Director Share Ownership – Is It Time For The Rules To Change?
04/09/2006
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Yesterday it was reported that Treasury was reviewing director penalties that serve to increase directors’ risk aversion.  Treasury also is reviewing insider trading rules in very limited circumstances (e.g. interest rate swaps and foreign exchange forward contracts that are over the counter between just two parties).  We think it may be about time for the Treasurer to expand the review of insider trading rules.

Various governance guidelines advocate non-executive directors and senior executives owning company shares.  For example, both CGI and ISS advocate directors holding shares.  They look for reasons that they do not hold shares in each company’s annual report. This gives rise to a number of issues related to insider trading.  How do directors and senior executives acquire and dispose of shares without running foul of these regulations?  Even outside of blackout windows, directors and executives may be aware of material information that is not public.

Some of this fear could be allayed by a board policy to publicly state the method and timing of regular acquisition under a director share acquisition plan.  But there is still the question of disposal.  Some companies require shares compulsorily acquired under a director share acquisition plan to be held by directors until retirement or resignation from the board.  These policies lead to criticism that was last heard during the director retirement benefits debate.  That is, a director’s behaviour may be unduly influenced by benefits that he/she would personally receive on termination.

These issues are not isolated to Australia.  In the US, where equity comprises a significantly higher component of NED and executive remuneration than in Australia, this was a very significant problem.  It was resolved with the introduction of SEC rule 10b5-1. SEC Rule 10b5-1 allows officers, directors and other insiders of publicly traded companies to transact in their company shares at all times, not just during open trading windows. This gives corporate insiders expanded trading opportunities. 

Corporate officers who wish to sell shares in their company often are hampered by limited trading opportunities. Trading “windows” may be closed when material nonpublic information exists and trading could potentially violate insider-trading laws. SEC rule 10b5-1, which became effective October 23, 2000, offers an opportunity for issuers and their officers and directors to structure trading programs without running afoul of the insider trading prohibitions. It permits corporate insiders to execute securities transactions in many situations where previously they might not have, out of concern over potential insider trading liability. Importantly, SEC Regulation 10b5-1 allows greater opportunity for corporate insiders to sell their shares.

Trading plans can vary in terms of complexity. However, every plan must expressly specify the amount, price and date of the purchase or sale or provide a written formula or algorithm for determining amounts, prices and sale dates. Additionally, the individual entering into the plan must do so at a time when he/she is unaware of material, non-public information.  Typically an independent 10b5-1 trading trust is established to administer the plan.

While the effectiveness of director share ownership is open to debate and further research (see HERE), we see no reason why those that believe in it should be constrained in ways that could have potentially harmful effects on shareholders (such as requiring the trading of shares after acquisition to cease until termination).  Legislation to exempt insider trading via the equivalent of 10b5-1 trading plans from current insider trading laws should be considered.  How about it Treasury?

© Guerdon Associates 2021
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