on share hawking has been simplified, relaxed and narrowed in scope. Under the changes made by the CLERP Act, subject to certain exceptions, a person must not offer securities for issue or sale in the course of, or because of, an unsolicited meeting with another person, or a telephone call to another person. The new restriction is limited to meetings and telephone calls, which consequently allows persons to be approached by other methods such as post, e-mail and facsimile. The CLERP Explanatory Memorandum notes that this is because the prohibition is only intended to cover forms of communication that result in badgering the potential investor. The provisions are therefore intended to be more firmly based upon the mischief which the prohibition seeks to avoid. Arguably, e-mails (if not also facsimiles and post) are almost as annoying as telephone calls and would be regarded by some as a form of badgering.
The following constitute exceptions to the share hawking prohibition:
The CLERP Act rewrites the previous provisions dealing with prohibited conduct, persons liable, the extent of their liability, defences available to those persons and remedies available with respect to fundraising activities.
Certain types of conduct are prohibited in connection with fundraising activities, including a prohibition against offering securities in a body that does not exist and, in the absence of a relevant exemption, offering securities without a current disclosure document.
The primary fundraising conduct which is prohibited is the area of misstatements, and misleading and deceptive conduct. The CLERP Act has simplified the relevant statutory provisions, and brought them together in one place. A person must not offer securities under a disclosure document if there is a misleading or deceptive statement in the disclosure document. An omission is also prohibited where the material is required to be included. An offence is committed if the statement or omission is materially adverse from the point of view of the investor.
Additionally, a person must not offer securities under a disclosure document if a new circumstance has arisen since the disclosure document was lodged, and it would have been required to be included under the general disclosure standards if it had arisen before the disclosure document was lodged. Again, an offence is committed if the new circumstance is materially adverse from the point of view of the investor.
Under the changes made by the CLERP Act, an issuer faces criminal liability in the event that there is a misstatement in a disclosure document and the statement, omission or new circumstance is materially adverse from the point of view of an investor. This is in contrast to the position on criminal liability under the previous law, which prohibited a person from authorizing or causing the issue of a prospectus that contained a material statement that was false or misleading or a material omission.
Under the new provisions, the only person facing primary criminal liability is the body that makes the offer of securities. The directors of the company will no longer face primary criminal liability. However, the Crimes Act of each Australian state continues to impose primary criminal liability on directors and officers for misstatements in prospectuses.
Even if a person involved in capital raising does not face primary criminal liability, they may be criminally liable as an accomplice under the federal Crimes Act. Accomplice liability requires knowledge of all the essential facts, even if the principal offence is a crime of strict liability. Recklessness or negligence does not amount to the requisite degree of knowledge.
The civil liability provisions in the Corporations Law apply independently of the criminal liability provisions. A person may be liable under civil liability provisions even if they did not commit a criminal offence in relation to the misstatement or were not involved in the contravention.
A person who suffers loss or damage because of a misstatement in a disclosure document may recover the amount of the loss or damage, as long as the action is started within six years, from the following persons:
Each of the persons above may be liable for any loss or damage caused by misstatement in a prospectus, even if that person did not commit, nor was involved in, the contravention.
Each other person (eg, an expert) who is named as having made a statement included in the disclosure document, or on which a statement made within the disclosure document is based, is liable only for the loss or damage caused by the inclusion of that statement. Any other person who contravenes or is involved in a contravention is liable only for that contravention.
Direct liability for promoters and a person who 'authorized or caused the issue of' the prospectus has been removed under the changes made by the CLERP Act. This is a positive development as there was some uncertainty as to who fell into these categories.
The other major reform in relation to persons facing civil liability is that it has been made clear that persons such as professional advisers are only responsible for statements attributed to them, rather then the entire document. This is sound from a policy perspective.
Onus of proof reversed
Previously, under the Corporations Law, a person who made representations about future matters had to have reasonable grounds for doing so. This requirement is retained in the changes made by the CLERP Act. However, under the previous regime, there was effectively a rebuttable deemed liability for such statements, as the onus of proof to establish reasonable grounds was on the maker of the statement. The onus will now lie on the person claiming that the prohibition has been breached. This change is intended to encourage the inclusion of material of potential use to investors without exposing issuers to liability for legitimate forecasting.
Overlap with other laws resolved
In what is perhaps the most important reform in the fundraising liability area, the prohibitions against misleading and deceptive conduct contained in the ASIC Act no longer apply to dealings in securities.
This is a sensible and long-awaited reform that addresses the deficiency under the previous regime, where fundraising activities were subject to both the ASIC Act and relevant provisions of the Corporations Law. The general liability regime under the ASIC Act undercut the prospectus regime and made it redundant. The main impact of this was that under the prospectus liability provisions, a due diligence defence may have been available, but was not available under the general liability regime in the ASIC Act. This created an incentive for claimants to bring action under the ASIC Act rather than the prospectus provisions, undercutting the legislative intention that due diligence be available as a defence in respect of fundraising activities.
In addition, the misleading and deceptive conduct provisions in the Corporations Law have been amended so that they do not apply to conduct that falls within the primary fundraising prohibition. This was necessary to present the misleading and deceptive conduct provisions of the Corporations Law (which do not depend on fault) from undermining the availability of due diligence defences.
The previous fundraising provisions of the Corporations Law contained a complex set of defences which have been criticized as lacking coherence and a clear underlying policy for identifying people liable in connection with a prospectus. The changes made by the CLERP Act attempt to address those deficiencies. The four primary defences are explained below.
The CLERP Act reformulates the traditional due diligence defence, available to each person with potential liability in relation to disclosure documents. For disclosure under a prospectus, a person will not be liable if they made reasonable enquiries and they believed on reasonable grounds that the prospectus did not contain any materially misleading or deceptive statements, or omit any material matter.
Lack of knowledge
The defence provisions are also modified to take account of the reduced disclosure requirements for profile statements and OISs. It is a defence to potential criminal or civil liability for a misleading or deceptive statement in, or an omission from, an OIS or profile statement if a person proves that they did not know of that misstatement or omission.
The CLERP Explanatory Memorandum states that external enquiries are not expected to be undertaken in connection with an OIS or profile statement. If only reduced enquiries are required to be made in the course of preparing disclosure documents, document preparation costs would be reduced accordingly.
However, it is doubtful that the lack of knowledge defence will, in practice, lead to a substantial reduction in the scope of enquiries made in the course of preparing disclosure documents. While the position of underwriters and professional advisers would be enhanced by limiting enquiries, the position of directors of the issuer is different. A director's duty of care, skill and diligence requires a director to actively monitor the affairs of the company, which undercuts the reduced need to make enquiries.
If a body proves that it placed reasonable reliance on information given to it by someone other than a director, employee or agent of the body, then it does not commit an offence and is not liable for a contravention because of a consequent misleading or deceptive statement in, or omission from, a disclosure document.
If a person proves that he or she placed reasonable reliance on someone other than an employee or an agent of that person, then there is no offence or contravention. A professional adviser is not necessarily an agent by reason of performing particular professional or advisory functions.
Withdrawal of consent
In a rewrite of the previous withdrawal of consent defence, a person named in a disclosure document as a proposed director or underwriter is not liable for a contravention if that person proves that he or she publicly withdrew their consent to being named in the document.
For further information on these topics please contact John Atanaskovic, Danny Simmons or Linda Morris at Atanaskovic Hartnell by telephone (+612 9777 7000) or by fax (+612 9777 8777) or by email (email@example.com, firstname.lastname@example.org and email@example.com respectively).
The materials contained on this web site are for general information purposes only and are subject to the disclaimer.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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