The regulation for how insiders can trade in Australia needs to change:
It is becoming increasingly clear to TDM Growth Partners that how Key Management Personnel (KMP) are allowed to trade in Australia is detrimental to both investors, the directors and employees under which trading policies apply to, as well as to the public market landscape more generally. It is our argument that ASX should consider the adoption of a similar system to that utilised in US markets, formally known as Rule 10b5-1.
ASX listing rules 12.9-12.12 (guided by note 27) outlines the basic compliance and regulation for ASX listed companies for trading of its securities by its key management personnel, specifically those who at certain times are in possession of market sensitive information.
Generally, listed ASX businesses have adopted two forms of trading policy to comply with these rules;
1/ Ability for KMPs to trade in securities for 10 weeks a year, over three open trading windows. These windows are four weeks after both half and annual results are released and for two weeks after the AGM
2/ Ability of KMPs to trade in securities for 42 weeks of the year, with blackout trading periods 4 weeks prior to half and full year results and two weeks prior to the AGM.
Trading in both cases is also namely subject to both Chairman approval and also importantly to compliance with the Corporations Act in relation to insider trading.
It is our opinion that the current system has some significant flaws:
1/ Signalling: Regardless of the timing of the trade, the duration between the trade and any update to public information, all trading currently made under this system is viewed by other investors as a signal to the market as to how the KMP views the business. While this signalling could be fundamentally incorrect, the effect of the trade on market perception is not addressed under current regulation.
2/ Significant pain points for directors and management:
These pain points can be summarised as;
a/ Signalling effect of insider share sales: Potential share price implications, questions and criticism by investors over the signalling effect of their trade.
b/ Uncertainty associated with determining “market sensitive inside information”: KMPs and Boards are exposed to more information than the public. Often, this information would not be deemed as market sensitive, but the rightful fear of insider trading causes significant debate.
c/ Taxation and Long-Term Incentive plans: Under current taxation law, tax occurs at the time the shares vest (not disposed of), and as such many KMPs sell shares to fund this tax bill. If the share price falls before they sell these vested shares, they now have a tax liability on a depreciating asset base.
As noted in Guidance note 27, “most people agree it is beneficial for directors and employees to own securities in the entity”, as it creates a significant alignment of interest between the board, management and shareholders. Unfortunately, under current guidelines, LTI plans based around equity remuneration is a huge catch 22 – everyone sees the benefit, but it is very hard to monetise in a fair and transparent manner.
We ask for serious consideration of the adoption of the US model, more specifically a relevant, Australian equivalent of Rule 10b5-1.
Under Rule 10b51, insiders are able to establish a written trading plan that details when they will buy and sell shares at a predetermined time, on a scheduled, automatic basis. This gives the KMP the ability to trade (by initiating a plan) at any time when they are not in the vicinity of material, non-public information. Under this rule, KMPs are not allowed to change (or adopt a plan) if they are in possession of market sensitive information.
This system has several benefits –
1/ They know what to expect and when to expect it, essentially mitigating any signalling effects. In our experience, shareholders get used to the regular cadence of trading and as such don’t view the trades with the suspicion that currently occurs in Australia. This has a side effect of improving the stability of share registries.
2/ It allows for a more transparent process, as regardless of the share price movement in the lead up to a trade, execution will take place automatically, nullifying any interpretation of the reasons for the trade, with the intentions of the KMP being known well in advance.
For the board and management;
1/ Optics – because of the pre-set systematic method of accumulating or disposing of shares, the possession of insider information becomes irrelevant
2/ Trading windows and blackout periods become irrelevant – Aside from starting, amending or changing a plan, nullifying trading windows for general trading activities allows for a more efficient and “clean” approach. By removing this friction for executives, they can focus their attention to core-business decisions.
We note the recent Kip McGrath (ASX:KME) announcement (12/9/18), which the Chairman “wishes to advise the market that he intends to sell shares over the next 4 years at an average of 45,500 shares per month”.
While we admire the sentiment of such an announcement, we suggest that such self-adoption is going to increasingly happen, and as such the ASX should provide some formal framework for executives to trade in this pre-arranged fashion.
We also think, if ASX were to use Rule 105b-1 as a framework, that there be a number of best practices considered for guidance. These may include but are not limited to: