Glacial progress on stockmarket inquiry

It would be fascinating to drill a core sample through the offices of the stock exchange market regulator.

A skilled geologist would probably find traces of investigations from a bygone age, the detritus of sporadic activity interrupted by aeons where nothing but the odd trilobite can be found in the mud.

Time goes so slowly there, investigations are often passed lovingly from father to son and preserved in boxes lined with cedar. They say the last time it passed judgment a tapestry was commissioned to mark the occasion, although the work appears to have been lost during the Papal Schism.

There were, it is true, some hints of movement last May, although the sands of time are slowly burying its delicate form.

On the 11th of that month, NZX Market Supervision said it had started an inquiry into trading in the shares of Blis Technologies after its staff had "detected potentially anomalous trades".

NZXMS said it was confirming the probe "in the interests of market clarity and confidence".

Nine months on and NZXMS has uttered not a squeak more about it, although on January 31 a spokesman told Chalkie the investigation continues.

What could be taking so long?

Perhaps one notable aspect here is the involvement of Eion Edgar, knight of the realm, chairman of big sharebroker Forsyth Barr, honorary president of the NZ Olympic Committee, former Reserve Bank director, trustee of this, that and the next thing and general South Island big cheese.

Edgar is half-owner, with Blis director Tony Offen, of Edinburgh Equity Nominee, a holding company with a significant stake in Blis, a biotech minnow based in Dunedin whose claim to fame is an antibacterial throat lozenge.

To be clear, it remains to be seen what involvement, if any, Edgar or Offen had in the trading that NZXMS is investigating.

However, shortly after the NZXMS investigation was announced last year, Edgar said the inquiry was "making a mountain out of a molehill" and that the trading "was just a straightforward arbitrage".

According to substantial security holder notices filed to the NZX, between May 2 and May 7 last year Edinburgh Equity Nominee sold 2.7 million ordinary shares in Blis for about $36,000, reducing its stake from 10 per cent to 8.5 per cent.

The transactions took place just before an important event for Blis shares on May 8, in which 4 million preference shares were converted to ordinary shareholdings.

Under the terms of the conversion, each preference share would buy $1 worth of ordinary shares at a price equal to 95 per cent of the market price in the prior 20 business days. This meant that the lower the Blis share price in the period, the more shares would be issued to preference shareholders.

So what prices do we see on market during the relevant period?

First of all, let's go back to late March when Blis reminded the market the preference conversion was coming up. At that point the shares, which had been trading around 4c, immediately dropped to 1.5c.

However, over the next couple of weeks the shares edged back up and by April 19 had hit 2.7c.

By Chalkie's reckoning the conversion period began on April 10, so the price gain was a factor in the preference conversion rate.

On April 30 the shares fell suddenly from 2.5c to 1.8c and continued falling to 1c on May 8.

As it turned out, the conversion was struck at 1.342c, which meant the 4 million preference shares converted to 298 million new ordinary shares in Blis.

Add in a preference dividend which was paid in ordinary shares and you get a total issue of 311 million new shares.

Given the previous number of ordinaries was 171 million, the preference conversion clearly had a big effect on the register.

For Edinburgh Equity, the effect was to convert a previous stake of 8.5 per cent in ordinaries and about 52 per cent in preferences to an ordinary shareholding of 178 million shares, or 37 per cent.

The question is, would the outcome have been significantly different if the share price had not fallen? Having crunched some numbers, Chalkie reckons a conversion price of 2.5c would have led to the issue of 160 million new shares, plus about 7 million from the preference dividend.

Under that scenario, Edinburgh Equity's interest would convert to a holding of 102 million ordinaries, or 30 per cent.

In a company as small as Blis - its current market capitalisation is about $16m after a $1.3m capital raising last October - the financial implications of the difference are not a king's ransom, but nor are they peanuts.

Chalkie reckons the conversion price of 1.342c meant preference shares turned into about 65 per cent of the ordinaries, while a conversion price of 2.5c would have turned into 49 per cent of the ordinaries.

For the company itself, the lower conversion price meant the issue of over 100 million more shares than it would have done at 2.5c, say.

Chalkie would say that raises an issue over whether share trading by Edinburgh Equity in the run-up to May 8 amounted to deliberately creating a false or misleading appearance of trading in Blis shares - a practice forbidden by the Securities Markets Act as amended in 2008.

Chalkie notes that these sorts of allegations are taken seriously enough by the law that there is a criminal offence carrying a maximum penalty of five years in jail and a $300,000 fine for an individual, or a $1m fine for a corporate.

The Securities Markets Act is enforced by the Financial Markets Authority. Although the FMA did not at any point say it was investigating the Blis trading, it did confirm to Chalkie in December last year that it had done so and "concluded that there was no breach of securities legislation".

This is all well and good, but it would be helpful to know how the FMA reached this conclusion.

It might shed light on the slow progress of the NZXMS investigation and enable comparison of the FMA's approach with a case in Australia involving share trading in the leadup to a preference share conversion.

In 1998 the Supreme Court of New South Wales considered an appeal against a judgment finding breach of corporations law in trading in shares of Jefferies Industries by a company controlled by its ex-chairman.

Like Blis, Jefferies was about to convert preference shares into ordinaries using a formula in which the lower the average market price in the previous 20 trading days, the more shares would be issued to each preference shareholder.

According to the Supreme Court judgment, it was in the interests of the ex-chairman's company, Fame Decorators, that the Jefferies share price be minimised "thereby increasing Fame's entitlement on conversion of its preference shares".

Fame then sold a chunk of shares on-market by accepting all the buy offers available, from A35c down to the wildly low offers around A14c put in by a speculative buyer who "didn't really think, in my wildest dreams, that anyone would sell them at 14".

The ex-chairman's claim that he sold low because he needed cash was not believed by the court.

In the end, two out of three Supreme Court judges found that the trading broke the law because it was likely to deceive others in the market "who were entitled to assume that market prices reflected the genuine interaction of forces of supply and demand".

Given the FMA's finding, Chalkie assumes there were important differences between the cases of Blis and Jefferies, but exactly what they are we can only guess.

We can also only guess what NZXMS is looking at, because despite its focus on market clarity and confidence it has provided bugger-all clarity and confidence on the matter for nine months.

Chalkie reckons an important part of market confidence is knowing that allegations of questionable trading will be dealt with swiftly and publicly. The FMA did the former but not the latter, while the NZX has done neither.

Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.