Perspective

Australia needs to change how ‘insiders’ can trade

The process by which ‘insiders’ can trade in Australia is currently flawed. The current system in Australia only allows insiders to trade within specified windows. This has significant and detrimental signalling effects and wider repercussions for the public markets.

We firmly believe that the Australian market would benefit from the adoption of a similar system to that which is utilised in US markets. Allowing insiders to establish a written trading plan that articulates when they will buy and sell shares at a predetermined time, on a scheduled, automatic basis would alleviate this tension not only for insiders, but also other shareholders.
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The first is an ability to trade in securities for 10 weeks a year. This takes places over three trading windows – two four-week windows after half and full year results are released and a two-week window after the AGM.

The second is the ability for insiders to trade in securities for 42 weeks of the year. Under this policy, there are trading blackout trading periods four weeks prior to half and full year results and two weeks prior to the AGM.

Regardless of adopted policy, trading is always subject to Chairman approval to ensure compliance with the Corporations Act in relation to insider trading – that is the ‘insider’ is not in possession of market sensitive information.

As an investor that has sat on several publicly listed boards, as well as worked closely with management and other insiders, TDM have seen and lived through the problems the current system creates. These can be best summarised as;

1/ The perceived signalling effect to the market of ‘insider’ trades

Regardless of the timing of the trade and the duration between the trade and any update to public information, all trading currently made by ‘insiders’, is viewed by other investors as a signal to the market as to how the insider views the business. Regardless whether or not this signalling reflects the insiders actual view, it is in fact irrelevant – the trade has created a perception and this perception endures all mitigating facts.

Share sales particularly creates various pain points for ‘insiders – the potential share price implications and undoubted questions or criticism by investors play on the mind of management and board members heavily when weighing up their decision to sell or not, regardless of their motivation for doing so.

2/ The uncertainty as to what is in fact “market sensitive information” creates fear and anxiousness amongst ‘insiders’

Key management personnel and board members are by nature, exposed to significantly more information than the public. Often, this information would not be deemed as market sensitive, but the rightful fear of insider trading causes significant internal debate, that both wastes time and causes significant stress points.

3/ The paradox of Long-Term Incentive plans

There is no disputing how critical it is to align the interests of management and shareholders through long term incentive plans. Unfortunately, under current Australian taxation legislation, long term incentive (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.

Australian tax law currently stipulates that tax is to be paid at the time the awarded LTI shares vest rather than when they are sold. This means that many ‘insiders’ with LTI plans face tax liabilities despite not disposing of any shares. Often ‘insiders’ are forced to fund this tax liability by then selling their LTI shares. but for all the reasons outlined above, this can be a convoluted process. On occasions, this problems is amplified by a falling share price or soft market conditions – in this case, the ‘insider’ is now forced to sell even more shares to fund the payment of the tax bill. This is now a self-defeating system! LTI plans are used to align the incentives of management and shareholders, yet in this common instance, it is in fact doing the opposite.

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 – the cadence can be as regularly as weekly, or as infrequent as quarterly. These written plans allows ‘insiders’ to execute trades with ease and regularity regardless of their possession of market sensitive information. Plans usually run for between six months to two years. Under this rule, it must be noted, insiders are not allowed to start or change a plan if they are in possession of market sensitive information.

A snapshot of the three policies and their trading cadence
  1. Investors 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 also 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. This nullifies any interpretation of the reasons for the trade, as the intentions of the ‘insider’ are known well in advance. This alleviates any tension the ‘insider’ may feel about the optics of the trade.
  3. Trading windows and blackout periods become irrelevant – Aside from starting, amending or changing a plan within a trading window, 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 on core-business decisions.

It needs to be noted that these plans work and are widely adopted in the US because the US SEC has passed rules that facilitate them.

In Australia, ASX Guidance Note 27 “Trading Policies” already contemplates the use of 10b5-1 type written trading plans by insiders, whereby “insiders” announce upfront that they will buy or sell shares in pre-determined amounts at predetermined times. This is not taken up in Australia because of our insider trading laws.

For these plans to work and be more widely adopted in Australia, a legislative change to insider trading laws is required. An interim step maybe to modify ASIC regulation to allow trades to be undertaken in accordance with the pre-determined investment or divestment plan even though the buyer/seller may be in possession of inside information.

We, like many, know the investment community in Australia can do better. Regardless of how hard or complex a solution may seem with the various competing interests of governing bodies, we are of the belief it is our duty to open conversations and continue to lobby the various stakeholders for change.

About the author

Ed’s dedication to high performance and passion for business are a perfect fit with TDM’s culture. Having travelled the world playing professional cricket for over 15 years, Ed knows more than most the dedication required to build long-term success.

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