Private company restates its financial statements due to ASIC inquiries regarding de facto control

There are two key takeaways from a recent media release by the Australian Securities and Investments Commission (ASIC) regarding a restatement of financial statements stemming from its financial reporting surveillance program:

1. In addition to listed entities, registrable superannuation entities and disclosing entities, the financial statements of private companies are also a key focus for ASIC. This includes large proprietary companies, both those that were previously grandfathered and those that aren’t.
2. The scope of ASIC’s review is much broader than its enduring and specific focus areas. In this instance, ASIC concluded that the large proprietary company in question controlled an investee because it had de facto control. That is, the entity had power over the investee, even though it did not hold more than 50 per cent of the voting rights.

Control assessment inadequate

As a result of its inquiries, ASIC concluded that the entity in question had not properly assessed whether it controlled the investee in accordance with the requirements of AASB 10 Consolidated Financial Statements. Previously, the entity did not consolidate an entity in which it held a 45.6 per cent ownership interest, where the remaining shareholders were widely dispersed.

What was restated?

In its current year financial statements, the entity prepared a consolidated report that consolidated the investee over which it had de facto control, and also restated its comparative period financial statements to fix the error, as the shareholding had been held for some time.

The restatement of the comparative period resulted in an increase in net assets of $129.8 million, an increase in profit after tax of $13.5 million, and a decrease in net cash outflows of $72.4 million.

What does ASIC expect?

ASIC has noted that it expects all preparers of financial reports to appropriately consider the control assessment and consolidation requirements in AASB 10.

Reminder - What is control?

AASB 10, paragraph 7, notes that an investor controls an investee if it has all of the following:

An investor has power over an investee if it has existing rights that give it the current ability to direct the relevant activities.

Usually, an investor concludes that it has control over an investee if it owns the majority of shares of its investee, and those shares have equal voting rights attached. For example, this would be the case where:

• The shareholders appoint the board of directors, who, in turn, make key decisions regarding the relevant activities, and
• Another party does not hold potential voting rights (options), which, if exercised, would result in that other party having control.

What is de facto control?

Sometimes, an investor may not hold a majority of the shares in an investee, but may own a large enough interest such that it has the practical ability to direct the relevant activities. In these cases, the investor is said to have ‘de facto control’ over the investee.

In order to determine whether it has de facto control over an investee, the investor must consider the following:

• The size of its holding of voting rights relative to the size and dispersion of holdings of the other vote holders
• The more voting rights it holds, the more likely it is to have existing rights that give it the current ability to direct the relevant activities
• The more voting rights it holds relative to other vote holders, the more likely it is to have existing rights that give it the current ability to direct the relevant activities
• The more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities
• Whether the investor, other investors or other parties hold potential voting rights
• The effect of any contractual arrangements
• All other facts and circumstances, including voting patterns at previous shareholder meetings.

Voting patterns at shareholder meetings

The lower the quorum required at the shareholder meeting, the more likely it is that an investor with a significant (but still a minority) shareholding will have rights that give it the current ability to direct the relevant activities (i.e. de facto control).

It is also important to note that when looking at voting patterns at previous shareholder meetings, the focus is on the number of vote holders that have participated in the past and the absolute proportion of voting rights that have historically been exercised. It is not on whether other vote holders have voted in the same way as the investor.

Examples of de facto control

The following examples demonstrate the complexity and judgement required when assessing whether an entity has de facto control:

• Example 1: Large minority shareholding with numerous and widely dispersed remaining investors
• Example 2: Large minority shareholding with a moderate number of other investors
• Example 3: Large minority shareholding with only two other investors
• Example 4: Large minority shareholding with eleven other equal shareholders
• Example 5: Moderate minority shareholding with several other minor investors and numerous, widely dispersed remaining investors.

Example 1: Large minority shareholding with numerous and widely dispersed remaining investors

Investor A acquires 48 per cent of the voting rights of an investee.

The remaining voting rights are held by thousands of shareholders, none of who individually holds more than 1 per cent of the voting rights.

None of the shareholders has any arrangements to consult any of the others or make collective decisions.

Analysis

On the basis of the absolute size of its holding and the relative size of the other shareholdings, Investor A concludes that it has a sufficiently dominant voting interest to meet the power criterion without the need to consider any other evidence of power.

This is likely similar to the fact pattern in ASIC inquiry noted above.

Example 2: Large minority shareholding with a moderate number of other investors

Investor B holds 40 per cent of the voting rights of an investee and twelve other investors each hold 5 per cent of the voting rights of the investee.

A shareholder agreement grants Investor B the right to appoint, remove and set the remuneration of management responsible for directing the relevant activities.

To change the agreement, a two-thirds majority vote of the shareholders is required.

Analysis

In this case, Investor B concludes that the absolute size of the investor’s holding and the relative size of the other shareholdings alone are not conclusive in determining whether it has rights sufficient to give it power.

However, Investor B determines that its contractual right to appoint, remove and set the remuneration of management is sufficient to conclude that it has power over the investee.

When assessing whether Investor B has power, it does not consider that it might not have exercised this right or the likelihood of it exercising its right to select, appoint or remove management.

Example 3: Large minority shareholding with only two other investors

Investor C holds 45 per cent of the voting rights of an investee. Two other investors each hold 26% of the voting rights of the investee. The remaining voting rights are held by three other shareholders, each holding 1 per cent.

There are no other arrangements that affect decision-making.

Analysis

In this case, the size of Investor C’s voting interest and its size relative to the other shareholdings are sufficient to conclude that Investor C does not have power. This is because only two other investors need to cooperate to be able to prevent Investor C from directing the relevant activities of the investee.

Example 4: Large minority shareholding with eleven other equal shareholders

Investor D holds 45 per cent of the voting rights of an investee.

Eleven other shareholders each hold 5 per cent of the voting rights of the investee.

None of the shareholders has contractual arrangements to consult any of the others or make collective decisions.

Analysis

In this case, the absolute size of Investor D’s holding and the relative size of the other shareholdings alone are not conclusive in determining whether it has rights sufficient to give it power over the investee.

Additional facts and circumstances that may provide evidence that the investor has, or does not have, power shall be considered.

Example 5: Moderate minority shareholding with several other minor investors and numerous, widely dispersed remaining investors

Investor E holds 35 per cent of an investee. Three other shareholders each hold 5 per cent of the voting rights of the investee. The remaining voting rights are held by numerous other shareholders, none of whom individually hold more than 1 per cent of the voting rights.

None of the shareholders has arrangements to consult any of the others or make collective decisions.

Decisions about the investee’s relevant activities require the approval of a majority of votes cast at relevant shareholders’ meetings (i.e. more than 50 per cent).

75 per cent of the voting rights of the investee have been cast at recent relevant shareholders’ meetings.

Analysis

In this case, the active participation of the other shareholders at recent shareholder meetings indicates that the investor would not have the practical ability to direct the relevant activities unilaterally, regardless of whether the investor has directed the relevant activities because a sufficient number of other shareholders voted in the same way as the investor.

More information

Please refer to section 3.3.7 of our publication for more information and practical examples for assessing control under AASB 10.

Need help?

Assessing control under AASB 10 is a complex task, and involves significant judgement. Our IFRS & Corporate Reporting team is here to help. Please contact us now.