Sunday, October 18, 2009

The Impossible Scheme - Hong Kong Court Finds Share Splitting Manipulative

Winston Churchill once said that (North) America and Britain were "two nations divided by a common language." I thought of this recently reading the Hong Kong Court of Appeal decision in Re: PCCW Limited.

One thing that has always struck me as peculiar is that some of what we in Canada and the US call "plans" (pension plans, plans of arrangement, etc.) the rest of the common-law world calls "schemes." This gives it a slightly sinister undertone. The PCCW case is about, well, a scheme to ensure a scheme of arrangement got implemented.

The scheme of arrangement in question was a privatisation in which minority shareholders would be cashed out at a premium to market. Despite this, many shareholders complained that they were being taken out at a time when the market price for the shares was at a nine-year low and they would miss an opportunity to profit from a market rise. Proxy advisors unanimously recommended that shareholders not approve the arrangement. The offerors behind the scheme (who would own and control the company if approved) had more than a majority of the shares. However, under the Hong Kong Companies Ordinance a double super-majority (75% of shares and 75% of shareholders) is required to approve an arrangement. At a preliminary meeting, a motion to adjourn was defeated on an initial show of hands.

In order to ensure the approval of the arrangement, some people connected with the offerors devised a plan to induce employees of their firms and friends to buy small amounts of shares. They were also given proxies to vote in favour of the arrangement. One of the persons bought 500 board lots and gave them away to 494 employees as a "bonus." Of the 1404 shareholders who voted in favour of the arrangement, 940 became shareholders after the preliminary meeting.

Under Hong Kong law (as in Canada) an arrangement must also be approved by a court. The arguments raised by PCCW and the offerors were:

(1) The court should not overturn a valid vote of the shareholders (it was conceded by all parties that the new shareholders were registered shareholders entitled to vote);
(2) Shareholders are entitled to vote the way they please; and
(3) So-called "share splitting" is a normal and accepted practice in these situations.

The court dismissed the first argument out of hand, stating that it made the requirement for court approval superfluous. The court had an obligation to review the arrangement regardless of the shareholder vote and ensure it is fair. In particular, the double majority requirements were adopted precisely to ensure the protection of minority shareholders.

The court then examined the other arguments. While shareholders have a right to vote as they wish, it was clear that they were being told to vote in favour in order to ensure a quick profit. The court found it unusual that the proxy forms were not obtained from PCCW but from the deputy chairman of the company instigating the privatisation. As for the argument that share-splitting was an acceptable practice, the court said:

"I do not consider that any right thinking member of society could condone a situation where the law required that a vote should be taken so as to balance the fairness between the holders of shares in different proportions and deliberate steps had been taken to distort that vote; in this case, it may be said, at minimal cost to those responsible. Vote manipulation is nothing less than a form of dishonesty. The court cannot sanction dishonesty."

Thus, attempts to manipulate voting in corporate transactions are unlawful in Hong Kong.