Friday, 29 July 2011

RPT's: why do all protective layers fail?

Related Party Transactions (RPT’s) in Malaysia have a horrible reputation, and for a very good reason, in the large majority of the cases overpriced assets are sold by the Majority Investor to the company it controls for pure cash. Security Commission and/or Bursa Malaysia should therefore be extra alert from the moment that the intention is announced and make sure that all is fair and square. Unfortunately, this is simply not the case.
It is very important to note that the rules regarding RPT’s are actually in favour of the Minority Investor:
“fair and equal treatment of all shareholders, in particular, minority shareholders”
In other words, if there is any doubt, the Minority Investor should be favoured. This rule could and should have been used many times by SC/BM, in my opinion it has never been used, puzzling, to say the least. Why is the SC/BM so biased?
There are many layers to protect Minority Shareholders, but many horrific cases of RPT’s have still been pushed through, in other words all layers of protection have failed in spectacular fashion. This is in itself is puzzling, and I would strongly advise an independent group to study this in detail.
The procedure for RPTs is as follows:
(a)    Directors of a company decide about the RPT: in theory, directors who are not related should decide about the merits of the deal, since it is a related party deal. In practice, there will be a huge amount of pressure on them to toe the line. SC means it well by giving education to directors, asking for a certain quota of independent directors, limiting them to a maximum number of years, etc, in practice it will all not matter for these really big deals. Even Warren Buffet admitted (when he was director) that the pressure to follow is just too big (for instance when Coca Cola used a much too aggressive way of accounting). In Malaysia I have never witnessed any opposition against any plan by Independent Directors. In two cases (the infamous UEM/Renong and the Maruichi deal), 2 directors resigned. In both cases, that was a sign that things were indeed very wrong, and things went downhill from there. Apparently, that is as far as a director can go in Malaysia, and it is very rare.
(b)   Company announces a RPT, SC and BM can start doing their work: Unfortunately, already in this very important phase often huge errors are made. SC/BM should be very pro-active, insisting on a large amount of relevant information. For instance, if the last audited account is more than say 6 months ago, SC/BM should insist on a set of new audited accounts. At this moment SC/BM should be alert on valuations, and if necessary insist on second opinions.
(c)    Company sends circular to SC/BM for approval: SC/BM has approved many circulars that were of dreadful quality (I will come with clear examples): which information is withheld, which opinions are unrealistic, which valuations are completely off, which rules were broken, etc, etc, etc. It is my experience that SC and BM focus much too much on form instead of on substance. The fact that these circulars are approved is very important, if from now any complaint by Minority Investors would be sustained against the circular, it would mean that SC/BM has not done its work properly. That is often the case, but to admit that is something else. From now onwards there is no way back anymore, Minority Investors will have no realistic chance at all is my experience and they still haven’t been involved at all.
(d)   Circular is send to Minority Investors: Although Majority Investors have many months to prepare their circular as much in their favour as possible, minority shareholders are very much hurried into doing their own research and making their decision. Often the time available is about ten days (sometimes even less, depending when one receives the circular by post). The only chance to try to stop the process is to hurriedly file a complaint to SC/BM, to try to get some attention from the media (in practice only The Edge will publish critical letters in English is my experience) and to hope that MSWG is interested to fight the case (in my two examples, Barmada and Maybulk/POSH they weren't). In reality, it is a sheer impossible task, the odds are hugely stacked against the Minority Investors and the clock is ticking.
(e)    Attached to the Circular is a report by an “independent” advisor: “Independent” reports are not worth the paper they are written on. They always follow the opinion of the Majority Investor (I remember having seen exactly one exception to this rule, besides some irrelevant ones where a company did a General Offer which was below the market price), and because of that alone they should be immediately abolished since they are so clearly biased and the effect is very negative. Majority Investors who want to push through their deals can fall back on the recommendation of the “Independent” report. It also gives a reason to EPF/PNB to follow suit and vote accordingly to the advice. Why do “Independent” advisors follow the Majority Investor? In my opinion, they hope that in the future they will get another corporate deal. They won’t get one from the Minority Investors, so the choice is simple. There might be other, more sinister reasons though, they might for instance be pressured by certain parties to follow the Majority Investor’s opinion. There is zero doubt in my mind that these “Independent” reports should be abolished as quickly as possible. They simply don’t work, and very much decrease the chances of Minority Investors for justice instead of increase.
(f)     SC/BM could stop the EGM: In reality, I have never seen an example of this. I have zero doubt in my mind that in the Maybulk/POSH case the circular was so biased that the SC immediately should have stopped the EGM. They didn’t, and that is puzzling, what were the motives of the SC?
(g)    At the EGM Majority Investor will abstain from voting: Although the Majority Investors abstain, related parties might still be able to vote. There is hardly any transparency and the BM is not exactly pro-active. I have never heard of another party being barred from voting. Related parties being able to vote will reduce the chances of the Minority Investors very much.
(h)    Minority Investors will vote: Unfortunately for the Minority Investors, given the huge odds against them, the misinformation they received in the circular, the hugely biased “Independent” Report, they can hardly expect to win the vote, especially since EPF/PNB will most likely follow the Majority Investor. EPF/PNB are completely not transparent in their actions (although they should be, managing other people’s money), in my opinion they have carried the vote for the Majority Investor in many (if not all) cases. I also fear that they are often (perceived to be) pressured to vote in the way they do.
Given the above, I have given some clear recommendations to change the whole procedure for RPT's, since the current one simply doesn't work at all.

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