Unethical way to raise capital

UNTIL recently, most listed companies that wanted to raise additional capital did so by means of proportional renounceable rights issues. New shares were offered to their existing shareholders in proportion to their existing holdings, usually at a discount to the previous market price.

The actual size of this discount did not matter greatly, as all shareholders were being treated equally and any seeming bargain element was cancelled out by the fall in the market price when the old shares began trading on an "ex rights" basis.

Now the current practice seems to be for companies to offer new shares to institutional investors at a substantial discount to the market instead of making a conventional rights issue.

At best, the companies offer a non-renounceable entitlement to new shares to their existing shareholders at a similar issue price, up to, at most, a token $10,000 in value per annum, irrespective of the size of each investor's existing holdings. This unethical practice has two serious disadvantages for the existing investors:

The market value of the existing shares falls to roughly the institutional issue price, as this becomes the new benchmark, creating massive losses for the non-institutional shareholders in the process, without any offsetting factor. Furthermore, the institutions are also able to make windfall profits at the expense of other investors by switching their existing holdings into the new shares being issued to them.

The interests of the existing shareholders get diluted and these finish up with a smaller proportion of the company, meaning that they will benefit much less from any future upturn. They will also get less income from dividends and franking credits than would otherwise have been the case.

Often the aggregate fall in the company's market capitalisation is of the same order of magnitude as the new money being raised, adding to the pain caused by the dilution.

One reason for the current practice is that it avoids the necessity for the issuing company to produce a prospectus - an expensive and time-consuming exercise. This requirement in the legislation was designed to protect investors against themselves, but on balance it probably now does more harm than good.

Investors seem quite content to acquire shares without getting a prospectus whenever they buy existing shares on the market or when they are participating in a dividend reinvestment or share purchase plan. They were also willing to subscribe to rights issues without receiving a prospectus before the new requirements became mandatory a few years ago.

Furthermore, anecdotal evidence suggests that most mum and dad investors cannot be bothered to wade through the 150 or so pages of a typical prospectus, so that the purported protection is illusory in any case and the exercise is just a monumental waste of money.

Of course, company directors also like not having to issue a prospectus for another reason - this makes it harder for the authorities to prosecute them for providing misleading information to the market.

A separate aspect also needs mention in this context. Some companies are making their special share purchase plans relatively unattractive by including provisions for a scale-back, possibly causing investors to tie up funds for several weeks without interest. Such a condition makes it likely that applicants will get their full entitlements to dud stocks while getting cut back in the case of popular issues.

Furthermore, arbitrary rules limiting applications to round-number amounts such as $3000 or $5000 or $10,000 are absurd. Are the boards of Australian companies really so old-fashioned that they do not realise their current computer systems can handle applications of any size chosen by an individual investor just as easily?