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ANALYSIS: Inconsistent shareholder spread

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Inconsistent shareholder spread – Disclosures

The JSE’s current Listing Requirements contain ambiguities that lead to inconsistent disclosures on public and non-public shareholders.

Listed companies need to disclose a shareholder spread in their annual report in terms of section 8.63(d) of the JSE’s Listings Requirements. The shareholder spread deals with the number and percentage shareholding by public and non-public shareholders. This distinction between public and non-public shareholders is an important parameter for listing on the JSE (e.g. for Main Board listing, a company must have at least 20% of each class of equity securities held by the public). Non-public shareholding can also be used when calculating the free float of a reporting entity. Due to inconsistencies in IFRS disclosures on share capital (as stated in the February 2011 issue of ASA by Wesson & Hamman), the shareholder spread disclosure could also be helpful to users of annual reports when trying to ascertain what the totals of company, group and treasury shares are actually.
We have, however, found inconsistencies in the Listings Requirements on the calculation and disclosure of public and non-public shareholders in the shareholder spread. This article aims to highlight the inconsistencies and provide some examples of these inconsistent disclosure requirements.

Section 8.63(d)
Section 8.63(d) of the Listings Requirements requires a listed company to disclose a shareholder spread, with separate disclosures for:
1. the number of public and non-public shareholders for every class of listed securities;
2. the percentages of each class of listed security that is held by public and non-public shareholders; and
3. the non-public shareholder disclosure as analysed in accordance with the categories set out in paragraph 4.25 of the Listings Requirements.

Section 4.25
Section 4.25 of the Listings Requirements states the categories of shareholders that are classified as non-public, e.g. the directors (and their associates) of the reporting entity and its subsidiaries; the trustees of any employees’ share scheme or pension fund established for the benefit of any directors or employees of the reporting entity and its subsidiaries; any person interested in 10% or more of the securities of the relevant class (unless certain circumstances apply); or employees of the reporting entity, where restrictions on trading in the reporting entity’s listed securities are imposed on such employees.

Assumptions and inconsistencies
In respect of the mentioned Listings Requirements, the assumption can be made that the total number of shares to be included in the shareholder spread, is the number of company shares (i.e. before the deduction of treasury shares). This assumption is based on the fact that the shares held by the trustees of an employee share scheme are included under the non-public shareholder disclosure. But these shares are usually deducted from the total number of company shares when consolidating the share scheme in terms of IFRS.
The following inconsistencies are evident:
1. Section 4.25 does not list shares held by subsidiaries as a non-public shareholder category. The definition of “associate” in the definition section of the Listings Requirements does however include a subsidiary. The following interpretations are therefore possible:
a) Entities may follow the logical deduction and include subsidiary holdings under non-public shareholders.
b) Entities may exclude subsidiary holdings these from non-public shareholders and include under public shareholders.
c) Entities may exclude subsidiary holdings from the shareholder spread.

Entities following the interpretation in b) above, therefore overstate their public shareholders and understate their non-public shareholders. Entities following the interpretation in c) above, understate their non-public shareholders and do not include all shares issued by the company in their shareholder spread.

2. Section 8.63(d)(iii) requires entities to analyse the non-public shareholder disclosure in accordance with the categories set out in paragraph 4.25 of the Listings Requirements. The following interpretations are therefore possible:
a) Entities may interpret the requirement as a calculation and disclosure basis and therefore disclose each of the non-public categories.
b) Entities may merely interpret the requirement as a calculation basis. In such a case one figure for public and one figure for non-public shareholders will be disclosed.
c) Entities may include subsidiary holdings under the subheading “associates”, “treasury” or “own holdings”, which makes it difficult for the users of annual reports to identify the true nature of the subheading (as the definition of “associate” includes many of the non-public shareholder categories in Section 4.25 and “treasury” includes subsidiaries and consolidated share trusts for accounting purposes, whereas “own holdings” does not have a clear meaning).

Entities following the interpretation in b) and c) above, therefore do not disclose the necessary detail to enable users of annual reports to reconcile the types of shareholders (e.g. subsidiaries) and/or the number of shares in issue with the share capital disclosure in the annual report.

Examples of inconsistent disclosures
Treatment of subsidiaries in shareholder spread
Many reporting entities include subsidiary holdings under non-public shareholders in the shareholder spread. There are however companies that interpret Section 4.25 of the Listings Requirements differently.

An example of a company not including shares held by the subsidiary under non-public shareholders is Convergenet Holdings Ltd. (in 2009 and 2011). This led to an overstatement of its public shareholders and understatement of its non-public shareholders.
Netcare Ltd. (2000 till 2011) and Crux Technologies Ltd. (2001) omitted shares held by the subsidiaries from the shareholder spread, which led to the understatement of non-public shareholders. The total number of shares included in the shareholder spread therefore did not reflect the number of company shares in issue, but the group number of shares.

Bowler Metcalf Ltd. disclosed its subsidiary holdings as a negative percentage (using the term “treasury”) under non-public shareholders (2009 to 2011). This led to the understatement of non-public shareholders. Bowler Metcalf Ltd. only included percentages in its shareholder spread; therefore the total number of shares could not be verified.

Analysis of non-public shareholders in shareholder spread
Many reporting entities interpret the requirement of Section 8.63(d)(iii) on the calculation and disclosure basis, and therefore disclose the categories of non-public shareholders. Certain companies do however interpret this requirement differently.
An example of a company disclosing one figure for public and one figure for non-public shareholders is the JSE itself (for reporting periods prior to 2010). Prior to 2010, the JSE did however present a separate line disclosure for directors in the shareholder spread. Since 2010 the JSE Ltd. discloses each of the components of non-public shareholders separately.

Remgro Ltd. also disclosed one figure for public and one figure for non-public shareholders (for reporting periods 2004 till 2011). The non-public shareholder figure was described in one line as “directors and their associates/share trust/treasury shares”.
As mentioned previously, Bowler Metcalf Ltd. disclosed its subsidiary holdings as “treasury” under non-public shareholders in 2009 till 2011. Invicta Holdings Ltd. used the term “own holdings” in 2005 and “treasury stock” in 2011 and 2012.

Reporting entities do not consistently interpret the Listings Requirements on shareholder spread disclosure. This leads to the inaccurate calculation of public and non-public shareholders as well as inconsistent disclosures on the categories of non-public shareholders. Public shareholding is an important parameter for listing on the JSE, while inconsistent disclosures on the categories of non-public shareholders may confuse users of annual reports when trying to reconcile the number of shares included in the shareholder spread with the share capital disclosure in the annual report.

The authors suggest that Section 4.25 should include subsidiary holdings as a non-public shareholder category and that Section 8.63(d)(iii) be revised to state that each of the categories of non-public shareholders should be disclosed (and not merely analysed). The terms “treasury”, “associate” and “own holdings” should not be used. Section 8.63(d)(ii) should also require disclosure of the number of shares (and not only the percentages), which will enable verification with the share capital disclosure in the annual report.
These amendments to Section 4.25 and 8.63(d) of the Listings Requirements will lead to more accurate disclosures and will improve the informational value of annual reports.

For references visit www.accountancysa.org.za

Authors: Nicolene Wesson CA(SA) and Willie Hamman CA(SA)are lecturers at the University of Stellenbosch Business School.

 

Reinvigorating – Business in South Africa

With liquidations placing considerable strain on both financial institutions and the national economy, there is a worldwide trend towards rescues, turnarounds and workouts. Piers Marsden talks to Accountancy SA about helping ailing businesses in South Africa.

What are some of the most common reasons for business failures in South Africa?
Typically, businesses in South Africa break down because of a shortage of working capital, mismanagement or fraud.

How severe does the financial distress need to be in order for a business to qualify for business rescue?
The business needs to look unlikely to be able to pay its debts in the next six months, which is termed ‘commercial insolvency’, or be likely to go actually insolvent within six months, for instance when liabilities exceed assets, which is called factual insolvency. Importantly though, it’s not for businesses that are terminal and need to be put into liquidation. Business rescue is for good businesses that have fallen on hard times or, as the new Companies Act says, ‘businesses that have a reasonable prospect of success’.

What does business rescue actually mean?
Technically, business rescue is the institution of proceedings, in terms of chapter 6 of the new Companies Act, to facilitate the rehabilitation of a company that is financially distressed. In plain English, it’s about allowing a troubled business to ‘press pause’ long enough for an independent person to take a look at its situation and develop a way forward that balances the rights and interests of all relevant stakeholders.

That might mean restoring solvency and liquidity or, in a worst case scenario, winding up the business for a result that is better for the shareholders and creditors than in the case of liquidation.

How does the process work?
So times are tough. Bullets are flying. Your customers need stock, your staff are panicking. In that sort of context, it’s neither useful nor sensible to expend all of your energy fighting off antagonistic creditors. You need to focus on getting your business back on its feet, and that’s what the pause button, or more technically, the ‘temporary moratorium’ allows for. Basically, during a business rescue, the business is protected from legal enforcement action by creditors for a limited period of time.
And that’s where the business rescue practitioner comes in.

Right. During this breathing period, a technically and commercially competent, independent person takes formal control of the business to identify the causes of the financial distress, uncover solutions and opportunities, and then formulate and execute the restructuring plan. Having a practitioner on board means that the incumbent management, usually under immense pressure, can focus on day-to-day operational issues. It also means that the restructuring process is independently managed and streamlined, minimising the costs and stresses of restructuring.

What skills does the business rescue practitioner need to have?
The obvious ones are the technical competencies: the Companies Act stipulates that a practitioner has to be in good standing in a legal, accounting or business management profession. Beyond that though, you need to have practical business sense, because you need to be able to manage liquidity, anticipate risks and look out for business opportunities.

Perhaps even more importantly, you need emotional intelligence (EQ), because you’ll be managing competing priorities among stakeholders during stressed times. Importantly, you’ll also need to be able to communicate the right messages to the right stakeholders, all of whom have different needs. And then you have to be able to execute. The business rescue practitioner needs to be results-oriented, pragmatic and able to implement rapid and often radical changes in a dynamic and often highly-charged environment.

The pressing question is, does business rescue work?
In the US and Canada, success rates are roughly two out of three for plan approval, with a doubling of the success rate in the last decade, but that’s partly because they are very particular about who qualifies for business rescue. And that’s really what it comes down to: business viability. With a viable business and a skilled practitioner, business rescue is generally very successful.

Can you share a success story with us?
We worked with a medical supply company that had been in business for 30 years. Its biggest customer stopped paying it and it was in the process of refurbishing a factory, so it was essentially operating on one cylinder. It was a good business, but it had cash flow issues,w and needed help. We went in as the business rescue practitioners and because we have great relationships with the banks, we secured funding to pay running costs while we worked on a plan of action. Within 60 days, we presented the plan to shareholders and creditors.

What might a plan like that entail?
It’s essentially a plan to give all stakeholders the best deal possible. In liquidation, secured creditors get paid and the rest often get nothing. In business rescue, we try to split the pain amongst all three role players – shareholders, secured creditors and trade creditors.

In this case, we got the creditors ten times more than they would have achieved in a liquidation. Trade creditors got bumped to the front of the queue, and while they had to take a haircut on their debt, they still got a reasonable deal.

Who makes the final call on the plan of action you propose?
Creditors do. We presented the plan to 98% of creditors and 100% of those present voted in favour of it. Technically, you need 75% approval and you can cram down on dissenting creditors. If you affect the rights of shareholders, they would need to vote in addition to the creditors’ vote.

What made this case a success?
First and foremost, it was a good business going through a tough time. In this instance, the shareholders contributed to the process and agreed to not draw any fees for three years. Everyone came to the party and that’s why it worked so seamlessly. We unfortunately had to retrench 25 of the 150 employees, but they got a full retrenchment package and we saved 125 jobs by saving the business.

So business rescue is good for job preservation?
It should be. Aside from the strain liquidations place on banks and our economy, on a micro-level, failed businesses mean job losses – and South Africa can’t afford that. The good news is that we’re starting to move to a more debtor-friendly environment. That’s good for business, which is good for jobs, which is good for the country. The new Companies Act is designed to invigorate businesses, to save jobs and to give businesses in trouble a second chance at success.
Perhaps in closing it can be summarised e the key success factors for business rescue.

To my mind, there are three primary success factors:
1. The ability to procure post-commencement finance.
2. Mature and responsible creditors.
3. An independent practitioner skilled enough to craft a plan that is approved by the requisite majority.

Piers is a Business Rescue Practitioner at Matuson Associates. He is a Chartered Accountant and a member of both the Turnaround Management Association and the Association of Insolvency Practitioners of South Africa. ❐

Author: Piers Marsden CA(SA) is a Business Rescue Practitioner at Matuson Associates.

 

Boardroom checkmate finale from where I sit

The second and final part of a discussion on how company boards should improve the quality of collective decision-making.

In the previous issue of Accountancy SA, I articulated what I perceive to be the main shortcomings in selecting the ‘mix’ of directors for company boards. In this article I conclude my discussion that boards can be enabled to provide superior guidance consistently by exploring the options that I outline below. Each option discussed is not sufficient on its own, nor can it be substituted for others, and each must be carefully considered on its own merits.

The company secretary is a key player and should be a useful resource to the organisation in playing various roles that can enhance the quality of delivery through effective boards. Ideally, the company secretary should review the ‘board packs’ prior to board meetings and brief the chairman regarding the quality, completeness and reliability of these packs. This should also include interacting with executive management on enhancing the meeting pack, and aligning it with the meeting agenda to facilitate good decision-making.

Professional assurance providers such as internal auditors should be engaged to review the packs for relevant content, consistency with the entity’s business direction and alignment with relevant governance structures. This should assist executive management to present better information to facilitate appropriate board decisions. While this may raise the question of internal auditor independence, in the balance this should be a non-issue if well understood and managed.

Co-opting relevant specialists in board meetings, particularly where such specialist expertise is crucial for the day’s agenda, will add immeasurable value. This may help bridge the gap created by not having board members considered specialists in topics of the day. While co-opted specialists cannot vote, their contributions will assist those in attendance to make more informed decisions.

Board development programmes should be designed to empower board members to be cognitive of specific subject matters so that they can meaningfully contribute to discharging their board roles. There is a crucial need to introduce specific technical and advanced director development programmes in appropriate fields. This does not however imply that all board members must now be masters of all trades over and above the specific skills they offer, but rather that specific expertise needed from board to board should be made available to the members of those boards.

In completing my checkmate-in-one-move, I challenge all chairpersons of board meetings to stand up to dealing with the issue of the quality aspects of their meeting quorums. Board decisions must be debated and made as a result of including the appropriate skills and technical know-how required by the subject matter. By so doing, the good governance vision of establishing and leading a board that achieves superior performance manifests itself.

Aluta Continua (The Strugle Continues) to the era of insatiable shareholders, good governance and of course, long live shareholder activism! ❐

Author: Ronald Moyo CA(SA) is Executive Director, SekelaXabiso.

 

What is Other Comprehensive Income?

An explanation of the other comprehensive income concept, illustrating the ‘reclassification’ principle. Other comprehensive income (OCI) is not easy to define, however, the concept behind it is quite simple. This article introduces the concept and illustrates the differences between OCI items that may be reclassified and OCI items that may not be reclassified.

What exactly is this line item called ‘Other Comprehensive Income’? Chartered accountants who qualified more than a couple of years ago may not be entirely confident with this term. The Conceptual Framework for Financial Reporting does not specifically mention it; IAS 1- Presentation of Financial Statements refers to OCI as ‘non-owner changes in equity for a reporting period’.
OCI is a financial performance concept (i.e., gains and losses measured over a period) that was created to provide for items that companies traditionally did not want recorded in their net profit and earnings per share (EPS) figures. This is because these items tended to distort EPS figures, for example. Prior to the OCI concept, such gains or losses were taken directly to the Statement of Changes in Equity (think of the Revaluation Surplus that arose from revaluation gains from property, plant and equipment).
At the end of the reporting period the total net profit (the financial performance concept over a period) is closed off to retained earnings. In the same way, individual OCI gains or losses are closed off to their respective equity accounts.

For periods after 2012, two categories of OCI need to be disclosed, namely OCI that may be reclassified versus OCI that may not be reclassified. The following is an example illustrating the accounting for an investment in a private company under IAS 39 versus its replacement standard IFRS 9 – Financal Instruments.

Tabaldi (Pty) Ltd purchases 100% of Seltus (Pty) Ltd for R100 000 on 1 January 2011. At reporting date 31 December 2011, Seltus has a value of R180 000. On 31 January 2012 Tabaldi sells Seltus for R200 000. On 31 January the total fair value gains that are closed out to mark to market reserve (equity) is R 80 000 (2011) plus R 20 000 (2012), being equal to R100 000 (tax ignored for simplicity purposes).

Journal entries relating to OCI and the mark to market reserve (equity) upon derecogonition on 31 January 2012 under the two standards are as follows:

IAS 39 requires reclassification:
Dr Reclassification of gains on Available for Sale Financial Asset (OCI)
100 000
Cr Reclassification gains (P or L) 100 000
Reclassification of gains accumulated in the Mark to Market Reserve (Equity) under IAS 39 upon derecognition. A separate journal for deferred tax is also required.

IFRS 9 does not permit reclassification, but does allow for an optional direct transfer within equity:
Dr Mark to market reserve (SOCE) 100 000
Cr Retained earnings (SOCE) 100 000
This would be performed net of tax in one journal entry.

The following is a list of IAS/IFRS standards that may give rise to OCI:
A) Instances where OCI may not be reclassified:
• IAS 16 – Property, Plant and Equipment: Gains or losses on PPE revaluations;
• IAS 19 – Employee Benefits: Actuarial gains or losses on defined benefit plans;
• IFRS 9 – Financial Instruments: Gains or losses due to changes in own credit risk (financial liabilities) designated at fair value;
• IFRS 9: Gains or losses on investments in equity instruments subsequently measured at fair value through OCI.

(B) Instances where OCI may be reclassified:
• IAS 21 – The effects of changes in Foreign Exchange Rates: Exchange differences on translation of foreign operations;
• IAS 39: Gains or losses on Available for Sale financial assets;
• IAS 39: Gains or losses due to changes in fair values of cash flow hedging instruments.

OCI’s evolution is an example of how the world of financial accounting is evolving at a furious pace. Being technically proficient will separate you from your peers and ensure that you remain at the cutting edge of global financial reporting. ❐

Author: Richard Starkey CA(SA) is CEO of Tabaldi Accounting Intelligence.