Corporate Advisory

11 Sep 2008

NZX Guidance Note: Toughening the Rules for Backdoor and Reverse Listings

Backdoor and reverse listing transactions have been used in New Zealand as a mechanism for listing entities on the New Zealand Stock Market (NZSX) efficiently and economically. Due to recent market failures of backdoor and reverse listings, NZX Limited (NZX) is now tightening the rules around these types of transactions.

NZX has reviewed its policy and practice on backdoor and reverse listing transactions and, as a result, has issued a guidance note (Guidance Note). This will assist companies, intending to complete a backdoor or reverse listing transaction, to comply with their obligations under the NZSX/NZAX Listing Rules (Listing Rules).

As a general policy position, NZX now intends to subject backdoor and reverse listings to the same level of disclosure, liability for misstatements, and fees as standard IPO listings (IPOs). This note discusses the key changes that have been made to requirements in respect of backdoor and reverse listing transactions.

We believe the new strict liability regime may unreasonably deter desirable transactions.

What is a Backdoor or Reverse Listing Transaction?

Backdoor and reverse listing transactions have been a long-standing feature of New Zealand's capital markets. They generally occur when a defunct NZX listed company (NZX Issuer) purchases a private company or its business (Target Company) in order to list an entity that incorporates an existing business of the Target Company (Post Transaction Issuer). Often the NZX Issuer effectively "pays" for the Target Company business by issuing shares to the Target Company or its owners.

Backdoor and reverse listings can take place on both the NZSX and the NZAX markets.

NZX Policy

In the last 24 months NZX has seen a number of these types of listings in its markets, largely due to the time and cost efficiencies associated with this method. Backdoor and reverse listings are also used by shareholders of a defunct company to extract residual value from their investment. However, the failure rate of backdoor and reverse listings has generally been high. After a series of public failures (eg, Blue Chip and The Joneses), NZX has reviewed its policy and practice in this area and issued a Guidance Note to place these types of transactions under the same market scrutiny as IPOs.

Process

To participate in a backdoor or reverse listing transaction, a NZX Issuer is required to obtain shareholder approval under the Listing Rules, as the acquisition of the Target Company will result in either:

• a change in the essential nature of the business of the NZX Issuer; and/or
• a purchase of an asset of which the gross value is in excess of 50% of the Average Market Capitalisation of the NZX Issuer.

A Notice of Meeting is prepared to approve the transaction, and must be approved by NZX in accordance with the Listing Rules before it can be circulated to shareholders.

Additional Requirements

For  NZX approval to be granted for a backdoor or reverse listing, the Guidance Note states that a Notice of Meeting must now be accompanied by:

• a Profile;
• an Independent Report (in respect of the Target Company); and
• a Certificate (included in the Profile).

This information is required by NZX in order to:

(a)          "…enable the shareholders of the NZX Issuer to appraise the implications of the proposed transaction; and

(b)          adequately inform the market in relation to the business and operations of the Post Transaction Issuer."

Disclosure and Liability for Misstatements

Previously, unlike IPOs, backdoor and reverse listings were generally not subject to the requirements of the Securities Act 1978 and the regulations made under that Act (Act), due to the fact that a backdoor or reverse listing does not involve an offer of securities to the public. Similarly, backdoor and reverse listings were not subject to misstatement liability under the Securities Markets Act 1988 (SMA) unless a director knowingly made a false statement.

Under the Guidance Note, a backdoor or reverse listing will be treated as if it were an offer to the public by the Target Company of securities in the Post Transaction Issuer. A company intending to complete a backdoor or reverse listing must now provide a Profile that contains all information required to be contained in a registered prospectus for an IPO under the Act.

Subjecting the Profile to the same content requirements as an IPO prospectus means more thorough disclosure. This is desirable as such disclosure provides important pricing signals to the post transaction market.

In addition to the Profile, the Guidance Note also requires that directors personally certify the accuracy and completeness of the information contained in the Profile. This certification may expose directors to liability under the SMA.

The reasonableness of this exposure to liability is questionable. In particular:

• some matters required to be certified are matters for which directors normally rely on professional advice or a verification procedure, as opposed to possessing personal knowledge of the matter (eg, legal advice on the contents of the Profile and management verification of factual statements in the Profile);
• the Certificate suggests that directors do have personal knowledge of these matters required to be certified as the Guidance Note requires that directors must "certify" these matters after "due inquiry". Directors can be strictly held to this but will be aware that they do not possess personal knowledge of the matters certified and, incidentally, aware of the misleading nature of the certificate; and
• further, given the above representation, questions may arise regarding "wilful blindness" and whether directors "ought to reasonably know" of errors in or omissions from the Profile.

The effect of the certification is that, in the event a statement in the Profile proves to be incorrect or required information is missing, a director may immediately be exposed to liability, based on the Certificate, to the extent that they knew or ought reasonably to know of the inaccuracy or omission. Given the "due inquiry" requirement, it would be difficult for a director to establish that the "ought reasonably to know" test was not satisfied as "due inquiry" implies that the test is automatically satisfied.

Unlike the IPO regime, the Guidance Note does not provide suitable defences. Particularly, there is no defence of reasonable belief in the truth of a misrepresentation. This effectively subjects the director to strict liability, potentially resulting in various pecuniary and compensatory orders, criminal liability of up to five years imprisonment, or a $300,000 fine. Consequently, the risk for directors under the new regime has increased and is serious and unavoidable. This may unreasonably deter directors from participating in backdoor and reverse listings.

Fees

Under the new regime, the fee structure has been changed to remove the cost efficiency incentive previously associated with backdoor and reverse listings and bring the costs of this type of transaction in line with IPO fees.

Given that the entity has already paid fees for listing, imposing a fee on entities intending to change their business direction by completing a backdoor or reverse listing may be viewed as arbitrary and eroding value where shareholders wish to extract value from a defunct company.

Authors

Kevin Jaffe

Partner - Corporate & Commercial

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Shelley Cave

Partner - Corporate & Commercial

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Peter Hinton

Partner - Corporate & Commercial

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Don Holborow

Partner - Corporate & Commercial

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Michael Pollard

Partner - Corporate & Commercial

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Mark Verbiest

Consultant - Corporate & Commercial

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Alex Campbell

Senior Associate - Corporate & Commercial

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