“Please tell the board to not pay me in shares” pleaded the executive of one client company, “as they are worth little to me”.  Unfortunately, due to Australia’s insider trading laws, this is not an uncommon refrain.  But now the government has signaled its readiness to change. 

Guerdon Associates has long advocated changes to insider trading laws (for example, click here).  Insiders in companies paid in shares or options very often are unable to trade these, even during so called trading windows, because they possess material inside information.  This is particularly a problem in acquisitive and rapidly growing companies.  The lack of liquidity associated with payment in company equity effectively reduces the payment’s value in the hands of the recipient.  Well, the government has listened. Persons will be able to deal under non-discretionary trading plans, notwithstanding that they may have relevant inside information at that time.  This is very good news.

In early March, just after we published our last newsletter, the Government released a discussion paper on changes to insider trading laws (see here).  It has agreed with the majority of the Corporations and Markets Advisory Committee’s (CAMAC’s) recommended changes to the insider trading law found here.

One consequence of the current law is that those directors and other persons involved in management who are regularly being exposed to inside information may be deprived of reasonable opportunities to deal in their company’s securities, even at pre-determined dates under a non-discretionary trading plan. The practice adopted by many companies of encouraging their officers to limit trading in the company’s own securities to a ‘trading window’ period (for instance, a limited period after release of a company’s financial statements) will not assist officers who nevertheless hold inside information at that time. A total prohibition on trading by these persons when they are informed may work against the general interest of shareholders in having corporate officers exposed to the risks and opportunities associated with ownership of shares in the company.  The net effect is that shares and options are not liquid, their value is diminished, and the reward becomes insufficient to motivate.  CAMAC recommended that Australia adopt laws similar to US SEC rule 10b5-1. 

CAMAC’s recommendation 16 said that there should be an exemption from the insider trading provisions for trading under non-discretionary plans where:
• The trading takes place in accordance with a plan entered into when either the person was not aware of any inside information or any information of which the person was then aware was no longer inside information when any trading under the plan took place
• There are no discretions under the plan, other than to terminate it, and
• The plan was entered into in good faith and not as part of a scheme to evade the insider trading prohibitions.  

The person seeking to rely on the exemption should have the legal onus of establishing the above elements, rather than merely an evidential onus to raise them.

US Securities and Exchange Commission (SEC) Rule 10b5-1, introduced in October 2000, permits persons to operate trading plans, notwithstanding that they are aware of relevant inside information, provided they devised these plans before becoming so aware and they have no discretion to alter those plans once so aware, other than to terminate them.

The government has also accepted other recommendations.

Section 205G of the Corporations Act currently requires a director of a listed company to notify the market operator (for example, the Australian Stock Exchange) of:
• Any relevant interests of the director in securities of the company or a related body corporate; and
• Contracts to which the director is a party or under which the director is entitled to benefit and which confer a right to call for or deliver shares in, debentures of, or interests in a managed investment scheme made available by the company or a related body corporate.

Notice must be given within 14 days of the director’s appointment or any change in the director’s interests.

The Government has adopted CAMAC’s recommended changes to s205G. They include:

• Extending the obligation to all listed entities, not just listed public companies;
• Extending the obligation to senior executives as well as directors;
• Extending the obligation to the one-month period after resignation; and
• Reducing the disclosure period from 14 days to two business days in most cases (this is shorter than the five business days currently allowed under ASX Listing Rules).

Reducing the disclosure period may be a big challenge to some companies, which cannot seem to do it in the current five days required by the ASX. A review by the BT Corporate Advisory service revealed that directors at 16 companies breached the ASX rules in 2005, an improvement on 22 companies in 2004, while six companies breached the Corporations Act, compared with 20 previously.

But not all of CAMAC’s recommendations have been accepted, with the government appearing uncertain on some issues.

As a result, the Government is seeking further submissions on the CAMAC recommendation regarding exercising options with inside information. An insider who exercises an option right for physical delivery of a product covered by the insider trading law may be guilty of insider trading, even if the insider only came into possession of the inside information after entering into the option contract. CAMAC has recommended that persons who, in good faith, enter into fixed exercise-price, physical delivery, option contracts when they are not aware of inside information be entitled to exercise their physical delivery rights, even when they hold inside information. The Government appears to be concerned about the potential advantage that this change could give an insider when deciding whether to exercise an option. It has called for further submissions.

In the meantime keep watching this space.  We will let you know when government intent becomes reality.

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