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The Sunday TimesBusiness

2nd, March 1997



Go back to basics

While the economy plunges further down ward and political stability deteriorates, the government is looking hopefully at foreign investors for some relief. The approach the government is taking in this regard is one of generous incentive packages and high-profile investment promotion missions. Deputy Finance Minister, G.L. Peiris left last Thursday to lead an investment promotion crusade that will take him to Hong Kong, South Korea, Bahrain and London in the coming week.

Investment promotion missions, and the meetings, press conferences, and photo opportunities that accompany them, are good public relations tools and certainly help to establish links between Sri Lankan officials/industrialists and their foreign counterparts. However, such missions are only for the preliminary, polite, formalities. The real investment decisions are based on thorough evaluations of the ground situation in Sri Lanka. Even the most skillful investment promotion mission will not be able to persuade investors if the ground situation is not reasonably stable.

One of the main elements of an investor-friendly climate is stability. Potential investors must be confident that their investment will be secure and fruitful in the medium to long-term. This stability has deteriorated noticeably in the past year or so. Political instability can be attributed not only to the ethnic conflict but also to a massive breakdown in the functioning of civil society.

An MP being murdered in broad daylight in a crowded place while the assassin goes unapprehended. A popular restaurant in Colombo being ravaged while the police fail to respond to calls for help. This seems more like the Wild West than a modern democracy. Labour instabillity is another constraint to investment that any number of investment promotion missions cannot fix. Sri Lankan soft drink giant Pure Beverages recently stopped its local operations because of irreconcilable labour problems. If Coca Cola should exit from Sri Lanka it would be a massive setback for the government's investment promotion crusade because it would symbolise the government's failure to support existing industry. Potential investors would more likely be influenced by this type of development than the most generous of incentives.

We must be careful not to let our investment incentive schemes show desperation for foreign investment. Discerning investors have been known to remark that a government which is over-eager to offer incentives is probably trying to make up for something more basic that they cannot provide. The government must go back to the basics. It must show that it can provide its own citizens with social and political stability. Incentives must be developed strategically to bolster vital areas of the economy and society. These incentives and strategies must respond to local needs as much as they should anticipate and capitalise on external trends.

In its rush to solicit foreign investors, the government seems to have forgotten the importance of bolstering domestic savings. In today's Sri Lanka, wages are so low relative to the high cost of living that few are able to save. This is an urgent problem that the government must address. What we have seen, however, is that the government often courts foreign investment at the expense of local investment. Also, in sectors like housing, investment incentives benefit the small group of super-rich individuals rather than the larger middle-class. The magnitude of domestic savings, however, is more a function of the savings of the middle-class than the super-rich.

Singapore is a good example of a country which has placed considerable priority on "taking care" of the middle class and reaped great rewards as a result. In Singapore, 86 percent of the population live in high-rise government-subsidised flats. More than 90 percent of these people own their flats. This housing subsidy not only adds to political and social stability but also keeps the cost of living down and enables higher levels of savings.

Investment incentives and government subsidies are not instruments that must be introduced or removed in a hasty or flippant manner. They must fit into the larger framework of national needs and priorities. And they must not replace, negate, or divert attention from the more basic responsibilities of government.

All - round protection for shareholders

The main points of a talk given by Mr. Saleem Marsoof (Deputy Solicitor General) on the Take Over and Mergers Code of Sri Lanka at the annual general meeting of the Association of Lawyers in Employment held on February 14 1997

The main objective of the Take Overs and Mergers Code is to protect the shareholders of companies that may become the target of a take-over bid or merger operation. To achieve this objective the code stipulates rules for the fair and equal treatment of all shareholders, for the provision of adequate accurate and timely information to the shareholders and for the controlling of harmful defensive action that may be taken by the management of target companies to frustrate a take-over bid.

The Sri Lankan Code is based on the London City Code. But the former has certain noteworthy features which are not found in the London City Code.

Firstly, the Sri Lankan Code is applicable even to non-resident companies, while the London Code applies only to companies resident in the United Kingdom.

Secondly, the Sri Lankan Code is rigid and statute-based, while the London Code is voluntary and flexible.

Thirdly, the London Code contains certain important legal principles which are not found in the Sri Lankan Code, such as the Substantive Acquisition Rules.

Fourthly, there are areas in the London Code which permits the London City Panel (equivalent to the Securities & Exchange Commission) to exercise a certain degree of discretion, which is not granted to the SEC making it extremely difficult to work with.

Fifthly, the provisions contained in the Sri Lankan Code relating to anti-fraud and anti-insider dealing transactions can cause considerable difficulties due to the lack of a proper regulatory regime based on procedural rules.

This situation can be further aggravated since the Sri Lankan Code does not set out the procedure for approaching the SEC for consultation or approval or for appealing against any decision of the Commission to an administrative body or to a court of law. This could give rise to writ actions by aggrieved parties against the decisions of the SEC.

Another important distinction is the application of the Sri Lankan Code being limited to only listed companies, whilst the London Code applies to all public companies and to certain private companies.

The main focus of the Sri Lankan Code is on Take-Over and Merger transactions by attempting to regulate voluntary offers. In the local Code a 'take-over' is defined as 'a transaction or series of transactions' whereby an individual or a company acquires control over the assets of a company either directly, by becoming the owner of those assets or indirectly, by obtaining control of the management of the company.

The Sri Lankan Code does not attempt to define the word 'control' leaving it to the SEC or the courts to determine whether in a given case there is a sufficient acquisition of control to attract the provisions of the Code.

A take-over bid is launched by the offerer in the form of a public announcement to all the relevant shareholders of the target company to the effect that if they tendered their shares with a named depository within a specific period, they will receive a premium in excess of the then market price of the shares. This type of an offer can be categorised as a 'voluntary offer' since it is an ordinary type of a take-over offer which an offerer has an option to make.

The Sri Lankan Code makes it imperative for such an offerer to forward his offer in the first instance to the board of directors of the offeree company. Both parties are required to maintain absolute secrecy till an announcement is made to the Stock Exchange.

In terms of the Sri Lankan Code, an announcement is required if a purchaser is sought for more than 30% of the voting rights of a company. A copy of the announcement setting out the contents is then forwarded to every shareholder of the offeree company within 28 days of the announcement of the offer. Rule 12 of the Code requires the offeree board to obtain independent advice and to keep the shareholders informed of such advice.

The offer does not become unconditional as to acceptance unless the offerer has acquired or agreed to acquire shares carrying more than 50% of the voting rights attributable to the equity share capital of the offeree company.

Rule 31 of the Sri Lankan Code is a classic example of the manner in which 'fair and equal treatment' is provided to all shareholders of the target company. Rule 31 compels a purchaser acquiring 30% or more of voting rights in a company to make a cash offer to all the shareholders at the highest price paid by such purchaser in the previous 12 months.

Such an offer is known as a 'mandatory offer'. Rule 31 also provides that an announcement should be immediately made when a person or persons acting in concert acquires by a series of transactions over a period of time shares carrying 30% or more of the voting rights or while holding between 30% and 50% of the voting rights acquires in any period of 12 months, additional shares carrying 2% of the voting rights in the same company.

Since Rule 31 does not cover acquiring 'control' of a company, as it presently stands the mandatory offer would not apply to a listed company(A) which takes 'control' of another listed company(B), by purchasing the entire voting rights of a private company having as its assets more than 51% of the voting rights of the said listed company(B).

This type of a situation can take place under the present privatisation operation, where a private management company which is totally owned by a listed company becomes the holder of more than 51% of the voting rights of another listed formerly government owned entity.

The Sri Lankan Code is a set of rules having the force of law, it would, therefore not apply to a given situation unless it clearly falls within the Rules of the Code. In view of this, proposals have been made to amend Rule 31 so that it would cover the aspect of 'control' of a target company for the benefit of its minority shareholders.

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