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Focus: Securities trading policies to become mandatory

4 November 2010

In brief: The Australian Securities Exchange will amend the Listing Rules so that all ASX-listed entities will be required to make public their securities trading policy for their key management personnel. Partner Warwick Painter and Senior Associate Matt Ireland report on the mandatory requirements of the new Listing Rules, and highlight some potential issues for listed entities to consider ahead of the effective date of 1 January 2011.

• Background
• What are the changes?
• Closed periods
• Other prohibited periods
• Key management personnel
• Excluded trading
• Exceptional circumstances
• Margin lending and options or derivatives trading
• Recommendations

Background

Following the Federal Government's referral of the issue of blackout trading by directors to the Corporations and Markets Advisory Committee and ASX's own quarterly reviews of trading by directors during blackout periods, ASX initiated a public consultation process in December 2009. In April 2010, ASX released an exposure draft of amendments to the Listing Rules and, at the same time, Recommendation 3.2 of the ASX Corporate Governance Council's 'Recommendations' (the CGC Recommendations), which related to trading policies, was flagged for removal.

ASX finalised the relevant amendments to the Listing Rules earlier this year and has confirmed that they will come into effect on 1 January 2011, at which time the CGC Recommendations will also be amended to remove Recommendation 3.2. ASX has also issued a new Guidance Note 27 explaining its views on the new Listing Rules.

What are the changes?

The most fundamental change is the removal of the 'if not/why not' reporting obligation that existed under the CGC Recommendations, in favour of a mandatory requirement under the Listing Rules and formal disclosure of the trading policy to the market.

ASX has not adopted a 'one-size-fits-all' approach; rather, it is for each listed entity to determine the details of its own trading policy. However, the new Listing Rules require that a trading policy specifies as a minimum:

• the entity's blackout periods (referred to as 'closed periods' in the new Listing Rules);
• the restrictions on trading that apply to key management personnel during closed periods and other 'prohibited periods' when trading blackouts may be imposed;
• any trading circumstances that are excluded from the policy;
• any 'exceptional circumstances' in which key management may be permitted to trade during a closed period or other prohibited period with written clearance; and
• details of the procedures for obtaining written clearance to trade.

The new Listing Rules require the disclosure of any material amendments within five business days of the amendment taking effect. (The ASX Guidance Note indicates the type of material amendments that it expects would require disclosure.)

Much of this could appear to be straightforward and in line with existing trading policies formulated by ASX-listed entities by reference to the existing CGC Recommendations. However, there are a number of potentially difficult aspects of the new Listing Rules and the ASX Guidance Note, which need closer attention.

Closed periods

Appropriate closed periods will vary from entity to entity, but as a rough guide these should be periods when key management personnel are more likely to be in possession of non-public material information than at other times.

Accordingly, closed periods for an entity's trading policy will generally be dictated by the entity's reporting cycle, and common practice is either to specify:

• the period between the close of a company's books and the date of release of the relevant results (whether annual, half-yearly or quarterly); or
• a specified period prior to the preliminary announcement of results and the release of the results themselves (again, whether annual, half-yearly or quarterly),

as blackout periods. While the current approach appears unlikely to change under the new Listing Rules, some precision is required in defining such periods and deciding whether simply to have blackout periods or, alternatively, to have 'trading windows' with trading prohibited at all other times. If adopting primary blackout periods around reporting dates, then other appropriate closed periods also need to be considered. For example, specified periods prior to the announcement of:

• periodic re-negotiations of pricing for material long-term contracts; or
• material periodic sales or purchasing events (such as commodities auctions).

Other prohibited periods

Although a trading policy is only required to state the 'closed periods' when a standing blackout on trading applies, the new Listing Rules implicitly require listed companies to consider whether there will be other 'prohibited periods', defined as 'any additional period when key management personnel are prohibited from trading imposed by the entity from time to time when the entity is considering matters subject to Listing Rule 3.1A'.

This would apply, for example where a confidential incomplete strategic proposal is being considered by the board and that is exempt from immediate disclosure under the continuous disclosure rules in Listing Rule 3.1.

Listed entities will need to consider carefully how their trading policies should deal with trading during periods falling into the second limb of this definition of 'prohibited period'. Obviously, announcing such a prohibition on trading (eg by an email announcement to all restricted personnel) would not be possible, as it is effectively flagging to a wider audience that a confidential proposal exists but has not been disclosed to the market.

There are no easy answers to this problem, although ASX suggests that imposing a permanent blackout on trading with 'trading windows', open for only limited periods, may be a solution. Requiring clearance for all trades, even outside blackout periods, may be another solution. In submissions on the proposals in February 2010, the Law Council of Australia identified the potential broadcasting of such prohibited periods as a problem and pointed out that the use of 'trading windows' may not be appropriate for all companies. There was some response to these concerns in not requiring the Director's Change of Interest Notice to flag trades as occurring during any prohibited period. However, the Listing Rules still have not effectively addressed the problem that such prohibited periods cannot, in practice, be communicated to an extended group of employees affected by the trading policy, where those employees may not otherwise have had inside information. ASX-listed entities will need to pay close attention to how any additional prohibited periods are defined (having regard to the clear implication that ASX expects to see provision made in the trading policy for additional prohibited periods).

Key management personnel

For the purposes of the new Listing Rules, key management personnel are defined by reference to the Australian Accounting Standards Board's AASB 124 Related Party Disclosure, being persons with authority and responsibility for planning, directing and controlling the activities of the entity (directly or indirectly) including any director (whether executive or otherwise). The former CGC Recommendation 3.2 referred instead to 'potential insiders' by reference to specific positions and persons who are involved in material transactions or likely to be in possession of inside information.

While the list of relevant officers and employees caught by the new definition may, at first glance, appear to be similar, the new Listing Rule could potentially require the trading policy to cover a much broader class of senior managers.

Excluded trading

The ASX Guidance Note gives several examples of trading that a listed entity may consider excluding from the operation of its trading policy, including the:

• exercise (but not the sale of securities following exercise) of an option or a right under an employee incentive scheme; or
• conversion of a convertible security.

Listed entities will need to consider the implications of their trading policies on their key executives' remuneration where that remuneration includes the grant of options or performance rights. Prohibiting the sale of securities following the exercise of options (as contemplated by the ASX suggestion) may also cause problems for executives who need to sell down some securities in order to fund the exercise of the options.

The Corporations Regulations currently exclude from the operation of the insider trading prohibition (but not the tipping prohibition) the application for, and acquisition under that application of, securities issued by an entity to the entity's employees (or a trustee for the entity's employees) under an employee share scheme. The sale of such securities following the acquisition is, quite properly, not included in the exemption as this would potentially permit a sale of securities by an employee with insider information. However, including such a prohibition in a securities trading policy may be unduly onerous, where the employee or executive does not in fact have insider information.

Other examples given by ASX in the Guidance Note are:

• transfers of securities already held by a superannuation fund;
• an investment in a managed fund;
• a disposal resulting from a secured lender exercising its rights (eg under a margin lending arrangement); and
• trading under a non-discretionary trading plan, subject to certain limitations.

Exceptional circumstances

Under the new Listing Rules, consistent with the former CGC Recommendations, company trading policies may still permit trading by restricted persons during prohibited periods in instances of severe financial hardship or other exceptional circumstances with prior written clearance. (Of course, such clearance will not excuse the relevant person from the restrictions under the insider trading provisions of the Corporations Act 2001 (Cth).)
Company trading policies should set out a process for seeking clearance, including identifying the:

• officer from whom clearance should be sought;
• duration of clearances to trade; and
• form of written clearance that is acceptable (ie will an email do?).

The Guidance Note acknowledges that, by definition, it will not be possible to articulate all circumstances that might qualify as exceptional circumstances in advance, so that it may be appropriate for a company trading policy to grant the relevant officer some discretion to grant clearance to trade in other circumstances that they are satisfied are exceptional, and where they are satisfied that the sale or disposal of the relevant securities is the only reasonable course of action.

The Guidance Note states that it is for each listed entity to determine what constitutes exceptional circumstances and to set that out in its trading policy. However, it indicates that:

• a tax liability would not normally constitute severe financial hardship unless the person has no other means of satisfying the liability;
• a tax liability relating to securities received under an employee incentive scheme would also not normally constitute severe financial hardship or otherwise be considered an exceptional circumstance; and
• a sale or disposal of securities under a court order or enforceable undertaking (such as a bona fide family settlement), or a disposal under some other overriding legal or regulatory requirement, may be exceptional circumstances.

Margin lending and options or derivatives trading

The ASX Guidance Note indicates that an entity's trading policy should also:

• set out rules applicable to key management personnel with respect to entering into agreements granting lenders rights over their interests in the entity's securities; and
• apply to financial products issued or created over, or in respect of, the entity's securities (eg options or derivatives).

In formulating their trading policies, and their application to margin lending and options or derivatives trading, listed entities should have regard to the ASX/ASIC Joint Companies Update 02/08 issued in February 2008 on company disclosure. In the update, ASX and ASIC reminded listed entities that information about shareholders and their shareholdings can be material under the continuous disclosure Listing Rule 3.1 and require immediate disclosure to the market.

On margin lending arrangements, the update noted that where a director has entered into a margin loan or similar funding arrangement for a material number of an entity's securities, Listing Rule 3.1 may operate to require the entity to disclose the key terms of the arrangement, including the number of securities involved, the trigger points, the right of the lender to sell unilaterally and any other material details.

The update also referred to Listing Rule 3.1B, which requires a listed entity to disclose information necessary to correct or prevent a false market where ASX considers that there is, or is likely to be, a false market and noted that this requirement may arise even though the entity is not aware of any information that would be required to be disclosed under Listing Rule 3.1.

These comments could equally apply in respect of options or derivatives trading that relates to a material percentage of securities in the listed entity.

Accordingly, careful consideration should be given of how such arrangements are included in the trading policy and the interaction with the Listing Rule 3.1 disclosure issues mentioned above. In particular, listed entities should consider whether their trading policy should require the key management personnel to disclose to the entity all margin lending arrangements and options or derivatives trades, so that the entity can properly assess whether it should disclose such arrangements or trading to the market under its continuous disclosure obligations.

Recommendations

It is possible a trading policy that complied with the former CGC Recommendations will also comply with the new Listing Rules. However, this should not be assumed and all ASX-listed entities should review their trading policies and compliance ahead of the 1 January 2011 deadline.

Generally, we expect that the new Listing Rules will standardise disclosure of company trading policies, which will enable a better comparison of practices between listed entities. However, as can be seen above, there are several potentially problematic areas to which ASX-listed entities will need to give careful consideration, when reviewing or formulating their trading policies.

The addition of a mandatory reporting requirement that each Change of Director's Interest Notice specify whether the trading occurred during a closed period under the trading policy is likely to bring the content of such policies into sharp focus.

For further information, please contact:

• Jon WebsterPartner, Melbourne
  Ph: +61 3 9613 8832
  Jon.Webster@allens.com.au
• Andrew KnoxPartner, Brisbane
  Ph: +61 7 3334 3356
  Andrew.Knox@allens.com.au
• Andrew PascoePartner, Perth
  Ph: +61 8 9488 3741
  Andrew.Pascoe@allens.com.au
• David WengerPartner, Hong Kong
  Ph: +852 2840 1202
  Ulaanbaatar
  Ph: +976 7711 0231
  David.Wenger@allens.com.au