Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)2 Regulation impact statement
Background to proposed amendments
2.1 The Corporate Law Economic Reform Program has reviewed existing policy over the past 15 months of key areas of business regulation. The purpose of the program is to ensure that current regulation is consistent with the Governments economic objectives. In particular, it seeks to improve the efficiency of corporate regulation and reduce regulatory burdens on business. The reforms are aimed at facilitating a more efficient and competitive business environment.
Consultation
2.2 Under this program, the Government released policy papers containing detailed proposals and draft legislative provisions as a means of consulting widely. The Treasurer and the former Parliamentary Secretary to the Treasurer have consulted extensively with business and peak organisations, including through forums conducted in Adelaide, Brisbane, Hobart, Melbourne, Perth and Sydney.
2.3 So that the CLERP proposals could be developed in close consultation with business and community groups, the Government established the Business Regulation Advisory Group which represents key stakeholder organisations. This group was involved in the development of the policy proposals and reviewed all public submissions on the proposals. As well as key interest groups responding to the proposals, the Companies and Securities Advisory Committee and its Legal Committee which represent the business and professional communities have provided detailed comments on all the proposals. As noted above there has been strong support from the business community for the CLERP program as it is seen as addressing those issues that are of particular concern to business.
Problem identification and regulatory objectives
2.4 The current regulatory environment has failed to keep pace with changes occurring in financial markets and commercial practices. Liberalisation of world capital markets in combination with technological developments in information and telecommunication industries have fundamentally altered the way business operates. Australian firms are being exposed to greater international competition. In light of that, the regulatory framework needs to adapt to respond to challenges posed by changes in the way business is conducted. In addition, changes in investor behaviour which are reflected in growing financial sophistication require a reassessment of the regulatory framework.
2.5 The purpose of the review has been to develop a regulatory framework that is consistent, flexible, adaptable and cost effective. The objective of the CLERP program is to streamline the operation of regulation in order to improve the efficiency of the regulatory environment and to reduce costs on business and market participants. It seeks to reduce the transaction costs, remove barriers to entry for service providers and improve harmonisation of Australias laws with those applying in major world financial markets.
2.6 To address these issues the CLERP reviewed the Law relating to the making of accounting standards and the regulation of directors duties, fundraising and takeovers.
2.7 The following identifies problems with existing regulation, the key drivers for changes in these areas and the proposed solutions to meet these problems. Where applicable the options that were available to the Government are discussed. However, given that each of these areas are covered by existing regulation the recommended option in each of the areas is to amend the operation of existing regulation through making amendments to the Law.
Directors duties
2.8 Directors are subject to both the general common law and a range of statutory duties (eg approving company financial statements, signing a prospectus). Directors have a contractual relationship with the company and a fiduciary relationship with shareholders. The Law codifies common law duties of loyalty and care. It also requires directors to exercise their powers in good faith and in the best interests of the company. A breach of requirements imposed under the Law may result in civil and/or criminal liability for directors.
2.9 Director uncertainty as to liability for decisions made in good faith is operating as an inhibitor of business activity and is leading to risk averse behaviour by directors. The option for the Government is to take no action and allow the courts to clarify this area of the Law. However, the courts have failed to provide clear guidance to directors on the level of skill and care expected of them, particularly in relation to the responsibilities and liability of executive and non-executive directors. The incremental approach of the courts has not clarified uncertainty in the operation of the Law.
2.10 At the same time shareholders are demanding greater accountability from directors. However, the Law does not provide an adequate remedy for shareholders who wish to take action on behalf of the company where directors have failed to do so.
2.1 A clarification of directors duties will lead to improved corporate governance practices and market confidence. Clarification of directors duties will also lead to a reduction in agency costs by addressing the uncertainty of directors in decision making and thereby freeing them up to take calculated business risks to maximise company profits. Allowing directors to delegate and rely on judgments of employees of the company or other experts will give recognition to the complexity of management of large corporations and remove impediments to decision making and the efficient management of a corporations business.
2.2 Providing an enhanced remedy for shareholders will increase incentives for management to conduct their affairs in the appropriate fashion. It may also lead to shareholders being more vigilant of the operations of management.
2.3 There is strong support from the business community for removal of uncertainty in relation to directors duties and for the recognition of the changing role of directors in corporations. Investor groups strongly support the introduction of a statutory derivative action which is seen as remedying a key defect in shareholders rights at the present time.
2.4 The CLERP proposals recommend the introduction of a statutory business judgment rule to provide directors with the confidence that if they make informed business decisions in good faith they will meet their duty of care and diligence. This will remove the uncertainty for directors and should lead to better management processes within companies for the taking of decisions.
2.5 It is proposed to introduce a new action for shareholders, a statutory derivative action, to enable shareholders in a company to take action on behalf of the company where directors fail to do so. The Law will prescribe tight constraints on the availability of this action to ensure that it is not used by vexatious shareholders to usurp the appropriate management of the board.
Takeovers
2.6 The Law regulates the market for corporate control through prescriptive procedures to be followed in the launch and acceptance of a takeover bid. The Law imposes obligations on bidders and target companies for the purpose of ensuring that acquisitions of substantial parcels of shares are conducted in a transparent and equitable manner. As well as the black letter law, the Eggleston principles - rules to ensure sufficient information and fairness in takeovers - give jurisdiction to the Corporations and Securities Panel (the Panel) to declare conduct as unacceptable even if it does not involve a breach of the Law.
2.7 The current regulatory regime overly constrains takeover conduct. Too often litigation is used to as a defensive tactic and bidders are inhibited by having to enter into an auction for corporate control. The CLERP proposals assessed whether the code should be replaced or liberalised to facilitate changes in control. They also considered whether responsibility for adjudicating on takeover disputes should be taken away from the courts and given to a Panel which could reduce costs, speed up resolution of disputes and bring to bear greater market expertise in the adjudicative process.
2.8 The CLERP review concludes that takeovers are an essential element of a competitive business environment in that they allocate capital to its most productive uses by providing incentives for management to optimise performance. The concept of the equal opportunity principle whereby the premium for control is shared equally with all shareholders is to be retained as it contributes to investor confidence and market integrity.
2.9 The retention of the equal opportunity rule encourages market integrity in Australian securities markets through providing certainty and confidence to investors. The introduction of a mandatory bid rule would remove an impediment to changes in corporate control by providing greater certainty to bidders. This would reduce the costs of making a takeover bid. Investors would benefit from being offered the best price paid in the past 4 months for the shares. Changes to the compulsory acquisition rules would reduce costs for companies by making it easier to rationalise corporate groups. Removing tactical litigation and disputes from the courts would lead to a more timely resolution of those matters reducing costs for the parties involved.
2.10 Market participants support the retention of the equal opportunity rule. There is strong support for the introduction of a mandatory bid procedure so long as the safeguards which are proposed for shareholders are included. There is strong support for a greater role for the Panel in the resolution of takeover disputes.
2.11 To improve the operation of the takeovers code, two key changes are proposed. The concept of a mandatory bid would be introduced whereby acquisitions above a statutory threshold would be permitted if the acquisition preceded the immediate announcement of a full takeover bid. This approach is intended to facilitate the making of takeover bids by reducing uncertainty as to the outcome of the bid. All shareholders will be required to be offered the highest price paid during the last 4 months.
2.12 The Panel will be given an enhanced role replacing the courts as the venue for dispute resolution during the period of the bid. Parties rights to seek injunctive relief from the courts for contraventions of the black-letter takeover law will be removed. This will have the benefit of enabling takeover disputes to be resolved on a final basis within the period of the bid. As well, disputes will be reduced through the Panel being able to initiate changes to takeover documents and negotiate with parties to minimise areas of dispute.
2.13 A prospectus is required where funds are sought through the issue of securities. A prospectus is generally required to disclose information that investors and advisers reasonably require and reasonably expect to find in the prospectus to make an informed decision about the financial position and prospects of the corporation and the rights attaching to the securities.
2.14 Current regulation results in long and complicated prospectuses with high costs of preparation and distribution to fundraisers. In particular, uncertainty about the liability regime leads to excessive due diligence procedures. The current rules are a clear barrier to fundraising by small and medium sized enterprises (SMEs).
2.15 The CLERP proposals canvassed whether the general disclosure test should be retained or whether Australia should revert back to a checklist approach for disclosures.
2.16 CLERP concluded that the advantage of the general disclosure test is that the quality of information available to the marketplace has improved since the introduction of the test. The check-list approach was easily circumvented by fundraisers and led to less meaningful disclosures to investors. Additionally, the onus was placed on the regulator to ensure that the check-list was fulfilled. In contrast, the general disclosure test places the onus on the fundraiser to provide such information as is necessary for investors to make an informed investment decision. Given this position, attention has been focussed on improving the operation of the fundraising rules by addressing the source of the high costs of prospectuses.
2.17 The use of short form prospectuses will lead to reductions in costs for fundraisers while at the same time improving disclosures to retail investors. As well distribution costs for fundraisers would be reduced. Allowing certain industries, eg the funds management industry, to use profile statements, which contain key information, will benefit investors by allowing them to compare similar investments.
2.18 Costs of fundraising will also be reduced by removing uncertainty as to liability for parties involved in the preparation of prospectus. Measures addressing small business fundraising would have a significant impact on attracting SMEs to undertake fundraising and reduce the transaction costs for those companies.
2.1 There is very strong support from the business community for the general disclosure test, removal of the uncertainty relating to liability for professionals involved in fundraising and for specific measures to facilitate SME fundraising.
2.2 The CLERP proposals provide a range of measures to improve the fundraising rules to facilitate the raising of investment capital by Australian companies. A fundraiser will be able to prepare a 2-part prospectus with a short form document being provided to retail investors with further additional information available on request.
2.3 The potential strict liability under the Trade Practices Act will be removed. The due diligence regime under the Law will provide a defence for mandatory disclosures where appropriate inquiries are made.
2.4 Issuers will be able to raise up to $5 million through the issue of Offer Information Statements (OIS). The disclosure required by an OIS will be limited to certain specific matters. A warning will be provided to investors that the OIS only discloses material information already within the knowledge of the corporation, its directors or promoters.
2.5 The OIS is a specific measure aimed at facilitating SME fundraising. The limitations imposed with OISs are intended to ensure that the general disclosure rule would remain the paramount rule for fundraising. As well a corporation will be able to raise $2 million each year from up to 20 persons. This should assist business angels making investments in SMEs. A corporation will also be able to more easily raise funds from sophisticated investors as high worth individuals will be able to invest amounts of less than $500,000 in a corporation without the need for the corporation to prepare an OIS or a prospectus.
2.6 Australian accounting standards have been found to be too prescriptive and overly technical, imposing excessive costs on business. Business considers that the standard setting process is captured by the accounting profession and that there is no real accountability to users. Australian accounting standards are not widely understood in international capital markets resulting in high capital costs for business. There is a strong push from some parts of business for Australia to embrace the greater use of standards set by the International Accounting Standards Committee (the IASC).
2.7 The options for the Government in this area are to either improve the existing process for the making of accounting standards and have a policy of moving towards adoption of international standards or, alternatively, as soon as possible, adopt without modification the standards set by the IASC.
2.8 Companies and financial markets will derive significant benefits from improvements in the development of accounting standards. Greater involvement by business and stakeholders in the development of accounting standards will improve financial reporting. Compliance costs will be reduced for companies as accounting standards will become more easier to prepare. The move towards adoption of international accounting standards should reduce costs for companies operating in international capital markets.
2.9 The CLERP proposals have received strong support from the business community. However, some interest groups suggest that Australia should move more quickly to adopt international standards. It is proposed that the Government would take advice from the Financial Reporting Council (the FRC) and other interest groups before taking decision on when Australia should seek to move to adopt international standards. The FRC will report on the extent to which international accounting standards have been adopted in the worlds major capital markets and whether it would be in Australias best interests to adopt such standards.
2.10 It is proposed that a clear mandate be given to the standard setting body in relation to the objectives of standards, their development and interpretation. In the immediate future, Australia should continue to harmonise with IASC standards as far as possible. In the longer term, depending on the acceptance of international standards in overseas capital markets, Australia should adopt international standards as a basis for financial reporting by foreign and domestic companies.
2.11 The FRC, an advisory body representing key interest groups, will be established to oversee the accounting standard setting process. The FRC would approve the agenda/priorities and the business plan of the accounting setting body. The benefits of this proposal are that it would lead to greater stakeholder involvement in accounting standard setting and should lead to financial reporting which is more informative and useful to business and investors.
2.12 The reforms are being implemented through changes to the Corporations Law. In addition, a plain English rewrite is being undertaken of the relevant areas of the Corporations Law. This will make the law more user friendly and reduce compliance costs for corporations and market participants.
2.13 The reforms in relation to SME fundraising, the mandatory bid for takeovers and enhanced role of the Takeovers Panel will be reviewed after 2 years.