Many people will be suprised to hear this, but Australian takeover laws, under certain (limited) circumstances, allow a body to insider trade shares. The situation occurs when a company is planning to launch a takeover bid (or scheme of arrangement).

The Corporations Act actually provides a specific exemption to the insider trading laws which allows a company to acquire shares in another company if they are about to launch a takeover bid or propose a merger.

Interestingly, the corporations laws also prohibit the buyer from paying a premium to acquire a pre-bid stake. For example, an acquirer cannot pay a shareholder $2.00 per share to acquire a 19.9% stake and then offer everyone else $1.50 per share in a formal takeover bid. The reason for this law is to ensure that “all [share]holders must have a reasonable and equal opportunity to participate in any benefits [arising from a bid]”.

But it seems unusual that the law is, on one hand, willing to promote equality, but at the same time permit the trading of securities where there is a clear information imbalance — that is, the buyer knows that its impending offer will set a new higher price but the seller does not.

Using a real life example, prior to Cemex bidding for Rinker a few weeks ago, Rinker shares were trading at around $14. Under the current laws, Cemex would have been allowed to purchase up to 19.9% of Rinker shares on market for approximately $14 (without actually launching a bid), despite knowing full well that it was about to launch a takeover bid at AUD$17 per share shortly after.

Under that example, those who may have sold their Rinker shares at $14 to Cemex would have been deprived of an opportunity to participate in the bid.

Taking the analogy one step further, what is stopping an opportunistic private equity player from acquiring a stake in a company and launching a highly conditional bid which is unlikely to win board approval?

After an initial bid (no matter how opportunistic), the target company effectively becomes “in-play”. This happened with Coles Myer, which is now trading at just under $14 – a 27% premium compared to before KKR launched its rejected scheme of arrangement. Had KKR acquired a 15% pre-bid stake in Coles Myer, it would be sitting on a $500 million paper profit. Arguably, that $500 million paper profit belonged to Coles shareholders. While such tactics would be of no interest to a KKR, other firms might be happy to make a quick buck courtesy our law makers.

Proponents of the current laws argue that allowing a buyer to acquire a secretive pre-bid stake means that there is a far greater chance of the bid succeeding (and therefore, more likelihood that shareholders will receive a premium).

However, that benefit needs to be weighed up against the notion that not all market participants would be trading on the basis of equal information. Similarly, it is argued that most pre-bid stakes are acquired from sophisticated institutions. However, it is perhaps more important that even the most sophisticated large holders are able to trade with the knowledge that the share they are selling is about to be worth far more than what they are getting.

Peter Fray

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