Treasury shares

By David Landy.

Key Points:
Treasury shares may be a useful treasury management tool, but legalising them raises a lot of regulatory issues.

Treasury shares are shares in a company that the company itself holds. They have been a feature of American commercial life for many years. In December 2003, they were legalised in Britain.

While the Australian market is always willing to explore new capital management tools, there has been no lobbying for Australia to follow Britain's lead. In part, this may be due to the relatively restrictive rules that are a feature of the new British regime.

In some respects, the tight controls that Britain has imposed on treasury shares are reminiscent of the straitjacket on share buy-backs when they were first legalised in Australia 15 years ago. At that time, it was thought that the potential for abuse and fraud was so great that buy-backs should only be allowed if they were subject to a minutely-detailed set of procedural rules.

What happened, of course, was that those rules were so restrictive that few companies bothered trying to do buy-backs. Eventually, official anxiety dissipated and the procedures were streamlined to the point where buy-backs are now an everyday feature of Australian corporate treasury practice.

What are they good for?

The theory behind treasury shares is quite simple. They are shares that the company has bought back from its shareholders and which it now holds in its own name.

In theory, treasury shares can be used for a variety of purposes:

• transfer to an employee share scheme
• sale to raise cash
• transfer as consideration for a purchase
• bonus issues to shareholders.

Of course, all of these can also be achieved through a share issue. However, there are important differences between a share issue and a sale of treasury shares.

In large part, these are matters of scale. For example, the number of treasury shares that a company owns is restricted, by both the extent of its previous buy-backs and by statutory rules (in Britain, for example, a company can't hold more than 10% of itself). Many substantial capital fundraisings would therefore, continue to be by way of an issue.

Conversely, treasury shares offer the opportunity to micro-manage capital. Because the shares are already issued and quoted, their transfer or sale would not (in theory, at least) incur the expense or delay of a full-blown issue. (Given the relative ease with which Australian companies can issue small amounts of new stock, this feature of treasury shares may not be particularly exciting.)

Let's do it ! … perhaps

As the statutory history of buy-backs and secondary sales shows, the devil in capital management regulation is in the detail. Before treasury shares were made legal in Australia, a number of policy issues would have to be hammered out.

Most of these issues are already familiar to Australian companies and regulators. In broad terms, they revolve around market integrity and disclosure.

Market integrity issues include:

• misuse of insider knowledge
• price manipulation
• related party transactions (If treasury shares are anonymously sold on-market, there is a possibility that a related party could buy the shares without it or the company being aware of their being related parties)
• substantial shareholder disclosure (If, as in Britain, substantial shareholdings were measured as a percentage of issued, non-treasury shares, a sale of treasury shares would dilute the holdings of existing shareholders and potentially trigger a requirement to notify changes in substantial shareholders' percentage holdings)
• M&A planning and tactics (Could treasury shares be subject to a takeover bid? Would there need to be formal restrictions to prevent an incumbent board selling treasury shares as a takeover defence?).

Although these are important matters, they don't involve policy matters that the law hasn't dealt with in relation to other corporate transactions. They have been addressed and overcome in the new British legislation.

Disclosure issues would arise when a company was selling or transferring treasury shares. What type of disclosure (if any) should the company be required to make? Should the sale be treated like any other secondary sale or should it be treated as a quasi-issue by the company?

Another obvious regulatory issue that would need to be addressed is taxation. The British tax laws treat treasury share sales as an issue of new shares. As a result, there is no assessable profit or loss on the difference between the price paid for shares when bought back and the price received when the same shares are returned to the market as treasury shares.

If you build it

In Australia, treasury shares have only appeared on the legislative radar twice, when they were the subject of law reform discussions in 1977 and 1987. That lack of interest among lawmakers appears to be shared by Australian companies.

In Britain, some believe that the regulatory controls on treasury shares are so extensive that British companies won't be rushing to use them.[1]

However, despite these statutory limitations, a range of British companies have flagged their willingness to use the new treasury share provisions in buy-backs. Those companies include BHP Billiton, Imperial Tobacco, BT Group, BAE Systems, Reckitt Benckiser, Vodaphone and Centrica.

The days are long-gone when Australian company law took its lead from Britain. Nevertheless, a trend towards using treasury shares in Britain can be expected to kickstart a debate about their adoption in Australia. Meanwhile, on the other side of the world, US companies - who have used treasury shares for a long time - may wonder what there is to debate.

[1] It should be noted, however, that one major British restriction is that, before being sold, treasury shares may first have to be offered to existing shareholders. This reflects existing British laws giving shareholders pre-emption rights over new share issues, unless a general meeting has waived those rights (in Australia, the equivalent rule only applies to proprietary companies). It is common for AGMs to grant such a waiver as a matter of course.