Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: A tough case ... and a long one

COMMENT


David Richwhite was back in the headlines this week after a long absence. Richwhite and Sir Michael Fay were on the front page because the Securities Commission is taking a groundbreaking insider trading case against one of their companies and other parties over the sale of Tranz Rail shares.

The case will bring back memories of the 1990s when many New Zealand companies were run almost totally for the benefit of their major shareholders and politicians sold assets to the highest bidder, regardless of the purchaser's industry expertise.

The story begins in September 1993, when Tranz Rail bought New Zealand Rail from the Crown for $328.3 million.

In an extremely clever move, Tranz Rail borrowed $223.3 million to buy NZ Rail.

Its shareholders contributed only $105 million to the acquisition price through the purchase of 105 million Tranz Rail shares at $1 each.

Tranz Rail's original shareholders were:

* Fay Richwhite, a New Zealand-listed company, 31.8 per cent.

* Wisconsin Central, an American rail company, 27.3 per cent.

* Berkshire Fund, a US investment group, 27.3 per cent.

* Alex van Heeren, the owner of Huka Lodge, 9.1 per cent.

* Richwhite family interests, 4.5 per cent.

At the time of the purchase, Tranz Rail had a strong balance sheet because the Government had earlier written off $1.2 billion of debt and contributed $360 million of new equity.

Fay Richwhite was the main financial adviser to NZ Rail during this restructuring.

In June 1995, Tranz Rail made a capital repayment of $100 million that reduced the equity contribution of the original investors to just $16.4 million.

Additional shares had been issued to Tranz Rail's management in the intervening period and they also participated in the capital repayment.

The capital repayment was mainly financed by the sale of 15 per cent of Clear Communications for $72.6 million, $20.1 million above the book value.

In mid-1996, Tranz Rail issued 31 million new shares - 25 per cent of the company - to the public at $6.19.

After this, the Fay Richwhite consortium had an average cost of less than 20c a share, after taking into account the $100 million capital repayment, whereas the public paid $6.19.

Tranz Rail was listed on the stock exchange on June 14, 1996, and its share price rose to $9 by mid-1997.

Some original shareholders took advantage of the high share price to sell all or most of their holdings.

Berkshire Fund sold most of its shares at more than $8 each between November 1996 and March 1997.

In 1998, van Heeren sold his holding for a profit of more than $42 million, and the next year Fay Richwhite sold 6.2 million shares at an average $3.67 a share.

The Securities Commission's insider trading case involves share sales in the first half of 2002, mainly 17.6 million shares sold by Fay Richwhite on February 8 at $3.60 a share and 4.3 million shares by Berkshire on February 12 at the same price.

Wisconsin Central's sale of 28.7 million Tranz Rail shares on February 21 has not been included because Canadian National Railway acquired Wisconsin Central in October 2001 and the Canadians had no Tranz Rail board representatives.

The announcement of the commission case has been greeted with widespread enthusiasm because many New Zealanders lost a great deal of money on Tranz Rail.

Shareholders who bought shares in the IPO at $6.19, took up their entitlement to the 2002 five-for-seven rights issue at 75c a share and accepted the directors' recommendation to sell to Toll Holdings at $1.10 a share, received only $28 for every $100 invested.

The four main original investors, Fay Richwhite, Wisconsin Central, Berkshire Fund and Alex van Heeren, made total profits of $370 million, mainly tax free, from the sale of their Tranz Rail shares.

There is little doubt that the market came to believe Tranz Rail was poorly governed while under the control of the Fay Richwhite consortium and it adopted unusually creative accounting policies.

Shareholders and the public have reason to feel aggrieved, but it is extremely difficult to prove insider trading.

Since the insider trading regulations, the Securities Amendment Act 1988, came into force, there have been eight major cases but none has gone to court.

Some insiders have paid compensation to complainants without admitting guilt. These include Eric Watson (in relation to McCollam Printers), Paul Hyslop (Fletcher Paper) and Kerry Hoggard (Fletcher Challenge).

Fay and Richwhite are no strangers to insider trading proceedings.

In 1993, Levin businessman Donald Kincaid applied to the High Court to bring proceedings against Capital Markets, Fay Richwhite, Sir Michael Fay, David Richwhite and others.

Kincaid claimed the defendants knew of serious problems at the Bank of New Zealand when Fay Richwhite sold BNZ shares in July 1990.

He was granted leave to take action against the defendants, with the exception of Richwhite.

But he did not have the resources to pay for the hearings arising from issues raised by the defendants, and he settled out of court.

The BNZ paid his legal costs, estimated at $600,000, and Fay Richwhite sponsored seminars on securities regulation and insider trading in Auckland and Wellington.

At these seminars, Australian High Court judge Justice Michael Kirby was highly critical of New Zealand's insider trading laws.

The defendants in the Tranz Rail insider trading case are expected to adopt tactics that will result in more protracted and costly litigation.

Some of the Tranz Rail defendants have the financial resources to string this case out as long as they can.

Fay and Richwhite and their associated companies made $402 million in profits from the sale of former state-owned assets - $274 million on Telecom, $41 million from the BNZ and $87 million on Tranz Rail.

They sold their merchant banking operation to the listed Capital Markets in 1990 for $225 million and bought it back five years later when Grant Samuel said it was worth less than $50 million.

They also made a profit of $36 million on the listed winebox company European Pacific Investments, even though shares were issued to the public at $11.85 each in 1987 and the controversial company was taken over two years later for only US$2.55 a share.

The Boston-based Berkshire Fund should also be able to finance a long and costly legal battle.

Its website says Berkshire's six investment funds have raised about US$3.5 billion of capital from investors.

Although many former Tranz Rail shareholders are extremely excited by this week's developments, the only sure winners are the lawyers.

The commission lost its last major case, a substantial security holder notice action against Sir Robert Jones in 1993, and has yet to prove it can win the really big ones.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.


* Email Brian Gaynor

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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