Backdoor Listing Up, Says ASIC

ASIC has today published the second report in its series on the regulation of corporate finance issues in Australia.

The report, which covers the period July to December 2014, provides companies and their advisers with insights into ASIC’s regulatory approach in the corporate finance sector and aims to assist them with their associated legal and compliance obligations.

ASIC is responsible for the regulation and oversight of corporate finance activity in Australia, with a particular focus on corporate transactions such as fundraising, takeovers, schemes of arrangement, share buy-backs, compulsory acquisitions, employee incentive schemes and financial reporting. The Corporations and Emerging Mining and Resources (EMR) teams are responsible for regulating disclosure and conduct by corporations in Australia in these areas.

In this period there was a 39% increase in the number of disclosure documents lodged with ASIC (compared to the period 1 January to 30 June 2014, and a slight increase in applications for relief from Ch 6D. The table below depicts the top 10 public fundraising transactions by value of the offer based on disclosure documents lodged with ASIC in this period. Hybrid securities make up a notable portion of these fundraisings.

When reviewing prospectuses in this period, among other things, ASIC responded to the following trends:

1. financial information (including pro-forma financial information) that is not sufficiently complete or adequately reviewed by a third party such as an auditor;
2. an increase in backdoor listing prospectuses;
3. poor quality information about companies operating in an emerging market; and
4. an increase in the number of listed investment companies seeking quotation.

Financial disclosures

Financial disclosures are of significant concern to ASIC, as they paint a picture of the history of the performance of the company and effectiveness of management. Financial information, both statutory and pro forma, is essential to informing investors about the past performance and future prospects of the company. Some of the concerns with the disclosure of financial information we identified include:

1. pro-forma adjustments described as one-off events;
2. a lack of prominent disclosure of material differences between statutory and pro-forma financial results; and
3. multiples not being included for all forecast

Backdoor listings

In this period ASIC reviewed disclosure by 30 companies seeking admission to ASX by way of a backdoor listing—that is, a company seeking to access capital by selling their business into a company that is already listed on an Australian exchange.

Businesses offering web-based products and services or start-up technologies are the most common type of business currently seeking admission by way of backdoor listing. These often have unique businesses requiring technical explanation of a high proportion of intangible assets in their financial statements. With these characteristics it is difficult for investors to make an informed decision unless:

1. considerable care is taken in explaining the business without the use of jargon; and
2. a justification for the valuation of intangible assets is provided.

ASIC raised concerns with 22 (73%) of these offer documents, with concerns being addressed by way of supplementary disclosure. In six instances ASIC made interim stop orders in relation to backdoor listing prospectuses; two stop orders were revoked, one had a final stop order made and three prospectuses are still subject to those interim stop orders.

Other concerns identified in a number of backdoor listing prospectuses include:

1. insufficient financial disclosure, including a lack of operating history, lack of audited financial information, and disclosure of information presented other than in accordance with accounting standards (non-IFRS financial information);
2. insufficient disclosure of a company’s business model and use of proceeds;
3. disclosure of directors’ history not consistent with our policy in disclosure of directors’ history not consistent with our policy in RG 228; and
4. risk disclosure not adequate or appropriately tailored to a company’s circumstances.

Half of the businesses seeking a backdoor listing come from a foreign jurisdiction, with the majority of these from an emerging market. ASIC continues to consider the challenges facing these entities when reviewing a prospectus, and will raise concerns where we consider disclosure is inadequate or misleading.

With the slowdown in the mining sector ASIC expects backdoor listing activity to remain strong.

Listed investment company disclosure

In the last year ASIC  saw an increase in the number of initial public offerings of listed investment companies. These are entities that seek to make a return for investors through their investment activities rather than through operating a business. This raises a few disclosure concerns unique to listed investment company prospectuses.

Firstly, listed investment companies often have similar characteristics to a hedge fund, and may use complex strategies like leverage, short selling and derivatives. These can be quite challenging to explain, and ASIC is concerned that retail investors may struggle to understand how a company intends to make money—particularly when jargon is used excessively. If a listed investment company has similarities to a hedge fund, then it should make disclosure that is similar to that provided by a hedge fund.

Another feature of listed investment companies is that they can have an external manager that may be a related party. The fees charged by the external manager can have a material impact on investors’ returns and, where this is the case, the prospectus should give meaningful disclosure. For example, in some circumstances it may be more appropriate to include a worked example or explain the practical effect of a fee, rather than just cite a complex formula. Where a performance fee formula means that investors’ returns are capped at 10%, it is not sufficient to disclose the formula. The prospectus must clearly and prominently disclose that investors’ returns will not exceed 10%.

Finally, listed investment company prospectuses often seek to include disclosure setting out the past performance of other entities managed by their manager. Concerns about these disclosures are commonly raised by ASIC.