If ever you wanted proof of how Australia’s system of public company capital raising is skewed against retail investors, look no further than today’s outcome of the $890 million Slater and Gordon entitlement offer.

When Slaters first announced the $1.266 billion acquisition of UK legal services conglomerate Quindell, management was talking up all the benefits and the stock was immediately suspended for three days while the company conducted the accelerated $608 million institutional component of the capital raising.

This was done with indecent haste and it was only in the subsequent weeks that we saw a pile of sceptical media and analyst reports, best summarised by this comprehensive piece in The Financial Times.

Surprise, surprise, the share price tanked from a high of $7.87 on the first trading day after the institutional offer, to a close yesterday of $6.49.

Even though the offer price was $6.37, underwriters Macquarie and Citi only managed to fetch a 1c premium yesterday when auctioning off the last $170 million worth of shares available in the capital raising. Contrast that with the $1.13 a share paid out to non-participating institutions and Slaters executives in the earlier pre-Easter bookbuild that cleared at $7.50.

The second bookbuild yesterday reflected what’s known as the “retail shortfall” after the 5000 smaller investors only took up 41% of their collective entitlement to buy $290 million new shares at $6.37 in a less rushed offer, which was open for almost three weeks.

As is so often the case, retail investors have been burned by the two-tier system with different bookbuilds. However, what is really interesting in this raising is the way some individual Slater and Gordon executives were able to deem themselves “sophisticated” and legally participate in the institutional offer.

Ken Fowlie is the long-time Slaters executive director who led the due diligence team on Quindell and will run the biggest legal business in the UK as the two operations are integrated.

Amidst all the drama of selling the deal before Easter, based on this April 16 director shareholding notice, Fowlie must have signed up as a “sophisticated investor” and committed to shell out $3.5 million to take up 550,000 entitlements at $6.37 in the institutional offer.

However, as the owner of 5.096 million shares before the two-for-three offer was launched, Fowlie was actually entitled to take up 3.397 million new shares for $21.63 million as was explained in this earlier Crikey piece.

This left Fowlie with 2.847 million surplus rights, which he sold off to other institutions for $1.13 each in the institutional bookbuild, pocketing a very handy $3.21 million.

If Fowlie had waited until the retail bookbuild like most of the “unsophisticated” small shareholders in Slater and Gordon, he would have received a miserable $28,470 for the rights based on yesterday’s 1c auction outcome.

This is most unfair. Many of the smaller Slaters shareholders could have participated in the institutional offer by satisfying the definition of “sophisticated investor” with a letter from their accountant declaring they’ve earned more than $250,000 in the previous two years or own at least $2.5 million in assets.

But they weren’t one of the Slaters insiders or clients of the underwriters who were offered this opportunity. Presumably, there is paperwork declaring who the eligible sophisticated individuals were.

With Slaters shares trading slightly higher at $6.56 this morning, the $1.26 billion Quindell deal has now effectively destroyed almost $200 million in shareholder value so far.

The emergence this morning of UBS as a substantial shareholder with 6.44%, points to the fact that some of the London-based hedge funds that profited so handsomely short-selling Quindell are now doing the same to Slater and Gordon.

I was at first sceptical about the Quindell deal but became as upbeat as anyone after seeing that $1.13 clearing price from the institutional bookbuild.

The theoretical price on the resumption of trade should have been $7.08 based on the last traded price of $7.55 before the capital raising was launched.

This means non-participating institutions should have received 71c, all things being equal, but the Quindell deal was viewed initially as a value creator to the tune of about $200 million, so they pocketed a collective $22.6 million for the circa 20 million entitlements that were auctioned off to other institutions at $1.13 in the first bookbuild offer.

Finally, this is where Slaters currently sits in terms of the worst relative outcomes for retail investors when institutional shareholders are offered the privilege of an earlier bookbuild than retail in an entitlement offer.

Slater and Gordon: $890 million raising in 2015 at $6.37. Non-participating institutions (and some Slaters execs) received 113 times retail with $1.13 vs 1c.

Connect East: $424 million raising in 2009 at 36.5c. Non-participating institutions received seven times retail with 3.5c vs 0.5c.

Energy Resources Australia: $500 million raising in 2011 at $1.53. Non-participating institutions received 3.92 times retail with 47c vs 12c.

Boral: $492 million raising in 2010 at $4.10. Non-participating institutions received 3.67 times retail with 55c to 15c.

Orica: $900 million raising in 2008 at $22.50. Non-participating institutions received 2.5 times retail with 25c vs 10c.

It is true that the opposite has happened in some entitlement offers but this comprehensive Australian Shareholders’ Association list shows that retail wins are clearly in the minority.

There’s an obvious solution here. Separate bookbuilds should only be permitted if the combined proceeds are pooled and then distributed evenly among all investors.

A spokesperson for Slater and Gordon writes:

As we have said consistently, we regard this transaction as transformational for Slater and Gordon and in the interests of our shareholders. We are excited by the opportunity presented by the PSD assets and believe the deal will create substantial value for shareholders. It goes without saying that we entirely reject any suggestion that the transaction or the means of funding it have been motivated in any way other than what is in the best interests of the Company, its shareholders and the successful completion of this transformational opportunity.

Your commentary appears to assume that the offer has occurred within a market vacuum, rather than acknowledging the increasing volatility in the market since early April which has impacted not only on Slater and Gordon.

Further, we make the following specific points:

• The offering was undertaken on a fully pro rata basis and was structured so as to be renounceable – this is the most shareholder-friendly method, particularly compared to a non-renouncable raising or a share placement;
• Alternative entitlement offer structures with a combined institutional/retail bookbuild have been discredited as delivering less value to both sets of shareholders;
• The discount achieved for the offering was tight relative to precedent, which further mitigated any dilution impact for non-participating shareholders and delivered cost effective capital for the company;
• Accelerating the institutional component was entirely appropriate for the PSD acquisition and delivered certainty;
• Any inference that the institutional component of the entitlement offer was “rushed” is incorrect. The entitlement offer followed the standard timetable for an entitlement offer as reflected in the ASX listing rules;
• As you know, at the time that participants indicate intentions with respect to the take up and renunciation of rights, they do so without knowing what any renounced rights might deliver by way of a return;
• Both executive directors took up a substantial number of their rights, demonstrating their confidence in and support for the transaction;
• The management team have continued to work assiduously throughout the offer period to explain the transaction to the market and to support the share price despite pockets of bearish commentary, noting of course, that there has been an overwhelmingly positive response to the transaction from both investors and analysts; and
• Slater and Gordon has taken advice from Citi, Greenhill and Macquarie throughout the fundraising process and followed that advice, including in respect to the approach to the institutional bookbuild.