The insider trading rules will get harsher from January 1. ASIC has already signalled a tougher stand when it recently charged high-profile investment adviser Rene Rivkin. Rebecca Maslen-Stannage and Paul Sheehy* explain what directors need to watch out for.
Australia has one of the strictest insider trading regimes in the world. This complex regime restricts directors' freedom - not only to buy and sell shares - but also to encourage others to invest in the company. It is a demanding task for directors to promote and invest in the company in their own right without overstepping the mark. From 1 January 2002, the trading of directors in listed companies will come under increased scrutiny. Recent amendments to the Listing Rules require increased disclosure of the details of directors' trades, and that the relevant information be announced to ASX within five days of each trade. Insider 'trading' and 'tipping' Despite its name, the term "insider trading" extends well beyond the conduct of actual buying and selling. A director who has:
• price-sensitive information;
• which the director knows or ought reasonably to know is not generally available; but
• which the director knows or ought reasonably to know might, if it was generally available, materially affect the price or value of securities;
• they must not subscribe for, purchase or sell those securities;
• request or encourage any other person to subscribe for, purchase or sell those securities; or
• directly or indirectly communicate the information to another person if the other person is likely to subscribe for, purchase or sell securities or encourage someone else to do so (commonly known as "tipping").
The insider trading law applies to transactions in "securities". As well as shares, this includes debentures, convertible notes, units of shares, interests in a managed investment scheme and certain option contracts. The law also prohibits insider trading in relation to futures contracts. Amendments to the law which come into effect on 11 March 2002 will extend the insider trading provisions to derivatives, superannuation products and any other financial products that are able to be traded on a financial market. What is 'information'? Information need not be specific or precise in order for it to be considered "inside information". The law specifically says that "information" includes:
• matters of supposition and other matters that are insufficiently definite to warrant being made known to the public; and
• matters relating to the intentions, or the likely intentions, of a person.
Even information which is not required to be disclosed under the ASX Listing Rules (for example, confidential incomplete negotiations) can still be considered "inside information, as can rumours. Information is materially price-sensitive if a reasonable person would expect the information to have a material effect on the price or value of the securities. Information which would influence people who commonly invests in securities in deciding whether or not to subscribe for, buy, or sell the securities is clearly materially price-sensitive. When is information generally available? Information is generally available if:
• it has been announced or otherwise publicised and the market has had sufficient time to reflect the new information in the company's share price;
• it consists of facts or material that are "readily observable" in a public arena; or
• it consists of deductions, conclusions or inferences made or drawn from information which is readily observable or has been sufficiently publicised.
Examples of generally available information include:
• information that has been announced to a stock exchange or is contained in a public announcement where the market has had a chance to absorb the information;
• published information of investment advisers and brokers;
• the decision of a court which has been published by the court;
• information obtained by investment research which is based on information freely made available by a company to the researcher, or is published on a company's website.
Exceptions to the insider trading prohibition
There are certain exceptions to the prohibition on insider trading - for example, a director obtaining a share qualification, communications with underwriters and trading by employee share schemes. However, some of these exceptions are defined narrowly. Some employee share scheme transactions, for example,
fall outside the wording of the exception. A director should therefore seek specific advice before relying on any of these exceptions.
Consequences of contravention
The consequences for a director of insider trading are very serious - a fine of up to $220,000 ($1.1 million for companies), imprisonment for up to five years and a potential life ban on acting as a director. Any person who suffers loss or damage due to the insider trading can also claim compensation from the director. From 11 March 2002, a court will also have the power to impose a civil penalty on the director of up to $200,000. Obviously, even insider trading charges or allegations, whether or not the person is convicted, can also irreparably damage the reputation of the director as well as the reputation of the company of which the person is a director. Practical steps to avoid liability Implement and enforce a securities trading policy Apart from the insider trading rules discussed above, the Act does not restrict the timing of trading by directors.
However, there are some times when a company is particularly likely to have inside information. For example:
• in the weeks leading up to release of the annual financial statements; or
• while drilling results are imminent during exploration.
To avoid any perception of insider trading, a director may wish to avoid any trading during those times, whether or not the director actually has inside information at those times. Best practice is for a company to implement a policy on trading by directors and officers as part of the company's corporate governance program. The degree to which the policy will impose "blackout periods" where directors and officers are not permitted to trade at all will depend on the directors' assessment of the likelihood of the company having inside information at various times and how cautious an approach the company wishes to take. For example, guidelines which have been adopted by some major listed companies provide that directors are only permitted to trade in the company's shares:
• in a "trading window" of, say, the six weeks immediately following the release of the company's profit results; or
• from three days after the company's AGM.
The guidelines should also apply to trading by a director's associates, such as their spouses, dependent children, family trusts and family companies. Of course, even during a "trading window" under the company's securities trading policy, a director can only trade if he or she does not actually have inside information at the time. Some companies also specify that a director cannot deal on the basis of short term considerations. For example, the companies' policy may require that a director must hold any shares purchased for a minimum of six months. A company's policy on the trading of its securities by directors, including the use of trading windows, is among the list of corporate governance matters that the ASX considers that a company should include in its annual report. Enforce continuous disclosure The quickest way to turn inside information into generally available information is to announce it to ASX. It follows that, by implementing solid disclosure procedures which ensure that material price sensitive information is disclosed to the market unless it is within one of the carve-outs from Listing Rule 3.1 and there is a good reason to keep it confidential, directors can reduce the risk of a breach of the insider trading laws.
Regulators such as ASIC and ASX naturally form views about corporate governance standards by considering, in part, company disclosure practices. In that environment, taking a proactive approach to disclosure of material information by directors will not only help directors avoid insider trading, but is also part of being seen as a "good corporate citizen". Disclosure to analysts and others The strong stance ASIC has taken recently against selective briefings of analysts or others outside the company has left some directors bewildered. Surely it is important that they sell their message to analysts so that they can promote the company and assist to dissipate the information? Provided they do not disclose any additional material information, why should they not discuss that information with analysts? While, as a strict matter of law, repeating to analysts information which has been publicly announced is not contrary to the Corporations Act, the difficulty here lies in the fact that:
• the lines between material and non-material, price-sensitive and non-price-sensitive, are often difficult to discern. In the moment a director might have to formulate a response to an analyst's question, it is difficult for a director to ensure that the answer does not cross the line; and
• the reality is that, since ASIC (together with its regulatory equivalents in other countries) has signalled this as a matter of concern to it means that directors must take particular care to ensure that their conduct is seen as above reproach in the area of analysts' briefings.
ASIC policy relating to disclosure of price sensitive information (see ASIC's guidance paper "Better disclosure for investors") states that such information should be publicly released by listed companies through the stock exchange before disclosing it to analysts or others outside the company. ASIC also suggests that the information be further disseminated to investors following release through the stock exchange. This can be done by posting the information on the company's website and, in the case of a company which involves a significant number of shareholders, but is not traded on a stock market, disclosing the information to ASIC itself. When a director speaks to analysts or anyone else about the company, the director needs to ensure that only information which has already been made publicly available or which is clearly immaterial is disclosed. Directors therefore need to be constantly aware of their company's announcements and the contents of their company's websites before engaging in discussions with outsiders regarding the company.
ASIC policy also suggests that directors implement a procedure for reviewing briefings of analysts or other outsiders to check whether any inside information has been disclosed inadvertently. If it has, the information should be announced to the market through the stock exchange, and then posted on the company's website. As mentioned under the heading "exceptions" above, there are certain, very limited circumstances where a director can disclose inside information legitimately. Also, since the concern of the insider trading law is to prevent disclosure which may encourage a person to buy or sell securities, in situations where the director has a legitimate reason to believe that the person to whom the information is being disclosed will not trade in securities, the information can be disclosed. For example, in order to negotiate a particular transaction on behalf of a company, a director may cause the company to give due diligence to the other party. However, the director should only do so after ensuring that the recipient has given undertakings of confidentiality and that the recipient will not trade in breach of the insider trading provisions.
Allow time for material to become 'generally available' While the strict letter of the law currently allows it, directors should be hesitant to trade or tip on the basis that information has become available as a "readily observable matter" or "deduction". In two recent related cases (R v Firns  NSWCCA 191; R v Kruse, District Court of NSW, 2 December 1999, No 98/11/0908), officers of a company knew that a particular appeal decision was to be handed down by a Papua New Guinea court at 9.30am on a particular Friday morning. The decision was duly handed down by the court, in favour of the company. The company's general manager in PNG was present in the court when the decision was handed down. He immediately telephoned his broker and instructed him to buy shares. The son of one of the company's directors also bought shares after being informed by telephone of the outcome of the appeal. The company did not announce the court decision until the following Monday. Both the general manager and the director's son were charged. The former was acquitted at trial. The latter, who was tried separately, was convicted, but was later acquitted on the ground that the court's decision was "readily observable matter". Despite the court's ultimate decision, a director would be taking a significant risk in relying on the "readily observable matter" exception. Differences in interpretation of the meaning of "readily observable matter" meant that the director's son stood convicted for over a year before the New South Court of Appeal overturned it.
It is also possible that readily observable matter is so closely connected with "inside" information that the director cannot safely trade. For example, the terrorist events of 11 September were given wide and immediate coverage in the media and therefore were "readily observable". However, an insurance company director could not have just assumed on 12 September that it was acceptable for the director to sell shares without first ensuring that the company made an announcement. The director would inevitably have had some degree of knowledge regarding the likely specific impact of those events on that company (for example, the nature and geographical location of business underwritten) which, taken together with the generally observable events, would have been likely to have a material effect on the price or value of securities in the company. Also, the Corporate and Securities Advisory Council has recommended that the law be changed so that corporate officers who become aware of some "readily observable matter", such as a court decision or natural disaster, must wait for a reasonable period for that information to be disseminated before being permitted to trade.
The insider trading laws are complex. Although they can be restrictive, given the wide scope of both the law and ASIC's interpretation of it and the penalties, a prudent director is advised to take a cautious approach. By implementing policies to minimise the risk of insider trading, and good disclosure practice, directors can avoid falling foul of the law and protect their reputation and that of their companies.
*Rebecca Maslen-Stannage is a partner and Paul Sheehy is a solicitor at Freehills, Sydney
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