ASIC Commissioner Cathie Armour says it could be time for companies to rethink their policy on margin loans for directors and officers.
With the heightened focus on directors and officers, now is an appropriate time for companies to reconsider any drivers of conduct inconsistent with the promotion of the long-term interests of the company. One such practice is the entry into margin loans by directors and officers to finance ownership of equity in the companies. Of course, there are benefits to be gained from directors and officers having “skin in the game” by owning equity in the company. However, funding that equity through margin loans poses risks and can create significant conflicts that can negatively impact market confidence.
In its Guidance Note 27 on share trading policies, the Australian Securities Exchange (ASX) urges listed entities to: “consider carefully whether its trading policy should prohibit KMP (key management personnel) and any other employees covered by its trading policy from entering into margin lending or other secured financing arrangements in respect of its securities or, at the very least, require disclosure of such arrangements so that the board and senior management are not caught unawares if there is a default”.
ASIC shares the ASX’s views and encourages listed entities whose share trading policies do not prohibit directors and officers from entering into margin lending in respect of the company’s securities to carefully consider the appropriateness of such a prohibition.
Funding that equity through margin loans poses risks and can create significant conflicts that can negatively impact market confidence.
Conflict of interest created by the entry into the margin loans can be a key risk for companies. The director or officer has a personal interest in maintaining the share price to avoid a margin loan call. This could drive short-term corporate decisions or a reluctance to disclose material information to the market. Clearly, such behaviour misaligns the interests of the director or officer with shareholders and contradicts the basis for directors having skin in the game in the first place.
If margin loans are allowed, the possible application of the insider trading provisions should be carefully considered. Even more importantly, companies should consider possible public and shareholder perceptions of director or officer trading because of margin loans in cases where directors have information (material or not) that is not available to the market more broadly.
The additional disclosure obligations in the Corporations Act 2001 (Cth) on directors regarding their ownership and trading of the company’s securities reflects the market influence directors have with the acquisition or sale of securities in the entity. Any significant sale of director securities under a margin loan may send a signal to the market regarding the company’s future. In a falling market, the momentum for such sales can become self-perpetuating, as was the case at the time of the global financial crisis.
Investor confidence can be negatively impacted if investors form the view that directors or officers are selling shares early in a falling market. This is particularly so when there is a perception they are in possession of confidential price sensitive information. While disclosure of the existence and terms of margin loans by directors and officers provides some transparency to investors, they could also provide incentives to persons seeking to drive down the share price to seek to trigger calls on these loans.
We urge companies to carefully consider the ability of directors and officers to enter into margin loans for their company.
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