2 ISSUES ON TAKEOVERS AND REVERSE TAKEOVERS ARISING FROM LIST! ISSUE 16

2.1 Introduction

Since the implementation of the EU Prospectus Directive (2003/71/EC), introduced into UK law on 1 July 2005, both the UKLA and regulators across the EU have unsurprisingly faced numerous questions from companies and their advisers on required prospectus content under the new rules. In an effort to address some of the frequently asked questions both the UKLA, in its List! publication, and the Committee of European Securities Regulators (CESR) have published extensive commentary on disclosure issues arising under the Prospectus Directive. The UKLA published an extended version of List! in July 2007, which addressed a series of questions on prospectus content requirements, in particular in "limited access situations" i.e. where a company, required to prepare a prospectus in connection with a hostile bid, is faced with the problem of needing to include information on the target company but without access to any of its non-public information or any assistance from its management.

This article will highlight some of the key issues addressed by the UKLA in this recent edition of List! and consider the implications for companies required to prepare prospectuses in the UK. Given the broad scope of sections 85(1) and (2) of the Financial Services and Markets Act 2000 (FSMA), where the requirement to publish a prospectus is set out, the requirement can fall on companies in a number of situations, not just on an IPO. In particular, a listed company wishing to acquire another company, to be paid for all or in part by shares in itself, may well find itself needing to prepare a prospectus in connection with the acquisition, for reasons outlined below.

2.2 Prospectus Requirement - Relevance

The prospectus requirement introduced by section 85 of FSMA is two-fold: companies are required to issue approved prospectuses in the event of a public offer of transferable securities (s.85(1)), or in connection with an application for the admission of transferable securities to trading on a regulated market (s.86(2)), subject in either case to applicable exemptions. Approved for these purposes means approved by the UKLA, the arm of the FSA with responsibility for vetting and approving all prospectuses issued in the UK.

The Main Market of the London Stock Exchange is a regulated market for these purposes, but AIM is not. For AIM companies, therefore, the requirement to publish a prospectus will only arise in conjunction with a public offer. A company on the Main Market however will also be required to publish a prospectus, on its initial admission to the exchange, and on any subsequent issue of shares, subject to applicable exemptions. The key exemption here is the ten per cent. exemption at Prospectus Rule 1.2.3, which allows a company to issue less than ten per cent. of the class of its shares listed on the regulated market, aggregated over a twelve month period, without being required to publish a prospectus.

Share for share acquisitions

To look at this in the context of a listed company carrying out a substantial acquisition, it is clear that where the acquiring company is on the Main Market, and will be issuing more than ten per cent. of the class of shares listed on the exchange in consideration for the acquisition, a prospectus will need to be prepared in the UK before these consideration shares can be listed.

The prospectus requirement is also triggered if the company is making a non-exempt public offer of shares in the UK in connection with the transaction - usually meaning the offer of shares in the acquiror is made to 100 or more shareholders in the target who are not qualified investors, as defined in s. 86 FSMA. The distinction between Main Market and other companies is not relevant to this requirement. AIM, or even private, companies making a non-exempt public offer will need to prepare a prospectus.

2.3 Reverse Takeovers

Working capital statement

For the reasons outlined above, a reverse takeover following which the shares of the enlarged group will be admitted to the Main Market, will necessitate publication of a prospectus.

Under the Prospectus Rules, one of the fundamental content requirements for any prospectus is a statement confirming the issuer has sufficient working capital for its present requirements, along the following lines:

"The Company is of the opinion that the working capital available to the Group is sufficient for its present requirements, that is for at least 12 months from the date of this document."

It is then a matter for the issuer, its sponsor and reporting accountants to do sufficient underlying work to enable the issuer to be comfortable in making that statement. Where an issuer cannot make a "clean" working capital statement, it would have to make a "qualified" statement instead. CESR has published quidance on the disclosures that should accompany such a statement (paragraphs 116-123 of CESR's recommendations for the consistent implementation of the European Commission's Regulation on Prospectuses no 809/2004 (CESR's Recommendations)), which must at least include a bald statement that the issuer "does not have sufficient working capital for its present requirements".

CESR's Recommendations state clearly that a working capital statement provided by an issuer needs to address the whole of the issuer's group i.e. to cover all group companies. This gives rise to the question in a reverse takeover situation, where shareholder approval is being sought and the prospectus is issued in advance of approval of the transaction, of which group the working capital statement is meant to cover. Is it the group as enlarged on completion of the transaction, or the group at the time the prospectus is issued?

The UKLA's answer is that the statement must cover both. A working capital statement which refers only to the working capital of the enlarged group is unlikely to be acceptable as it may be seen as stating an underlying assumption, that the transaction will be approved by shareholders and will proceed to completion, which detracts from the value of the statement and puts the onus on investors to reach their own conclusion regarding the adequacy of working capital.

Instead, the working capital statement, and the work underlying it, need to cover all possible funding scenarios that the issuer could face. So the UKLA appear to be stipulating a working capital statement drafted in the alternative, confirming the sufficiency of working capital in the event that the reverse takeover takes place and in the event that it does not.

2.4 Limited Access Situations

A hostile takeover situation, where the issuer does not have access to non-public information on the target company being acquired, will give rise to a number of difficulties in terms of compliance with relevant Prospectus Rule obligations:

2.4.1 Working capital statement

Without access to any non-public financial information on the target company, it will clearly be difficult for an issuer to provide a "clean" working capital statement in relation to the group as enlarged by the target. Making a "qualified" statement instead, without access to the necessary information, may equally be misleading.

Acknowledging the difficulty the issuer faces, the UKLA recommends the following: a statement that it has been unable to undertake the procedures that would enable it to provide a clean working capital statement, and why. The issuer must also then give a 12 month working capital confirmation on the group as it is at the date of the prospectus, without the acquisition having taken place, and make clear that the acquisition has not been taken into account.

The UKLA also states that it would expect the issuer to produce a supplementary prospectus with an updated enlarged group working capital statement, as and when it is granted sufficient access to the target's non-public financial information.

For the initial prospectus, a working capital statement should therefore be along the following lines:

"The Company is not able to undertake appropriate procedures to support a statement in respect of the sufficiency of the Enlarged Group's working capital, when taking into account [the Acquisition]. The Company does not have access to non-public information on [Target] which would allow these procedures to be undertaken.

If the Company is granted access by [Target] and such access is sufficient for the purpose of making a statement in respect of the Enlarged Group, taking into account [the Acquisition], the Company will publish a document containing an updated working capital statement in respect of the sufficiency of the Enlarged Group's working capital.

The Company is of the opinion that the Group, excluding [the Acquisition], has sufficient working capital for its present requirements, that is at least the next twelve months from the date of this document."

2.4.2 Responsibility statement

The directors' and issuer's responsibility statement, in the following, prescribed form, is another key content requirement under the Prospectus Rules:

"The Company and its Directors (whose names appear on page ? of this document) accept responsibility for the information contained in this document. To the best of the knowledge and belief of the Company and the Directors (who have taken all reasonable care to ensure that such is the case), the information contained in this document is in accordance with the facts and contains no omission likely to affect the import of such information."

Thus, it is acknowledged that the issuer and its directors are responsible for the entire content of the prospectus, even where parts of it have been prepared and signed off by a third party, for example the accountants' report, or where information has been sourced directly from attributed third party sources. In the latter case, there is a further obligation on the issuer to include a statement that such information has been accurately reproduced and that, so far as it is aware, nothing has been omitted that would render it inaccurate or misleading.

The UKLA confirms that a limited access situation does not entitle an issuer or its directors to limit or qualify the prescribed form of responsibility statement that they are required to give under the Prospectus Rules, nor the confirmation as to the accurate reproduction of information sourced from third parties.

2.4.3 Risk Factors

Issuers in a limited access situation may want to include a statement within the risk factor section of the document that information on the target company included in the prospectus is limited to publicly available information, and that the issuer has not been able to verify independently the accuracy of such information.

As stated above however, such a risk factor must not seek to limit or qualify the responsibility of the issuer or its directors for the content of the prospectus. Issuers are advised in List! to add a statement at the end of the risk factor along the following lines: "nothing in this risk factor limits or qualifies the issuer or the directors' responsibility under section 5.5 of the Prospectus Rules or part 6 of FSMA".

2.4.4 Pro Forma

In the event of a significant gross change, an issuer must include pro forma financial information in its prospectus, this being a description of how a significant transaction might have affected the assets, liabilities and earnings of the issuer had it been undertaken at the beginning of a given financial period. There are various form and content requirements in the Prospectus Rules, one of which is particularly relevant here, namely that an independent accountant must opine that the pro forma information has been properly compiled on a basis which is consistent with the accounting policies of the issuer.

Where the accountant has not had access to the underlying financial information of a target company being acquired in a significant transaction, they will be unable to provide this opinion, which the UKLA acknowledges. The suggested solution is that the issuer includes a narrative description of the effect of the transaction in the prospectus.

2.4.5 Access Granted

In the event that an issuer is granted access to non-public information on a target company whilst an offer is still open, the UKLA indicates that this would usually be considered a significant new factor requiring the production of a supplementary prospectus. As mentioned above, this will give the issuer the opportunity to include fuller information on the enlarged group, including an appropriate working capital statement.

2.4.6 Information on the Target

Finally, the UKLA notes its own obligation under s.87A(1) of FSMA not to approve a prospectus unless it contains the "necessary information" and states that, in a limited access situation, it will ask the issuer to confirm that it considers the disclosure requirements have been met, without which it will not be able to approve a prospectus. Quite where this leaves an issuer who cannot gain access to certain information on a target company in a hostile bid situation is not entirely clear. The UKLA adopts a purposive approach to interpretation on a case by case basis, and all issuers who find themselves in a limited access situation are encouraged to contact the UKLA at as early a stage of the transaction as possible to discuss disclosure requirements.

2.5 Conclusion

The UKLA is careful to stress in the July edition of List! that the commentary included therein is not formal guidance as contemplated by the FSMA, and its technical explanations are illustrative only. However, the commentary does provide a helpful indication of the approach the UKLA is likely to take on particular issues, and should be considered by any company and its advisers which find themselves in, for example, the limited access situation described above.

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Clive Hopewell or Alexander Keepin (London), Francis Rundall, Richard Norton or Adrian Mayer (Cheltenham) or Catherine Drew or Geoff Sparks (Guildford) or Peter Elliott (Oxford) on 0207 203 5000.

This information has been prepared by Charles Russell LLP as a general guide only and does not constitute advice on any specific matter. We recommend that you seek professional advice before taking action. No liability can be accepted by us for any action taken or not taken as a result of this information. Charles Russell LLP is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Law Society. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide.