Every ASX entity must have a securities trading policy to restrict trading by its key management personnel at times when there is a heightened risk that they will possess material, price sensitive, non-public information. Recently we have seen a number of circumstances where individuals have failed to appreciate that compliance with an entity’s trading policy does not equate to compliance with the insider trading provisions.
As insider trading continues to be a key focus of ASIC’s enforcement policy and the sophistication of ASIC’s market surveillance technology increases, this article provides a refresher on insider trading laws and highlights three circumstances where a dealing in securities by key personnel may be permitted under an entity’s trading policy but could attract liability under the insider trading provisions including:
- disposals arising from the acceptance of an equal access buy-back offer, takeover offer or scheme of arrangement;
- acquisitions under a pro-rata issue or under a security purchase plan or a dividend or distribution reinvestment plan; and
- acquisitions under an employee incentive scheme.
What is the prohibition?
The law prohibits a person in possession of price sensitive, non-public information about certain financial products (including securities, derivatives and managed investment products) from:
- trading (including applying for, acquiring or disposing) or entering into agreements for trading;
- procuring that another person trades or agrees to trade; or
- directly or indirectly communicating, or causing someone else to communicate, inside information to another person who is likely to trade, or get somebody else to trade,
in those products.
‘Price sensitive’ means in this context, information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of the entity’s securities. Information is taken to have a material effect if it would, or would be likely to, influence persons who commonly invest in securities in deciding whether to trade.
As the test is based on the information that the person holdsand not their relationship with the entity, it is possible for someone who has absolutely no connection with the entity to be deemed an insider, for example, a person who is aware of a third party’s confidential takeover bid for a company. Information may also include statements, opinions, predictions or forecasts even if the person who makes or repeats them knows or believes that it is unreliable or has an unsound factual basis, or is unreasonable, false or a lie.
The purpose of the trading is irrelevant and it is no defence that a person did not rely on the inside information in trading.
Interestingly, an insider may use inside information to refrain from trading (eg by cancelling a trading order), to procure that another person refrains from trading and may also communicate the inside information to another person for that purpose.
A person is not prohibited from using inside information if the information consists of knowledge of their own intention to deal in an entity’s financial products.
Further exclusions from the insider trading prohibitions may apply in the following circumstances:
- the obtaining by a director of a share qualification;
- acquisition of securities under an employee incentive scheme by, or by a trustee for, those employees;
- acquisition of securities pursuant to a requirement under the Corporations Act 2001 (Cth) or a communication of information pursuant to a requirement imposed by law;
- withdrawal from a registered scheme;
- sale of financial products under certain security arrangements;
- applying for or acquiring securities under an underwriting or sub-underwriting agreement or disposing of those securities; and
- transactions entered into by a personal representative of a deceased person, a liquidator or a bankruptcy trustee in the performance of their official functions or certain transactions behind a Chinese wall arrangement.
Equal information defence
Insiders have a specific defence to a criminal prosecution if the court is satisfied that the counterparty to the transaction “knew or ought reasonably to have known” of the confidential price-sensitive information.
There is no equivalent statutory civil defence. However, if the counterparty to the transaction “knew or ought reasonably to have known” of the confidential price-sensitive information, the court may (at its discretion) relieve the insider wholly or partly from any civil liability.
A company whose securities are traded, but which is not a party to the transaction, may also have civil remedies against the insider. In this context, a counterparty equal information defence is irrelevant, as the company is not a transacting party.
THREE TRAPS FOR INSIDERS
1. Disposal of securities arising from the acceptance of an equal access buy-back offer, takeover offer or scheme of arrangement
A shareholder cannot accept an offer to acquire their parcel of shares under an equal access buy-back offer or a takeover offer while in possession of inside information in relation to that company.
If, however, the shares were compulsorily acquired, either under a takeover or scheme of arrangement, the disposal would not occur as the result of any dispositive act by the shareholder but rather by force of the relevant legislative provisions in the Corporations Act and there would be no contravention.
Similarly, a shareholder in possession of inside information would not be prohibited from voting in favour of a scheme of arrangement under which their shares would be acquired unless it could be said that by voting in favour of a scheme, they were “procuring another person (the bidder) to acquire” the company’s securities. It would be unlikely that in a normal situation, there would be a sufficiently direct connection between the shareholder’s vote and the acquisition of their shares to constitute a procurement. However, if a shareholder had sufficient shares to control the outcome of the vote, then conceivably it might be arguable that they “procured” the acquisition of the company’s shares.
2. An acquisition of securities under a rights issue or a placement
Companies making general issues of their securities (being either an offer of new securities to the market generally or an offer to its existing securities holders under a rights issue) are subject to the prospectus and other disclosure requirements in Chapter 6D of the Corporations Act. These provisions are specifically designed to ensure that prospective investors are fully informed, with civil and criminal consequences for persons involved in preparing disclosure documents if material price-sensitive information is not included.
Notwithstanding that the current prospectus and other disclosure requirements for securities issues cover the same conduct as insider trading, the insider trading provisions still apply to issuers of new securities, including under a general issue.
The insider trading prohibition also applies to any offeree who is aware of inside information affecting the value of the relevant financial products that is not known to the issuer (eg a confidential takeover bid). An offeree of new securities in possession of inside information would therefore be prohibited from taking up (or applying to take up) its entitlements under a rights issue or subscribing to a placement.
If the inside information was also in the possession of the issuing company, then the offeree would be able to rely on the equal information defence in criminal proceedings, although as outlined above, whether a court would relieve the offeree from civil liability is a matter for its discretion.
3. An acquisition of securities under a security purchase plan or a dividend or distribution reinvestment plan
A shareholder in possession of inside information in relation to the company is not permitted to acquire shares under a security purchase plan.
In the case of a dividend or distribution reinvestment plan, the agreement on the part of a shareholder to participate in the plan would not give rise to any acquisition of securities; this would only occur when the securities are issued or transferred to the shareholder. However, the prohibition extends to a person “entering into an agreement to apply for” securities and arguably would prohibit a person in possession of inside information from joining a plan.
Plans usually permit a shareholder to terminate their participation in the plan upon giving notice to the company, and if it is to be effective for a particular dividend, it will normally have to be received prior to a certain number of days after the record date for that dividend (usually by 5pm on the first trading day after the record date).
If the shareholder was not aware of any inside information at the time of joining the plan but subsequently came into possession of inside information, the shareholder could lawfully terminate their participation in the plan prior to the issue of any securities under the plan provided notice was given within the permitted period. The termination of a plan whilst in possession of inside information would not fall within any of the prohibited acts and in any event, as noted above, to refrain from trading is not unlawful.
However, a difficulty would arise if a shareholder came into possession of inside information after it was too late to terminate their participation in the plan in relation to a particular dividend. While the insider trading provisions prohibit a person from entering into an agreement to acquire or dispose of securities when in possession of inside information and also prohibit the actual acquisition or disposal of securities, there is nothing that deals with a situation where a person comes into possession of inside information in between the time of entry into an agreement for purchase or sale of a security (at which point the person is contractually bound to acquire/dispose of the security) and completion of that agreement. The fact that a person may have entered into an agreement to apply for or purchase a security when not in possession of inside information would not protect them from contravening the insider trading prohibition if they subsequently came into possession of inside information and acquired securities pursuant to that agreement in accordance with their contractual obligation.
The absence of inside information at the time of agreement in a bona fide purchase or sale may be relevant to whether ASIC would prosecute a contravention caused by completing the contract or to a court’s consideration of the imposition of a penalty or remedy. The only practical way to avoid a situation where a plan participant comes into possession of inside information after the cut-off date for terminating their membership of the plan for a particular dividend (and therefore becomes committed to acquire securities in lieu of that dividend under the plan) is to not participate in the plan at all.