The recent case concerning the purchase of shares in David Jones by two of its directors in close proximity to receipt of a merger proposal and release of a quarterly sales update has raised a number of important legal and corporate governance considerations that companies and directors need to be reminded and aware of. Even though ASIC dropped its investigation and issued a "No Further Action" letter, the David Jones matter is a cautionary tale that the public perception of the conduct is paramount and can have reputational, business and personal repercussions that are as severe as any legal prosecution.
In this Alert, Partner Michael Hansel and Associate Katherine Hammond set out seven key lessons for companies, directors, market participants and investors about corporate governance matters arising from the issues associated with the David Jones matter.
David Jones – the facts
One day after David Jones Limited (David Jones) received an initial confidential $3 billion scrip merger of equals proposal from Myer (Merger Proposal) and three days before David Jones released a quarterly sales update which saw its shares increase by 15 percent, David Jones directors Leigh Clapham and Steve Vamos purchased 20,000 and 12,500 David Jones shares respectively (Share Purchase).
The Share Purchase was within a permitted trading window in the David Jones trading policy (Trading Policy), and the Chairman Peter Mason was reportedly given prior notification of the proposed Share Purchase in accordance with the Trading Policy.
ASIC launched a two month investigation of David Jones over insider trading concerns arising from the Share Purchase, but has decided to take no further action at this stage, issuing a 'No Further Action Letter'.
ASIC was reportedly unable to gather enough admissible evidence to establish that the Merger Proposal was "Market Sensitive Information", which is a necessary element for a successful insider trading prosecution.
ASIC's decision has sparked public criticism of ASIC's enforcement procedures and David Jones' corporate governance practices, and serves as a timely reminder about the operation of the insider trading laws and their interaction with a company's trading policy.
In the wake of the controversy and on the back of shareholder agitation, on 10 February 2014 David Jones announced a "Board renewal process"; Mr Clapham and Mr Mason have notified David Jones of their intention to resign within the next three months and Mr Vamos notified of his immediate resignation.
While David Jones and its Directors have avoided legal prosecution, the matter has not left the Company or the directors unscathed or immune from further impeachment.
Why David Jones is relevant to you
The David Jones matter serves as a valuable lesson that whether or not a company or its directors have complied with the law, public perception is paramount and can have reputational, business and personal repercussions that are as severe as any legal prosecution.
It also provides a warning to directors thinking about buying company shares where they may have undisclosed market sensitive information, and raises important corporate governance matters relating to the trading policy requirements for listed companies, disclosure obligations and directors' duties.
Seven key lessons from the David Jones matter
ASIC No Further Action Letter
Lesson 1: A No Action Letter from ASIC does not exonerate the Company or its directors.
ASIC has issued a "No Further Action" letter to David Jones in relation to its insider trading investigation. However, the no further action letter is not an exoneration, but rather an acknowledgment that at this point in time there is insufficient evidence to take the matter further, while reserving ASIC's rights to re-open the matter if new evidence comes to light.
Lesson 2: Directors must not trade financial products with, procure trading with or communicate for the purpose of a person trading with, undisclosed Market Sensitive Information. Directors must also be mindful of the market perception and associated potential repercussions of any share trade notwithstanding that they may not in fact be in possession of undisclosed Market Sensitive Information.
The insider trading laws in Australia provide that, a person who has "inside information" must not:
- trade or procure a person to trade in financial products of a company; or
- communicate the inside information where it may be used to trade in financial products1.
Inside information is essentially information which is not generally available and which, if generally available, would reasonably be expected to have a material effect on the price or value of securities (Market Sensitive Information).
David Jones Investigation
In the David Jones matter, ASIC reportedly discontinued the investigation of the David Jones directors because it could not establish enough admissible evidence to establish that any information that the directors were in possession of was Market Sensitive Information.
To establish that the directors did not acquire the shares when in possession of inside information, David Jones Chairman Peter Mason claimed that it was immediately obvious that the Merger Proposal "was just not going to fly". David Jones did not, however, formally reject the Merger Proposal for approximately a month.
If there was indeed no prospect that the Merger Proposal would be pursued by David Jones, then it is certainly arguable that there was no information with the requisite materiality to be Market Sensitive Information.
Whether or not the directors were in possession of undisclosed Market Sensitive Information, the David Jones fallout serves as a warning to directors that they need to be mindful of the market perception of any share trade, notwithstanding that it may be within the law.
Lesson 3: Directors cannot hide behind the company's trading policy.
Trading Policy Obligation
Listed companies must have a trading policy under the ASX Listing Rules, and directors (and other key management personnel (KMP)2) are still exposed to the insider trading laws even if the share trade was during a permitted period under the trading policy and even if the trade has been sanctioned by the board.
David Jones Trading Policy
The David Jones directors made the Share Purchases during the six week period after the company's annual results were released which was a "trading window", when directors were permitted to trade shares, under the David Jones trading policy.
The directors justified the purchases by saying that it was to demonstrate confidence at the AGM after chief executive Paul Zahra announced his intention to resign a month earlier.
Notwithstanding that the Share Purchases were made during a permitted period under the trading policy, if the Directors were in possession of inside information, they may still have breached and be liable under the insider trading laws. Compliance with a trading policy does not absolve directors of liability for insider trading.
A trading policy should therefore explain the prohibition on insider trading under the Corporations Act and note that under the insider trading laws a person who possesses inside information may be prohibited from trading even where the trading occurs within a permitted trading window or outside a black out or other prohibited period, or in circumstances that are excluded from the trading policy.
Indeed, the David Jones trading policy specifically prohibited trading if directors possess unpublished price sensitive information.
ASIC Monitoring of Insider Trading and Market Manipulation
Lesson 4: ASIC is watching.
In October 2013, ASIC's real time market surveillance system, the "Flexible Advanced Surveillance Technologies" (FAST) system, went live and has been generating an average of 120 insider trading and market manipulation alerts each day.
The $18.5 million FAST system tracks markets in real time and is designed to pick up insider trading, market manipulation and possible breaches of the market integrity rules.
Since 2009, ASIC has prosecuted 32 insider trading matters and of those 23 have been successful, with a number still before the courts. Six matters have been unsuccessful, including one conviction that was quashed on appeal and one matter that was discontinued.
Suspicious Activity Reporting
Lesson 5: Market Participants must tell ASIC about suspicious trading.
Since 1 November 2012, under Rule 5.11 of the ASIC Market Integrity Rules (ASX Market) 2010, a market participant (such as brokers) must notify ASIC if it has reasonable grounds to suspect that a person has placed an order or entered into a transaction while in possession of inside information, or which has the effect of creating or maintaining an artificial price or a false or misleading appearance in the market or price for trading in financial products. The penalty for failing to comply is $20,000.
Lesson 6: Companies may need to disclose inside information to the market.
Questions were also raised about whether David Jones should have disclosed the Merger Proposal earlier in accordance with its continuous disclosure obligations.
Under the continuous disclosure regime in ASX Listing Rule 3.1 and the Corporations Act 2001 (Cth), a listed entity must immediately disclose to the ASX any 'Market Sensitive Information' - that is, information in relation to the entity that a reasonable person would expect to have a material effect on the price or value of the entity's securities.
There are very limited exceptions to this rule, which are contained in Listing Rule 3.1A including, relevantly, where the information is confidential and:
- concerns an incomplete proposal of negotiation; or
- comprises matters of supposition or is insufficiently definite to warrant disclosure.
David Jones did not make any disclosure about the Merger Proposal when it was made.
Chairman Peter Mason, claimed that it was immediately obvious that the merger proposal "was just not going to fly", suggesting that the information was not Market Sensitive Information. However, David Jones did not formally reject the Merger Proposal until almost a month later.
Whether or not the Merger Proposal was in fact Market Sensitive Information, David Jones is likely to be justified in not disclosing the Merger Proposal when it was made on the basis that it was confidential and it concerned an incomplete proposal or negotiation, comprised matters of supposition or was insufficiently definite to warrant disclosure, and therefore fell within the exceptions noted above.
Lesson 7: Directors' must always be mindful of their directors' duties, whether or not they are otherwise complying with the law.
If the Board immediately dismissed the Merger Proposal (as the David Jones chairman has reportedly claimed), questions are likely to arise about whether the Board members have fulfilled their directors' duties. On 20 February 2013, Myer sent a letter to David Jones reiterating its interest in a merger between the two companies. David Jones announced that it was considering the letter and would consider any proposal that is on terms that are in the best interests of shareholders. This response clearly suggests that David Jones is mindful of its duties.
1"Division 3 financial product", as
defined in section 1042A of the Corporations Act.
2As defined in Accounting Standard AASB 124 Related Party Disclosure.
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