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Report on Inquiry into Trading in the Shares of McCollam Printers Limited

Issues Relating to Substantial Security Holder Disclosure
Part II of the Securities Amendment Act 1988

Under Part II of the Amendment Act obligations are imposed on a person who has become a substantial security holder in a listed company to give notice to the company and to the NZSE. A substantial security holder is a person who has a relevant interest in 5% or more of the voting securities of the listed company. A substantial security holder must also give notice of changes in relevant interest equivalent to 1% or more of the total voting securities, and of changes in the nature of relevant interest held. Notice of cessation as a substantial security holder must also be given i.e. where the relevant interest falls below 5%. The form of any notice required to be given under Part II is prescribed in the Securities (Substantial Security Holders) Regulations 1997. (At time of the trading in MPL the 1989 regulations applied.) The notice is required to be given as soon as the person knows, or ought to know, of the matter giving rise to the obligation.
The purpose of the legislation is to ensure that investors are fully and promptly informed about the ownership and control of the listed companies in which they invest, thereby facilitating a transparent market. It is particularly valuable in the context of takeovers where knowledge of a person building a stake in a company is of prime importance to the market generally.
The term relevant interest is defined in section 5 of the Amendment Act. A copy of this provision is attached at Appendix D. A person has a relevant interest when that person is a beneficial owner of the shares (section 5(1)(a)). A person also has a relevant interest when that person has the power to acquire or dispose of the shares or the power to control the acquisition or disposition of the shares by another person (section 5(1)(d) and (e)). This also extends to any trust, agreement, arrangement or understanding relating to the shares (whether or not the person is a party to it) where the person may at any time have the power to do these things (section 5(1)(f)). In terms of the legislation, it does not matter whether the power is express or implied, is direct or indirect, or whether it is exercisable presently or in the future, or alone or jointly with another person or persons (section 5(4)).
Under section 32 the Court can make a range of orders (extending to the forfeiture of shares) whenever there are reasonable grounds to suspect that a substantial security holder has not complied with the law. These orders can be made on the application of the persons specified in section 31, including, any person who sold or purchased shares at a time when a substantial security holder had not complied with the disclosure obligations. The substantial security holder can become separately liable to these persons under section 34, as well as to any person who traded with the substantial security holder. In these circumstances the liability is based on the difference between the price that was actually payable and the amount offered pursuant to any subsequent takeover made by the substantial security holder or any related company.
At the time of the takeover of MPL by Blue Star, MPL had a total issued share capital of 23,721,916 ordinary shares. The total number of MPL shares acquired by the combined interests of Eric Watson, Richard Johnston and Craig Joynt amounted to 2,403,800 shares, equating to 10.13% of MPL. Of this total, 1,698,000 shares were acquired in the name of Seahunter, equating to 7.16% of MPL.
No substantial security holder notice was given in relation to these interests.
The position taken by Eric Watson, Richard Johnston and Craig Joynt appears to be that, at Eric Watson's initiative, they had together agreed to participate in a venture to buy shares in MPL. Eric Watson said that the intention was that he should acquire the first 4.99% and, thereafter, the shares would go to Richard Johnston and Craig Joynt for their own separate interests. Eric Watson said it was an essential part of the arrangements that on no account was he to exceed the threshold of 4.99%.
At the time of his appearance before the Commission Eric Watson was asked how he was able to determine the shareholding position, in particular, as to who owned what MPL shares at any particular point in time. He said that they hadn't sat down to sort this out however as far as he was concerned the first 4.99% would have been his and anything above that would have gone to the other two participants (Richard Johnston and Craig Joynt). Eric Watson was asked how this worked and how it was controlled. The transcript of evidence records the following exchange between Joanna Perry (Commission Member) and Eric Watson:

Ms Perry: ... How at any point in time can you be certain that in any share trading you have not breached, or you have not reached 5 percent, and therefore, need to file a Substantial Security Holder Notice, or that you've then gone 1 percent up or 1 percent down, if the three of you can deal on the accounts, if the money's coming out of a variety of bank accounts. Like it - to me, it sounds as though somebody needs to have immense control over pulling it all together to make sure that you do not breach the law by ever going - to getting to be 5 percent. Are you sure in your own mind that happens, that that control is there for your holdings? Because it's putting you in a very bad position if it's not.
Mr Watson: I - there's a few answers to your question. We have reached 5 percent in other New Zealand public companies and where appropriate we've made the filings. The - in my mind my advisors, be they Johnston, Gibson, Strowger, Kidd, should be talking to each other. They should have my interests under control, and I believe that to be the case. I'd be disappointed if it wasn't. My focus is on the macro ... I'm comfortable that I trust the people around me. I hope I don't have to change it.
Eric Watson then provided a schedule of his trading to the Commission at the end of May 1998, after his appearance before Members earlier in the month. The schedule (at Appendix C) shows his accumulation of shares throughout the period. In particular, it shows that the shares came to him in the first instance and that transfers to Richard Johnston and Craig Joynt then occurred whenever the 5% threshold was threatened.
The schedule of transactions completed at the end of May 1998 (at Appendix C) is the only evidence that the interests of the three have been reconciled. This was some twelve to eighteen months after the transactions had occurred and a year after the shares had been re-sold.
There is also the nature of the relationship between the three participants. It appears from the evidence that all three of them have had a close relationship both at the business level and at the personal level, and that this has existed for some considerable time.
There is also the matter of funding. At the time oral evidence was received from the parties in mid-May 1998 it was not clear to the Commission as to how the share purchases in MPL had been funded. Richard Johnston however subsequently informed the Commission that all the money (save for the purchase of the 398,000 shares on 16 May 1997) had come from Eric Watson's current account with Cullen (previously called Watson Investments Limited). Cullen is a private investment vehicle of Eric Watson. The Commission was informed that Cullen's current account also holds some money for Richard Johnston and Craig Joynt (in addition to Eric Watson), however, no accounting records have been provided about this. Looking at the purchase of the 398,000 shares, it appears that this was mostly funded from a re-sale of shares which had been purchased earlier and, on the Commission's analysis, was also funded out of Eric Watson's current account with Cullen.
Approximately 70% of the shares acquired were purchased in the name of Seahunter which is a company registered in the British Virgin Islands (a jurisdiction that has a reputation as a regulatory haven). The instructions for one of the Seahunter transactions (the purchase of the 500,000 MPL shares on 28 April 1997) were routed through J Henry Schroder Bank AG in Switzerland and Deutsche Morgan Grenfell in London. Also, payment for these shares came from funds which had been transferred out of New Zealand to Switzerland, and then back to Auckland to pay Cavill White.
The Commission also notes the use of different brokers and the use of four different names to undertake the trading (Craig Joynt, Richard Johnston, Kitchener and Seahunter) giving rise to a somewhat complex picture of ownership. On analysis, the brokers' nominee companies, as the registered holders, held for Craig Joynt, Richard Johnston, Kitchener and Seahunter who, in turn, held for the participants. As such, the true beneficial ownership of these interests in MPL has been obscured.
When Richard Johnston gave oral evidence to the Commission on 11 May 1998 he described the investment in MPL in different terms to what Eric Watson was to say (paragraph 30 refers). Significantly, Richard Johnston did not then say that he (and Craig Joynt) would only be entitled to shares once Eric Watson had reached 4.99%. The Commission finds this surprising given the importance of this aspect of the arrangements. It was only after Eric Watson had given evidence that Richard Johnston said that in his view also, this was part of the arrangements.
The whole matter is characterised by an absence of proper records e.g. about the money of Richard Johnston and Craig Joynt held in Cullen, about the adjustment between Cullen and Blue Star, about transfers of interests in shares, about the ownership of shares held by Kitchener and Seahunter.
Having regard to all these things, it is the Commission's opinion that a question of serious breach of the law on substantial security holder disclosure arises in relation to the trading in the shares of MPL. In the view of the Commission there are certainly reasonable grounds to suspect that at the time Eric Watson was either, the beneficial owner of all the shares (with Richard Johnston and Craig Joynt acting as his agents or nominees), or, that the three of them were acting together in this enterprise and each had joint beneficial ownership in all the MPL shares acquired. This was a total of 2,403,800 shares equating to 10.13% of the company. The Commission considers a notice should have been given when 5% was reached(on 27 March 1997). The Commission considers a notice should have been given in respect of subsequent acquisitions of 1% or more. No notices were given and the market was left uninformed about the interests. In the circumstances of the Blue Star takeover that was under negotiation at the time, a substantial security holder notice would have had profound interest so far as the market was concerned. The matter was undoubtedly material.
There is also the position of Seahunter, it having acquired 1,698,000 shares equating to 7.16% of MPL. Seahunter did not give notice of this interest. It would have had an obligation to do so unless it qualified as a " bare trustee" (section 6(1)(f) of the Amendment Act).

Other Comments

Another issue arises in relation to insider trading.Blue Star was not a public issuer (a listed company) for the purposes of the Amendment Act when it took over MPL (a listed company) in 1997. The insider trading law contained in Part I of the Amendment Act will apply where an insider of Blue Star receives inside information in confidence from an insider of MPL and then deals in the shares of MPL. The insider trading law however may not apply where an insider of Blue Star deals in the shares of MPL without having received any inside information from an insider of MPL. This is so notwithstanding that the insider of Blue Star has knowledge of the pending takeover of MPL by Blue Star. In these circumstances, the inside information (the knowledge of the pending takeover) derives from the bidder which is an unlisted company. Had Blue Star been a listed company then liability may arise under section 11 of the Amendment Act in respect of any dealings in MPL by an insider of Blue Star. Section 11 creates liability where an insider of a listed company has inside information about another listed company and deals in the shares of that other listed company.
This whole matter raises issues about the policy of section 11 and in particular the circumstances in which liability should arise, the proper scope of the section where the inside information is not information held by the company whose shares are traded, and the relationship of these matters to private remedies. The Commission intends to further consider the policy, ambit and operation of section 11.
Eric Watson (whether for his own personal benefit or the joint personal benefit of the three participants) acquired shares in MPL ahead of the announcement of the takeover offer by Blue Star on 16 May 1997. He did so in circumstances where he enjoyed a distinct advantage over the rest of the market by virtue of his knowledge of the intentions of Blue Star in relation to MPL. Irrespective of the terms of the insider trading law, and irrespective of Eric Watson's position under the law, the Commission does not consider that personal trading in these circumstances enhances the reputation and standing of our market.
The Commission has also had cause to consider whether the law on substantial security holder disclosure might be enhanced by the introduction of a criminal offence for a case of non-compliance. The MPL shares have been re-sold and as such there is little utility in the Commission taking action under sections 30 to 32 of the Amendment Act. It would be an added deterrent to persons who evade their obligations if they know they can be subject to prosecution.
This report does not purport to deal with any issues arising under United States law. It is devoted solely to a consideration of issues under New Zealand law.

Principal Observations

The principal observations of the Commission in respect of this report are:
1. It is the Commission's opinion that a question of serious breach of the law on substantial security holder disclosure arises in relation to the trading in the shares of MPL.
2. A breach of that law if established would give rise to certain remedies by shareholders and others under the Amendment Act.
3. Irrespective of the terms of the insider trading law and irrespective of Eric Watson's position under the law, the Commission does not consider that personal trading in the circumstances described in this report enhances the reputation and standing of our market.
4. The Commission intends to further consider the policy, ambit and operation of section 11 of the Amendment Act.

Supplementary Statement

The Commission draws attention to the Supplementary Statement attached to this report.

Referral of Report

The Commission proposes to refer the report to:
1. Australian Securities & Investments Commission
2. Australian Stock Exchange
3. Blue Star Group Limited
4. Institute of Chartered Accountants of New Zealand
5. Institute of Directors in New Zealand (Inc)
6. Listed Companies Association
7. Ministry of Commerce
8. New Zealand Stock Exchange
9. Shareholders of MPL in the period October 1996 to May 1997
10. United States Securities and Exchange Commission
11. USOP.
Euan H Abernethy
Chairman of the Securities Commission
18 December 1998