Dear reader,

Welcome to the December 2013 edition of The Director’s Dilemma. To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on ‘read the current issue’.

It seems like only yesterday that I was writing to you with the first newsletter for 2013 and now it is time for the last. Best wishes for the holiday season and I look forward to resuming contact next year. Feel free to email me with dilemmas and articles of interest.

This month our case study considers the disclosure requirements for a listed company when a local competitor takes unexpected action. 

Consider: What would you advise a friend to do under these circumstances?

Christine is a lawyer who has recently joined the board of a small mining exploration company and is keen to develop a career as a non-executive director. She is knowledgeable on the relevant corporate law and also the listing rules of her local stock exchange. She is hoping to add a reputation for practical common sense to her reputation for legal excellence and professional ethics.

Since Christine joined the board she has instituted some changes in the board papers and meeting procedures. The board now reviews changes in shareholding at each meeting and adheres to a policy of restrictions on directors and key management personnel when trading in the company’s stock. The company has always complied with continuous disclosure obligations but now has aspirational statements about prompt reporting and maximum transparency.

Last month a company with a tenement adjacent to Christine’s company’s exploration project appeared as an investor on the stock register. This month that company has bought even more stock and triggered a 12% increase in the share price with trading volumes well above the norm. Christine raised this as an issue of concern but her co-directors don’t see it as an issue. One felt that it probably meant their neighbours had found promising results and were betting on an ore body that crossed into their tenement. Another thought it might presage a takeover bid. None of them felt that they should comment on the share price, volume, current (ambiguous) drilling results or competitor activity. They want to focus on the ‘real’ business of planning their exploration and optimising their cash utilisation.

What should Christine’s board do?

There are two issues the board must take into consideration:

1. Whether or not disclosure is necessary; and
2. The potential impact of the stock purchase by the neighbouring company.

Regarding the disclosure issue, the neighbouring company buying stock in-and-of-itself does not appear to be material given the facts that are known to Christine. In the event that the neighbouring  company acquires more than 10% of Christine’s company’s stock, then it would be the neighbouring company’s responsibility to disclose it.  In addition, there does not appear to be enough evidence to conclude that the increase in trading volume was triggered by the neighbouring company’s stock purchases.

As a new director, Christine should share her knowledge about the listing rules of the local stock exchange that address rumours and unusual market activity with the rest of the board.  She should further suggest that the board instruct management to contact the local regulation services provider regarding the trading irregularity so it can investigate and report back if there is any reason for the company to disclose a clarifying statement based on its findings. With this information in hand, the board will be in a better position to make an informed decision on whether or not disclosure is necessary.

Regarding the potential impact of the stock purchase by the neighbouring company, Christine should explain, from a legal perspective, why it is imperative that the board consider the bigger picture i.e. why the neighbouring company is buying up stock in their company.  It is rare that a competitor would buy stock in a company that it competes against without good reason. A likely scenario may be that the neighbouring company is acquiring a ‘toehold’ to commence a takeover bid. Christine should stress that the potential impact must be given proper consideration by the board in order to mitigate risk and discharge the board’s duties of strategic oversight and direction.  In the case of a takeover bid situation, the ‘real’ business of planning for the company’s exploration and optimising its cash utilisation won’t be the board’s mandate any longer, as their duties will shift to optimizing value for shareholders.

Danielle Doll is a governance consultant and director based in Calgary, Canada.

Something is definitely happening. A 12% increase in share price should make an alert board sit up and ask questions.

First Christine should check her company’s exploration results remain ‘ambiguous’. If there is any change the company should make an announcement of preliminary results and state that exploration is continuing. She should remind staff of the company’s policy on share trading and also of their duty of confidentiality. 

Next Christine should check the stock exchange for recent announcements by the neighbouring company. If they have announced encouraging results they may be buying a strategic stake prior to any acquisition or merger talks or simply to benefit from information they have which is not yet widely known. In that case Christine’s company should treat the activity as ‘price sensitive’ and release a factual statement referring to the neighbour’s announcement and subsequent purchases. An exploration find in the vicinity can reasonably be expected to affect the value of Christine’s company’s shares.

If the neighbours have made no announcement, and there are no potential leaks from her own company, Christine is in an uncertain situation. She could approach the chairman of the neighbouring board and ask what they are up to, but should be aware that she may not get an answer; there is no law against one company buying shares in another and no reason, until a significant shareholding is amassed, for the purchaser to make any announcement regarding their purchase.

Christine should gather some intelligence on her neighbours: who are the major shareholders, how much capital they have, how much of that is required for the programmed exploration, etc. This will help Christine’s board to develop a strategy when the neighbour’s intentions become clearer.

Christine should remain alert. She must try to serve the needs of her shareholders whilst meeting the spirit (as well as the letter) of the disclosure rules.

Julie Garland McLellan is a practising non-executive director and board consultant based in Sydney, Australia.

Christine's board want to focus on what they think is their "real" business: "planning their exploration and optimising their cash utilisation". Shouldn't they get their eyes out of the cockpit a bit more, and think through their response if this should turn into a takeover bid? "Neighbourology" is an ancient, and not always wasteful, pastime amongst the juniors. What if the neighbours are onto a winning flutter, even if the publishable drilling doesn't say much?

The neighbour's board already know they've broken cover, and they've done so deliberately. Why would they now explain their game plan to Christine's mob? "No, no, we just thought that investing in your stock was a better use of our shareholders' money than drilling more holes in the ground!" Not. They know or suspect something significant, or they wouldn't volunteer for the chance of wearing a great deal of facial egg at the AGM. More capital is coming, or their chopper pilot spotted something, or their geo met someone in a pub...

Seems to me Christine's board should do a thorough horizon scan, and think through all the possibilities, not just what to say or not say to the ASX. This game is played for keeps.

Iain Massey is an independent director, advisor and interim executive. He is based in Western Australia. Readers who are not familiar with Australian idioms are advised that there is some sarcastic humour in his response.

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.

Entrepreneurial Boards, when should you form one, who should you invite to join, and how can you get value from it? - There are still a few places left on this interactive and insightful lunch-time course focused on the real dilemmas facing entrepreneurs as they approach the important task of building boards for fast growing companies. The course is on 3 December in Sydney. Click here for more information.

Book Review - The Shift - by Linda Gratton Directors are supposed to be leaders and you can’t lead if you don’t know where you are going. This book looks at current trends in the world of work and extrapolates to the future. The author lectures at London Business School and is involved in a world-wide ‘Future of Work’ research project so there is no shortage of well thought through arguments and case studies to support the premises in the book. Will it all come true? I don’t think so. But most of it may. Well worth a read over the holiday season. Available at Amazon.com in Paperback and Kindle editions.

Inspirational quote -

I have subscribed to a service that delivers an inspirational quote every day. It is a good way to get into a positive frame of mind for the work day ahead. I thought I would share my favourite quote each month. This month my favourite quote was:

"The fool, whose volume of words is as that of ten men, shoots a hundred arrows and each one misses of the target.  If thou art wise, shoot one, and that one straight."
~Saadi (or Sa’di)

This is advice all directors should read and heed before every board meeting. Think of the time we could save!

If you would like to subscribe the service is run by Darren La Croix at: https://365inspirationalquotes.com/.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Thank you - I was a bit (well, a lot) ill over the last two months and am now back to my usual fit and healthy self. I wanted to say a big ‘thank you’, from me, to all the people who wrote with good wishes for my recovery. You really cheered me up.

Farewell until the next issue (due 1 February 2014).
Enjoy governing your corporations; we are privileged to do what we do!

Best regards,
Julie