This paper has been prepared as part of the Government’s Corporate Law Economic Reform Program (CLERP) which is reviewing regulatory requirements with a view to facilitating investment, employment and wealth creation while protecting investors and maintaining confidence in the business environment.
This paper sets out proposals for reforms designed to significantly reduce the cost of fundraising by Australian companies. The proposals have been developed in consultation with the business community, in particular, the Government’s Business Regulation Advisory Group, see Appendix A.
Fundraising is one of the key areas identified for review and reform in view of its central importance to business activity. This is especially vital to small and medium sized enterprises (SMEs) which are a source of innovation and will be a major source of future employment. SMEs account for almost half of Australia’s private employment and around 40 percent of private sector output. A feature of the proposed reforms is their recognition that special provision should be made for capital raising by smaller enterprises.
An improved environment for raising capital will lower transaction costs and lead to increased levels of investment. To best harness the potential of Australian entrepreneurship, the law must facilitate investment in new and existing enterprises in a way that is cost-effective and underpins confidence in the integrity of our equity markets. The regulatory environment for capital raising has an impact on how quickly new technologies, goods and services can be ‘brought to market’. The proposals for reform in this paper aim to facilitate much more efficient and cost-effective access to equity for such enterprises.
The proposed reforms of the fundraising rules are designed to provide:
- a better framework for capital raising by small, medium and large enterprises;
- investors with relevant, comprehensible and cost-effective information for informed investment decisions; and
- improved opportunities to fund new and growing businesses.
Scope of this Paper
This paper sets out for public discussion the more significant issues relating to the fundraising rules in Chapter 7 of the Corporations Law. These rules apply generally to offers of securities, including shares, options, debentures and interests in managed investment schemes. On 24 August 1997, the Government announced changes to the Corporations Law concerning managed investment schemes. As part of CLERP, the Government will also be issuing papers on the regulation of futures and securities markets and electronic commerce. Those aspects of electronic commerce which directly relate to fundraising are dealt with in this paper. Legislation implementing the reform proposals of this paper would take account of proposals in other CLERP papers.
This paper also deals with recommendations of the Financial System Inquiry (FSI) which directly affect fundraising. These include recommendations that:
- notwithstanding section 52 of the Trade Practices Act, due diligence defences should operate where a positive duty is imposed to disclose material information (as in prospectuses) (Recommendation 4);
- profile statements should be provided for offers of retail financial products (Recommendation 9); and
- the regulator should promote more effective disclosure and encourage the use of shorter prospectuses, especially for smaller offerings (Recommendation 10).
Action taken in relation to a number of other recommendations of the FSI, which the Government is considering separately, may also affect fundraising. These include recommendations relating to disclosure obligations for retail financial products generally (Recommendation 8), the regulation of financial advisers and dealers (Recommendations 13, 14 and 15), the role and powers of the regulator (Recommendations 27, 28 and 29), the broader regulation of financial products (Recommendation 19) and the introduction of a central gateway for dispute resolution (Recommendation 25).
The case for reform: capital market efficiency and confidence
Corporate fundraising through the issue of equity securities makes a major contribution to the level of investment and therefore economic activity in Australia. For listed corporations alone, the amount of new capital raised in 199697 was over $16.4 billion, representing over 4 per cent of the total domestic market capitalisation. Overall, Australia's capital market represents a significant and increasing proportion of the country's wealth. In 199192 the market capitalisation of domestic equities listed on the ASX was $186 billion, while by 199697, this figure had risen to $387.1 billion.
It is therefore critical that the regulation of fundraising be in accord with a sound economic framework which is probusiness and underpins investor confidence in market integrity.
Under the capital raising system in Australia and major overseas markets, fundraisers must, in general, disclose to prospective investors all material information about the product on offer. For this purpose, they usually undertake due diligence investigations. This regulation is appropriate provided it serves the needs of investors and enhances market confidence.
Disclosure of material information in an effective way places investors in a position to make more confident assessments about securities without undertaking their own costly inquiries. It is generally more practicable and costeffective for the fundraiser, rather than numerous investors, to undertake inquiries and disclose details about its own business.
Unless disclosure is mandatory, investors will be unable to distinguish poor investments from promising investments in a costeffective way. Promoters of bad products are unlikely to voluntarily disclose their flaws. Nondisclosure will result in suboptimal investment and an increase in overall search costs for those investors who are prepared to remain in the market. It will dampen investment confidence and economic activity.
In cases where disclosure is appropriate, effective sanctions should be imposed to ensure that the disclosure rules are followed. The sanctions should be directed at ensuring that due diligence inquiries occur where appropriate and that material information is disclosed. They should not serve to increase due diligence and disclosure costs beyond affordable levels (and thereby deter fundraising) nor should they shift to fundraisers the investment risk properly accepted by investors in efficient securities markets. Investments in securities carry an inherent risk accepted by investors in order to receive the higher returns that such investments can bring. If liability for failed investments was imposed on fundraisers regardless of fault, that would discourage capital raising or result in disproportionate due diligence and disclosure costs ultimately borne by investors in the form of increased prices for securities and lower returns. Reducing the return to investors would in turn dampen investment.
Small to medium sized fundraisers are less able to fund full due diligence investigations, particularly in theirstartup phase. Further, the disproportionate cost of such investigations for small fundraisers must be recouped in the offer price and may raise it beyond attractive levels. The value of small business to the economy warrants a reduction in current disclosure requirements to a level within the means of the fundraiser, subject to appropriate safeguards on investor protection. Sensible and practical investor protection measures should underpin market confidence.
Sophisticated highworth investors do not have the same need as others for regulatory protection. Capital raising from such persons should not be inhibited by disclosure rules designed to protect typical retail investors. Hence mandatory rules for disclosure should not extend to such persons, w
ho can safeguard their own interests in a costeffective manner (which may or may not involve requiring full disclosure by the fundraiser).
The reforms addressed in this paper are designed to:
- maximise market confidence, stability and liquidity;
- promote Australia's international reputation for investment and therefore assist the expansion of the economy, particularly growth in the small business sector;
- create new employment opportunities; and
- facilitate bringing innovative products and services to market quicker.
For a more detailed economic analysis of fundraising, refer to Appendix B.
Enquiries concerning this paper and its implementation can be made to:
Financial Markets Division
Telephone: (02) 6263 3977