Originally published in the November/December 2007 issue of Lexpert magazine.
Insider trading rules and investor scrutiny of insider trading often make it difficult for insiders to buy or sell stock in their company. There is no formal safe harbour available in Canada, as there is under so-called 10b5-1 plans in the United States. But administrative practice allows for the establishment of similar pre-authorized trading programs, as long as specified program requirements are met and related disclosure questions are addressed.
Insiders of public companies who wish to buy or sell shares in their company face a number of issues. The company's insider trading policy will likely permit insider trading only during certain "trading windows" after the quarterly release of the company's financial statements. The policy will also enable the company to restrict insider trading when the company possesses non-public material information. In addition, under securities laws generally, the insider will be prohibited from trading whenever he or she is in possession of non-public material information regarding the company. These restrictions often result in insiders being unable to trade company stock for extended periods of time.
An additional concern for insiders is the message the market often takes from trades by insiders. Because insiders must report trades promptly after making them, and because those reports are public and easily monitored, the market will know when insiders are buying, or more importantly, selling.
The combination of short trading windows and the inability to sell when in possession of non-public material information means that an insider who wants to diversify by selling a portion of his or her holdings is placed in a difficult position. The insider cannot sell a small number of shares on a recurring basis over an extended period of time (e.g. 1000 shares per month for a year) because much of that time will be outside the trading window or will be a period in which the insider is in possession of non-public material information. On the other hand, if the insider sells a substantial portion of his or her holding all at once, the market will presume the insider knows something and that the sale by the insider should be taken as a sell signal.
In the United States, regulators have addressed this issue by allowing the creation of automatic securities trading plans for insiders, known as 10b5-1 plans, which are common in the US. The rules permit insiders to set up automatic trading plans with a stock broker at a time when the insiders are not in possession of non-public material information. The plans must be automatic, meaning that the creator-insider cannot alter trading instructions after the plan has commenced.
In Canada, securities regulation is a provincial matter. Under the laws of Ontario and most other Canadian jurisdictions, an exemption from the insider trading laws exists for trades made through dividend reinvestment plans, share purchase plans or other similar automatic plans. This exemption does not specifically address automatic share disposition plans.
The Ontario Securities Commission ("OSC") recently issued Staff Notice 55-701 - Automatic Securities Disposition Plans and Automatic Securities Purchase Plans. The Staff Notice represents the opinion of the staff of the OSC and does not have the force of law in Ontario. It is also not binding on the securities regulatory authorities of other Canadian jurisdictions.
The Staff Notice sets out the Staff's views of automatic share disposition plans (an "ASDP") that will comply with the automatic plan exemption, and the disclosure obligations in connection with both the implementation of an ASDP and sales made pursuant to an ASDP. The Staff Notice is also applicable to automatic share purchase plans. The Staff Notice includes a hopeful statement from the OSC that the Staff Notice will soon be replaced by a Canadian Securities Administrators' staff notice in relation to ASDPs generally. No such staff notice has yet emerged from the Canadian Securities Administrators.
The OSC will generally accept that an ASDP is "automatic" for the purposes of the exemption if it meets the following conditions:
(a) At the time of entry into the plan, the insider is not in possession of any material undisclosed information in relation to the company.
(b) At the time of entry into the plan, in the case of plans that have not been established by the company, the insider provides the broker with a certificate from the company confirming that the company is aware of the plan and certifying that, to the best of its knowledge, the insider is not in possession of material undisclosed information about the company.
(c) The trading parameters and other instructions are set out in a written plan document at the time of the establishment of the plan.
(d) The plan contains meaningful restrictions on the ability of the insider to vary, suspend or terminate the plan that have the effect of ensuring that the insider cannot profit from material undisclosed information through a decision to vary, suspend or terminate the plan. A simple requirement that the insider represent to the broker that the insider is not in possession of material undisclosed information at the time of a variation, suspension or termination would likely not be a "meaningful restriction". An example of a meaningful restriction could be a requirement that the insider notify the company and the public (via a SEDI filing) of a change in instructions which filing would include a representation that the insider is not in possession of any material undisclosed information.
(e) The plan provides that the broker is not permitted to consult with the insider regarding any sales under the plan and that the insider cannot disclose to the broker any information concerning the company that might influence the execution of the plan.
(f) The plan to purchase or sell securities was given or entered into in good faith and not as part of a plan or scheme to evade the insider trading prohibitions.
The Staff Notice states that it does not apply to a managed account where full discretionary authority over the securities in the account rests with the broker managing the account: questions relating to managed accounts are stated to be beyond the scope of the notice.
While the Staff Notice establishes certain parameters for an ASDP, there may well be others that the insider or the company may wish to establish for his, her or its protection. These include restricting the insider from trading in the company's stock outside of the plan; providing that the plan will not terminate any sooner than (say) one year after initiation (except in extraordinary circumstances); and prohibiting trades under the plan for (say) at least 30 days after plan initiation.
The Staff Notice states that there could be a disclosure obligation at the time the insider enters into an ASDP. Where the plan is established by the company, the company should consider whether establishing the plan constitutes a "material change", thereby triggering a news release and a material change report. Similarly, the company and the insider should consider whether the establishment of the plan constitutes a "material fact", with the result that no person with knowledge of the material fact can trade so long as it has not been generally disclosed. The Staff Notice states that reports could also be required under other identified provisions of the securities laws depending on the specific terms of the plan.
If the issuer and insider conclude that there is no legal requirement to disclose the existence of the plan when it is established, it may nevertheless be advisable to disclose the existence of the plan on a voluntary basis. Disclosure of the plan may eliminate questions about apparent trading activity by insiders outside of trading windows or in periods when insiders may have access to non-public material information.
The notice states that the OSC is of the view that the insider will be required to file insider trading reports each time there is a disposition under an ASDP.
ASDPs can be a useful tool to assist insiders in diversifying their holdings in an orderly manner, but there are a number of rules to be followed to avoid insider trading pitfalls.