Deep River Investment vs GEM
Rumblings in Corporate Boardrooms
Is the FSC satisfied that due processes have been followed in rejecting GEM’s bid?
— MURLI DHAR
Deep River Investment (DRI) is part of the CIEL Group of companies. It is a listed company on the Development and Enterprise Market of the local stock exchange. As such, it comes under the purview of the regulator of securities, notably the Financial Services Commission (FSC) and operates within the ambit of the Securities Act 2005 and the Securities (Takeover) Rules of 2010. These Rules are broadly a replica of those obtaining in the UK and are thus meant to be reflective of internationally applicable standards. The CIEL Group encompasses a wide array of economic activities including sugar through the Deep River Beau Champ and others such as Ferney Land, CIEL Textiles and Novelife. It is an important stakeholder in the economy of which it has been a key player for long.
Companies normally go for a public listing in order to, amongst others, tap the capital market for their expansion and development. In so doing, they remain open to takeovers by interested bidders. Listing on the stock exchange also means that such companies should abide by the rules laid down by the securities regulator and thus make themselves as publicly transparent and accountable as possible. Some companies, which cannot make it to these standards, either do not get themselves listed or arrange to de-list from the stock exchange if they cannot bring themselves up to the standard of disclosure of their practices which a sound regime of financial regulation calls for. It goes to the credit of DRI therefore that it has opted to go for a listing.
Since last year however, certain directors of DRI have been expressing their discontent with the style of its management. This could mean that, in their assessment of the situation, value is not being created by the company as much as those shareholders would have thought it possible. It could also reflect a situation in which certain controlling directors would be appropriating to themselves a disproportionate amount of the company’s earnings or giving excessive hand-outs to certain selective executives beyond what they would actually deserve. We do not know what exactly they would be reproaching management for but they have been asking for reform of the company’s governance structure.
There are many aberrations in general in companies’ economic and financial behaviour, some of it being deliberately designed to get on to specific targeted results. Thus, certain companies are known to be raising expensive loans from related parties to fund themselves up in lieu of raising additional equity capital from the market for this purpose. This seeking of financing through related party loans in preference to equity ensures that a good part of the company’s earnings get diverted towards paying interest on loans (usually at above market interest rates) to the related parties, thereby diverting the companies’ earnings away from their shareholders to the extent the interest expense has to be met.
All of this hurts companies’ bottom lines so that dividends are not paid out to shareholders or very little of it. Sometimes, a case is made out even to portray such companies as having to operate in distressful economic conditions, especially where the projects funded with the loans misfire due to misguided investment decisions by management/dominant board members. This state of affairs, which gets reflected in a weak profit and loss account, also helps concerned companies to put a lid on claims for salary compensations except for the privileged “management” class. The duty of a company board is not to allow the situation to deteriorate due to excessive overheads or management hand-outs, which tend to make the company or certain units operating as part of it become uneconomical. However, the Board cannot always make its point in such cases when it is confronted with blocking shareholder voting majorities. The latter overrule any proposal that does not suit their own convenience.
In the case of DRI, the discontent of certain of its Directors is being aired since last year to the point that they would have expressed their intention to dispose of their shares in the company. They were unhappy that despite their requests, the Company’s management was allegedly unable or unwilling to restructure itself effectively. In the circumstances, three of the Company’s shareholder-directors holding 38% of the total shareholding decided that they would be willing to dispose of their shares in one lump sum if the situation did not improve to their liking. They were prevented from proceeding in this direction thanks to an injunction of the court limiting shareholders from disposing of their shares at will on the basis of a prior shareholders agreement signed some years earlier.
In early March 2012, the Company was in the presence of a letter from an investor group by the name of GEM offering to acquire up to 100% of the company through a public offer of its shares. This is not unusual for listed companies; in fact the regulatory rules go in this direction of encouraging takeovers of listed companies. Moreover, the shareholders having 38% of the company could have sold their shares at a reasonable price to GEM. An acquisition of the company in this manner would have constituted a way to circumvent the constraint imposed by the shareholder agreement referred to, the object of which appears to be not to allow company shares to shift over to unauthorized eventual owners.
Takeover of listed companies of the sort is governed by the Financial Services Act 2007 and the Securities (Takeover) Rules 2010. The Cautionary Announcement issued by DRI in March this year in connection with GEM’s bid stated that it had spotted shortcomings in the proposal made by GEM which would be addressed by its Board.
The three dissenting shareholder-directors who constitute the bloc shareholding of 38% in the company were dismissed in the meantime as Directors by the Board inasmuch as the Company would have received legal advice that by their action, including disposing of their shareholding in this context, they would have allegedly acted in a position of conflict of duties and contrary to their fiduciary responsibility towards the Company. Their removal means that their dissenting views will therefore not be heard in the public and it looks very much like a blocking majority of shareholders/Directors would be at work. Moreover, their removal will have the effect of frustrating the offer made by GEM insofar as they could have contributed to give controlling interest by selling their shareholdings in the company at a good price to the bidders.
At the DRI’s level, the point was raised as to whether the proposal made by GEM constituted a firm intention to make an offer under Rule 9 of the Securities (Takeover) Rules. The Chairman of DRI (Mr Arnaud Dalais) subsequently informed GEM that its proposal did not constitute a “firm intention to make an offer” for the Company, and was therefore unacceptable. There are doubts as to whether this interpretation of the offer made by GEM is correct. This interpretation of the Rules governing a firm offer may be flawed or one-sided. It would appear, in the face of such information as has come to our attention, that GEM has effectively met all the conditions for making its proposal to DRI qualify as a firm offer as set out in the Takeover Rules, which are ultimately under the responsibility of the Financial Services Commission (FSC) as regulator of the market. If so, arbitration as to whose interpretation of the Rules was correct became an open question.
On the other hand, the FSC, having been solicited by the concerned parties to deal with the matter, has declined to intervene, considering it as an internal issue that were best left to be dealt with among the two parties. It is not known as to what were the views of the Stock Exchange of Mauritius, which is vested with responsibility to enforce trading rules on the market, in the matter. On this score, DRI would appear to have decided that the offer of GEM is not in accord with the Rules and has thus rejected it. This could be the end of the matter. It would be a matter of concern if the FSC allowed the listed company to interpret the Rules unilaterally and dispose of an otherwise valid firm offer by GEM according to DRI’s own interpretation of market regulatory rules. There is surely an element of public interest if the listed company has, acting on its own, effectively discarded a firm offer from GEM which is compliant with the law and existing rules applicable to all listed companies. One would be happy to be informed by the FSC that due processes have been abided by and that a fair treatment has been meted out to GEM investors.