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The Howard government has created a nation of shareholders but they want to stop rabid green groups forcing expensive EGMs for publicity stunts. In what is almost an exclusive, Hindenburg tells Crikey readers why he’s introducing the so-called square-root rule.

Introduction

Companies must be free to get on with the business of maximising wealth. That said there is a legitimate supervisory role for the shareholders in general meeting. The Corporations Law must ensure that without limiting individual shareholder rights companies are not unreasonably subjected to the substantial cost of conducting a general meeting. Most commentators agree the current 100-member test is too low, especially for our larger listed companies.

The Government has not sought to alter the ability of small shareholders to put resolutions at annual general meetings. Thus, at a normal scheduled meeting 100 shareholders or shareholders representing 5% of the total votes may require their company to distribute to all shareholders, at the company’s cost, any notice of resolution or any shareholder statement.

The matters the subject of this article are quite different to those raised above. What the Government is grappling with are extraordinary general meetings that could be unreasonably used by special interest groups. The Corporations Law should limit the incidence of avoidable and unjustifiably expensive meetings that are not wanted by the majority of shareholders. In the usual course the concerns of special interest groups can be easily accommodated under the existing law by tabling resolutions at the annual meeting.

A Corporations Law Regulation replacing the 100-member threshold with a 5% of members rule for calling a general meeting of a listed public company came into force in April 2000. The changes were prompted by concerns that company meetings could be requisitioned for improper purposes resulting in unnecessary and significant costs and in anticipation of the recomendations of the Final Report of the Companies & Securities Advisory Committee (CASAC). Many people felt that the 100-member threshold potentially gave a disproportionate influence to minority shareholders particularly where large companies with substantial numbers of shareholders are involved. The Senate disallowed the regulation on 28 June 2000 in a combined move by Labor, the Democrats and the Greens.

Consistent with the final CASAC recommendations the Government sought to put in place a regulation that would have would have approximated (as far as allowed by the regulation making power) the effect of the CASAC proposal. As the Senate chose to ignore the expert opinion of CASAC, the Government has been working on possible solutions that could strike ” the right balance between input from shareholders and the responsibilities of management”.

After considering a wide range of alternatives the Government has developed an alternative proposal to determine the number of members required to requisition a members’ meeting under section 249D of the Corporations Law: “the square-root rule”.

The square-root rule

The proposal involves retaining the proper purpose test currently in the Corporations Law as well as the 5% voting rule. In addition, it is proposed to replace the existing 100-member test with a new square-root rule. Under the new rule the number of members required to call a company meeting would be the square root of the total number of members of the company.

In contrast to the existing 100-member rule that is fixed arbitrarily, under the square-root rule, the number of members will always be proportionate to the size of the member base. It is a fair, objective and simple formulation that links the required number of shareholders with the size of the company’s shareholder base, but without sacrificing shareholder democracy. Under the proposal a company like AMP Limited, with a shareholder base exceeding 1 million members, would require just over 1000 members to call a company meeting. For smaller companies, the number of shareholders required would decline accordingly. While 1000 members seems like a large number it is a tiny proportion of AMP’s 1 million members and the cost of a general meeting of AMP would be very substantial. The attached charts demonstrate the effect of the square-root rule in respect of a number of scenarios.

At this time the square-root rule will not include a specific mechanism to exclude persons who have become members solely for the purpose of joining in the requisitioning of a meeting that is; by acquiring a small number of shares or splitting a parcel of shares among themselves to meet the required threshold. However, if evidence of abuse is discovered then it may be necessary to go beyond the proper purpose rule and consider a range of measures to eliminate abuse of the provisions.

Alternative solutions

1. An issued share capital test only

There have been numerous alternatives considered including: removing the existing 100 member threshold and retaining as the sole test members holding 5% of the voting shares of the company as recommended by CASAC. This test would be in line with the position in the major capital markets overseas. However, this test proposes a threshold that many commentators have suggested is too high in a market that increasingly contains a material proportion of retail investors.

The Government recognises that globally, companies are being asked to be more accountable but it cannot condone the idea that companies can be run by some form of constant shareholder referendum. Our system of corporate regulation requires that management is the responsibility of the company’s management.

2.A material economic interest test Another suggestion has been the retention of the current 100 member test modified with the additional requirement that each shareholder holds a ‘marketable parcel of shares’ or similar. CASAC believed that requisitioning shareholders should have some minimum economic interest in the company, but they thought this would be more directly and uniformly achieved through the issued capital test. A minimum economic value or marketable parcel proposal has merit; however, the proposal has some serious limitations. Currently, a marketable parcel is a parcel of shares with a market value of $500. This means if the parcel size was, say $500, then the requistionist would, at the time of requisitioning the meeting need to hold a parcel of at least $500. If the reason for holding the meeting were say, a falling share price a requistionist could be called upon to ‘top up’ her parcel: it is conceivable that requistionists would be reluctant to ‘throw good money after bad’.

Another option is to have a test based on a market value at the time of acquisition, while this would eliminate a need to acquire further shares in a falling market it does add another level of complexity. How could the returning officer or similar determine whether the requistionists parcel satisfies the material economic interest test.

Further a marketable parcel test could not easily apply to companies with non-standard capital and voting shares. Such a test would require modification to cater for non-standard companies. There are a very large number of companies that do not have all of their shares quoted, so a test based on a market value would necessarily be complex and could involve a difficult and potentially expensive valuation exercise.

3. Sliding scale

Some commentators have suggested that the best way of accommodating different size companies would be to adopt some form of alternating or sliding scale with would provide petitioners with two possible thresholds. This test would require shareholders wanting a special meeting to hold either 2% of the capital or shares valued at $10 million.

While a sliding scale does have some attractive features it is a difficult test to administer and operate for many of the reasons discussed above.

Others

Other options have been suggested such as having minimum and maximum numbers overlayed on top of the square root rule and/or drawing distinctions between annual general meetings and general meetings held independently of an annual general meeting. While these options may have merit their biggest down side is that they add an unnecessary level of complexity to the business of calculating the necessary numbers.

Conclusion

The Government has developed a threshold that ensures that small groups of shareholders cannot hold companies to ransom. Shareholder democracy is an important feature of modern company law however; the function of shareholder democracy is not to impede management’s ability to get on with business.

There is clearly a need for shareholders and the wider community to be able to bring social and environmental issues to the attention of management and for directors to appreciate the trend towards greater levels of accountability. The general meeting remains the primary forum for shareholder participation in the modern corporation, but that role is limited.

The CASAC Final Report recognises that while today’s companies are different to their early English ancestors they share a common goal of collective wealth creation. Investors band together as shareholders to create wealth that is shared evenly in proportion to their investment. To preserve their equity, and ensure the maximisation of their returns, shareholders are empowered to make management of the company accountable to them, through the general meeting.

Are general meetings still relevant in an Internet age? How should meetings be conducted? What rights should shareholders have to pursue specific concerns? These were the kinds of questions considered by CASAC in its Final Report.

Our corporate law gives shareholders a number of means by which to have their views aired, including compulsory annual general meetings. In the future, it may be that new technology will provide better ways for shareholders to participate, but for the time being shareholders should get involved in the annual general meetings of companies in which they hold shares. This means reading the materials, talking to other shareholders, visiting the companies’ (or others) chat rooms and generally getting involved.

The Final Report is a significant contribution to the debate about shareholder participation in the modern listed public company. The Government has been carefully considering the reports of CASAC and the Parliamentary Joint Statutory Committee on Corporations and

Securities and has settled on a three part test that will adequately address one of the issues raised by CASAC, ie the threshold for requisitioning a general meeting. The Corporations Law will continue to require that a meeting be held for a ‘proper purpose’. The directors of a company would be required to call and arrange a general meeting on the request of:

members representing at least 5% of the votes that may be cast at a general meeting; or

members greater than or equal to the square root of the total number of members.

The combined proposal strikes the appropriate balance between shareholders’ rights to call a company meeting in extraordinary circumstances, while lessening the potential for abuse of such a right.

“This article by the Federal Minister for Financial Services and Regulation originally appeared in Butterworths Corporation Law Bulletin Issue No 1 for 2001”

If you have a strong view about this, try emailing Hindenburg’s chief of staff Andrew Lumsden at [email protected] He’sa good bloke and might even give you some shares tips along the way.

Peter Fray

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