It is fundamental to the integrity of the capital markets that trading in securities takes place on a "level playing field," i.e., that buyer and seller have equal access to all relevant material information. To this end, Canadian securities laws, inter alia, require that reporting issuers make public, on a quarterly and annual basis, their financial results and related MD&A; disclose on a timely basis all "material changes";1 and prohibit insiders and others in a "special relationship" with the issuer from trading when in possession of a "material fact" or "material change" that has not been generally disclosed (i.e, "insider trading").2
The prohibition against insider trading creates a particular hardship for CEOs and others in senior management. On the one hand, CEOs are encouraged, and very often required, to hold a significant amount of the issuer's stock, and will generally have been granted a sizable number of stock options as an important component of their employment compensation, in order to align their interests with those of the shareholders. On the other hand, by virtue of their position, CEOs will almost constantly be in possession of non-public information, some of which may be material or border-line material.3
The CEO, as an insider, must file insider reports describing each of his or her trades in the issuer's stock within 10 days of the trade. Should it happen that such a report is filed in close proximity to the occurrence of a material event, suspicions will invariably arise as to the propriety of the trade, i.e., did the CEO have knowledge of the material event at the time of the trade, so that there was a connection between the two? At best, this will create a perception of impropriety. At worst, it may lead to allegations of improper trading and to a distracting internal or even regulatory investigation. Even if the allegations prove unfounded, they may tarnish reputations and erode the market's confidence in the issuer and its management.
To avoid the perception of questionable trades and to protect the reputation of the issuer, Canadian issuers typically adopt insider trading policies pursuant to which the CEO and certain other officers and employees may not trade in the issuer's stock, including exercising options, during regularly scheduled "blackout periods."4 This will leave the CEO with only very limited periods of time each year during which he or she may trade, and even these limited periods may not be available if they happen to fall during a discretionary blackout period or when the CEO is otherwise in possession of non-public information. The limited time periods during which a CEO may trade may be particularly problematic in the case of stock options, since these must be exercised before their expiry date5 and will be worth exercising only if the option is "in the money" at the relevant time.6
To alleviate the hardship created by the insider trading rules and the issuer's own insider trading policy, issuers and their boards should consider amending the issuer's insider trading policy to permit their CEOs (and other senior management, as appropriate) to establish "pre-arranged trading plans" or "automatic security disposition plans," pursuant to which the CEO would be able to dispose of securities on a pre-arranged schedule, regardless of whether a blackout period existed at the time of sale or the CEO was otherwise in possession of material undisclosed information.7 These plans, if properly established, will benefit from the statutory exemption from the insider trading rules available in the case of automatic dividend reinvestment plans, share purchase plans or any other "similar automatic plan that was entered into by the person or company prior to the acquisition of knowledge of the material fact or material change."8 The OSC has provided guidance as to what conditions such a plan must meet in order to qualify for purposes of this exemption.9 In particular, the insider must not have been in possession of material undisclosed information at the time of entry into plan and must so certify in certain cases; the plan must contain 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; the broker charged with executing sales under the plan is not permitted to consult with the insider regarding any such sales; and the issuer must be aware of the plan.
Such plans may apply generally to all shares held by the CEO10 or may be restricted to exercising options and selling the acquired shares. Both TD Bank and CIBC recently announced that the latter type of plan had been established for their respective CEOs.11 CIBC's related press release states that the pre-arranged option exercise plan "includes a timetable to exercise a set number of options for CIBC common shares at regular, predetermined intervals before they expire" and "provides for the [CEO] to exercise approximately 10,000 options each month beginning February 2 until December 1, 2009." It also states that the number of common shares [the CEO] "would continue to hold during or after the execution of the plan far exceeds CIBC's guidelines on executive share ownership" and that the participant "has no discretion to alter the terms of the arrangement or influence the execution of the plan."
Pre-arranged trading plans, and in particular pre-arranged option exercise plans such as the ones recently established for the CEOs of TD Bank and CIBC, may provide a nice compromise between adopting and enforcing insider trading policies, while at the same time ensuring that the CEO is not unintentionally deprived, as a result of untimely blackout periods and insider trading rules, from being able to take advantage of selling opportunities for at least a part of his or her shareholdings, and particularly from exercising options and selling the acquired shares which, after all, often represent a significant portion of his or her compensation.12
1 Stock exchange rules generally require the immediate disclosure of all "material information," which would include "material facts" as well as "material changes," unless such disclosure would be detrimental to the issuer.
2 The terms "material fact" and "material change" refer to facts or certain changes that would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer. In Québec, the prohibition is against trading when in possession of "privileged information," i.e., information that could "affect the decision of a reasonable investor."
3 Even where the CEO does not have actual, direct knowledge of certain of the company's non-public information, there will be a general perception that he or she does have such knowledge, or in any event should have it, by virtue of his or her position.
4 The TSX recommends that listed issuers adopt such policies: See Section 423.8 of the TSX Company Manual. Regularly scheduled blackouts typically extend from the end, or even somewhat before the end, of an issuer's financial quarter until two or three days after the release of the financial statements. These policies will generally also provide for "discretionary" blackouts during periods of time when the issuer is actually in possession of undisclosed material information. Conversely, certain insider trading policies permit trading only during certain "windows" of time during the year, typically during the 20 to 40 days beginning two to three days after the release of the issuer's quarterly and annual financial statements.
5 The TSX permits option plans to provide that the expiry date of options may be automatically extended for five to 10 days following a blackout period should such date occur during or immediately after a blackout period: See TSX Staff Notice #2006-0001.
6 The exercise of options will generally trigger an income tax inclusion, such that optionholders exercising options will likely wish to immediately sell at least a portion of the shares issued on exercise in order to cover income tax payable.
7 These plans are the equivalent of "Rule 10b5-1 Plans" often used by US issuers. Note that similar plans can be used by issuers in connection with their normal course issuer bids, to permit repurchases notwithstanding that the issuer may be in possession of non-public material information at the time of repurchase: see s.629(l)6 of the TSX Company Manual. The Royal Bank of Canada recently announced such a plan in its press release dated October 17, 2008, as did Manulife Financial in its press release dated October 16, 2007.
8 See S.175(2)(b) of the Regulations under the Securities Act (Ontario) — and analogous provisions of other provincial securities statutes. Note that the equivalent provision in the Securities Act (Québec) requires that the automatic plan be "established by the reporting issuer."
9 See OSC Staff Notice 55-701 – Automatic Securities Disposition Plans and Automatic Securities Purchase Plans. This Notice also discusses the issuer's disclosure obligations at the time a plan is entered by an insider. It also indicates that, with appropriate exemptive relief, sales under these plans may qualify for insider reporting on annual basis pursuant to Part 5 of National Instrument 55-101.
10 Research In Motion announced last year the adoption of such plans by certain of its senior executives: See its press release dated November 23, 2007. See also the press release of Gildan Activewear dated May 5, 2007.
11 See the press releases of TD Bank and CIBC dated, respectively, May 28 and September 29, 2008.
12 The CEO may wish to dispose of shares for estate planning purposes, philanthropic reasons or otherwise. The TD Bank press release mentions that the CEO will be donating 40% of pre-tax net proceeds to charity.
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