Product Disclosure Statements - What do You Need to Know?
by Warwick Painter and Frank Tearle
What's a PDS?some hybrid securities (eg where a hybrid includes a call option over issued shares or a guarantee or 'protected' investment feature);
A product disclosure statement (PDS) is a disclosure document for use in offers of financial products to retail investors (other than offers of shares, debentures or certain Government debt instruments).
From a capital markets perspective, the types of financial products covered are very broad including some very popular classes of financial product:
managed investment schemes, (ie units in listed or unlisted trusts);
infrastructure funds; and
exchange traded funds.
Currently, issuers who are able to rely on the FSR transitional provisions can avoid the need to produce a PDS and will offer such financial products under a prospectus. In our experience, issuers have been keen to rely on this exemption because of the certainty a prospectus provides in terms of content and procedural requirements.
However, the time is running out for such issuers. From 11 March 2004, all such offers of financial products will have to be contained in a PDS.
Set out below are some of the important points to bear in mind when you are preparing a PDS.
How does a PDS differ from a prospectus for shares?
In terms of content, a PDS does not differ greatly from a prospectus, even though a PDS does have a different and more prescriptive content requirement (see sections 1013B-1013K of the Corporations Act).
This similarity should not be surprising as the general content requirement for both a PDS and a prospectus are expressed in similar terms as follows:
a PDS must contain such information that might reasonably be expected to have a material influence on the decision of a reasonable person, as a retail client, whether to acquire the product (section 1013E of the Corporations Act).
a prospectus must contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the risks and other relevant matters relating to the security (section 710 of the Corporations Act).
The main difference is that for a PDS the benchmark is set by reference to a retail client whereas for a prospectus one needs to consider the needs of 'investors and their professional advisers'. Concerns were initially voiced as to whether in practice this would lead to a difference in the language used in a PDS. In our experience, this has not been the case. One reason for this could be that, although the content requirement tests are different, the key trigger for the liability provisions under both regimes is the same (ie is there a misleading or deceptive statement in the offer document). Given this, it is not surprising that in most cases the result from the two processes should be very similar.
Is a PDS lodged with ASIC (and is there an 'exposure period')?
Only a PDS for a managed investment product which is listed or intended to be listed needs to be lodged with ASIC. Other financial products may be specified by Regulations for this purpose, but none have been (yet).
For a PDS which is lodged with ASIC there is an exposure period very similar to the exposure period which applies for a prospectus (in brief, it's a period of seven days which ASIC may extend up to a maximum of 14 days). During this period one cannot issue or sell the financial product to which the PDS applies.
For unlisted managed investment schemes and for other financial products, there is no obligation to lodge the PDS with ASIC.
However, instead there is an obligation to lodge a notice with ASIC advising that the PDS is in use. This notice must be lodged as soon as practicable, and in any event within five business days, after a copy of the PDS is first distributed. The issuer must keep a copy of the PDS for seven years and must make a copy of the PDS available to ASIC if requested and must comply with any reasonable requests from any other person for a copy of the PDS.
What risks are there for issuers of unlisted financial products?
Issuers were initially very happy that there was no exposure period for a PDS for an unlisted managed investment scheme. However, it is important for such issuers to note that because there is no exposure period there is a risk if ASIC decides to intervene (eg because it suspects the PDS may be defective) then this will occur at a time when the PDS is actually being distributed and offers are being made under it or even after financial products have been issued under the PDS.
Also, unlisted financial products are subject to what appears to be a quite onerous 'continuous disclosure' regime, set out in section 1017B. The obligation to inform investors for the life of the financial product of any 'material change' or 'significant event' is potentially much broader than the requirements for disclosing entities under Chapter 6CA and the ASX Listing Rules. On 6 June 2003, proposed amendments to Chapter 7 were announced, which included amendments to clarify section 1017B.
Stapled products and hybrid securities - combining a PDS and a prospectus
An interesting issue arises over the form of the offer document where you have a stapled security which triggers both of the disclosure regimes: Part 7.9 (eg units) and Chapter 6D (eg shares).
ASIC has stated that:
'It may be open to the issuer of stapled products to prepare a combined disclosure document complying with both the PDS requirements and the prospectus requirements. Obviously the issuer would need to ensure that the document complied with both the PDS and prospectus requirements'.
Recent examples of such an approach include offers by Valad Property Group and Prime Infrastructure.
But be careful – there are important differences between the two regimes, including:
different disclosure tests and content requirements;
different 'knowledge' tests for advisers and their directors;
different defences regime (eg due diligence vs reasonable steps defence);
a PDS is evergreen whereas a prospectus has a 13 month life;
different procedures for updating disclosure document (eg supplementary PDS/prospectus rules; no statutory regime for 'replacement' PDS);
differences between concepts of 'sophisticated investor' (in Chapter 6D) and 'wholesale client' (in Part 7.9);
no incorporation by reference (as in section 712 of Chapter 6D), but PDS may consist of two or more separate documents (section 1013L);
section 1012J of Part 7.9 (information must be up to date) not mirrored in Chapter 6D (and consider the effect of the new Class Order exemption CO 03/0237);
practical differences (eg in-use notices; lodgement with ASIC; requirements for signing and dating; title and presentation of document; application form requirements, etc);
need to ensure that the cooling-off period (section 1019B) does not apply to the units (or any other component which may be a financial product).
Also, where a hybrid security involves an embedded financial product (eg a put option or a guarantee) or a managed investment scheme involves a separately identifiable interest in a share or debenture, then it may not be possible to easily separate the two different parts of the product for prospectus and PDS disclosure purposes. This may lead to difficulty in strictly complying with the content requirements for each component. Of greater concern is the risk of producing a document which is confusing (and hence potentially misleading) or, worse, a document which does not satisfy the PDS content requirements for information to be presented in a 'clear, concise and effective manner' (see section 1013C(3) ).
No 'transaction specific' PDS for continuously quoted securities
Currently, there is no ability to issue a 'transaction specific' PDS for continuously quoted financial products. Under section 713 of the Corporations Act, an issuer can produce a short form prospectus (ie with reduced disclosure obligations) for continuously quoted shares or debentures. However, there is no equivalent provision for other financial products.
For listed issuers of financial products, this is one of the key differences between Chapter 6D (the regime which governs the offer of shares/debentures) and Part 7.9 (which governs the offer of financial products other than shares/debentures).
CLERP 9 Proposal 28 states that: 'Issuers of managed investment products that are continuously quoted will be permitted to issue transaction specific PDSs'. We understand that ASIC supports this proposal. Draft legislation has not yet been released, but it is expected to be enacted in the Spring 2003 session of Parliament.
In the meantime, a listed issuer of financial products should consider whether section 1013F(2)(d) permits some relief from the content requirements in respect of matters already disclosed to the market. That section permits the issuer to take into account the market disclosure obligations of the listed issuer when deciding what information it is reasonable for a retail investor to find in the PDS.
Similar to the provisions for a prospectus, section 1014A provides for a supplementary PDS to be issued for any of the following purposes:
to correct a misleading or deceptive statement in the PDS;
to correct an omission from the PDS;
to update or add to the information in the PDS; or
to change statements about the minimum amount of the issue or the proposed listing of the financial product.
The fact that a PDS (or, for that matter, a prospectus) contains a misleading statement does not of itself create a positive obligation to issue a supplementary PDS or prospectus (see, for example, sections 719 and 724 for prospectus and section 1016E for PDS which imply a discretion as to whether a supplementary prospectus or PDS is issued). In many respects the rules are the same for both a prospectus and a PDS (the focus being whether a misleading statement is 'materially adverse' from the point of view of an investor). However, in respect of civil liability it is possible that any misleading statement in a PDS will give rise to liability if a person suffers loss or damages because of that misleading statement (regardless of whether the statement is materially adverse to the investor). Therefore, where there is a misleading statement or omission in a PDS it will be necessary for the issuer to decide whether:
the misleading statement or omission is materially adverse from the point of view of a reasonable person deciding as a retail client whether to acquire the financial product; or
even if not materially adverse, a person could suffer loss or damage as a result of the misleading statement or omission.
In either of these circumstances a supplementary PDS will be required.
Note that the PDS regime does not provide for a replacement PDS in the same way as it is possible to have a replacement prospectus, although in practice it is likely that a replacement PDS would simply be a new PDS issued under section 1012B(3)(a)(iii). Section 1014E seems to contemplate this possibility.
The emphasis in Part 7.9 is upon the function of a supplementary PDS in 'updating' the original PDS (ie consistent with the view that a supplementary PDS is not just about defective behaviour). However, where a hybrid PDS issue has been underwritten, the issue of a supplementary PDS, in any circumstances, may have adverse consequences for the issuer.
Cooling-off – when it applies and how it operates
The concept of 'cooling-off' for investors in financial products was introduced as part of the FSR changes on 11 March 2002. It came into effect immediately with no transition period. The relevant provisions are contained in Part 7.9, Division 5 of the Corporations Act and the associated regulations which are set out in Part 7.9, Division 7.
In brief, it gives retail clients, but not institutional clients, a right to return a financial product and to have the money they paid to acquire the financial product repaid. It allows investors to change their mind about an investment during the cooling-off period.
The cooling-off period does not apply in some situations. These are set out in Regulation 7.9.64 and include:
a managed investment product which is listed or will be listed shortly after it is issued; and
where the managed investment product is not liquid in accordance with chapter 5C (section 601KA ) at the time it is issued.
The cooling-off period would naturally be of concern to an issuer of hybrid securities, where certainty as to receipt of application proceeds is important for a variety of reasons (eg underwriting, funding of an acquisition).
If the hybrid issue is structured around a managed investment scheme, it is likely that either or both of the above exceptions will apply. If not, then another exception will need to be found, the cooling-off period factored in or relief sought.
How does the cooling-off period operate?
There is a 14 day period for exercising the right of return which starts on the earlier of when a transaction confirmation is given to the holder or five days after the product is issued.
The right to return cannot be exercised after the holder has exercised a right or power under the product's terms. For managed investment products, there is little guidance given as to the meaning of the 'exercise of a right or power under the product's terms'. There is a regulation which provides that this does not include the making of a distribution to the holder. An example of a right or power which we think would be caught by the section is the exercise of a holder's right to withdraw from the managed investment product if holders have this right. For a hybrid issue, holders commonly do not have a withdrawal right for a period of time following the IPO.
The amount to be repaid will vary in accordance with the current market value of the product. In simple terms, the holder bears the investment risk and enjoys the investment reward which arises during the period.
The amount repaid may also be reduced on account of tax, duty and reasonable administration and transaction costs. However, there are special rules relating to these deductions. For example, the reasonable administration and transaction cost must be reasonably related to the acquisition of the product and the subsequent termination and must not exceed the true cost of an arm's length transaction. The payment of commissions or similar benefits is specifically excluded.
Where the cooling-off period applies, a PDS should describe the right of return that retail clients have.
ASIC and ASX relief
Although not always the case, in our experience, the ASIC and ASX relief that has been required for an offer by way of a PDS has tended to be product specific (ie it would have been needed whether the offer was made through a prospectus or a PDS). However, where both securities and other financial products are being offered together in a hybrid disclosure document it is possible that there will be aspects of the content, disclosure and practical requirements where further ASIC relief will be required.
The need to submit applications to ASIC and ASX as soon as possible is true in any offer of financial products. However, in the case of offers by way of a PDS we think it is even more important, at least at this stage of development. The general policy principles are well understood, but their specific application is still being considered in some areas and as a result this may lead to greater scrutiny of applications for relief and a requirement to seek approval from higher levels within ASIC or ASX. Therefore, ASIC and ASX issues should be given a high priority in planning an offer timetable.