Tight restrictions apply to directors when selling or buying securities in companies in which they are a director – and the recent message from the courts is that these restrictions will be applied stringently, overriding any private agreements.
Discretion is therefore very definitely the better part of valour and directors should consider the following options:
- seek an independent valuation, although this may not guarantee protection as a different valuer may later arrive at a different fair value. You would also need to get the company’s permission before disclosing sensitive company information to the valuer
- seek an indemnity from the buyer, although you may not get it and its enforceability will be doubtful
- transfer your shares to someone else first, such as another company you control as the law only applies to dealings by directors, not their companies; or
- resign. The law does not apply to dealings by former directors.
The rules applying to private and to listed companies are delivered through different statutes but are similar in both intent and effect.
Private companies are covered by section 149 of the Companies Act 1993 which provides that if a director holds information acquired in his or her capacity as a director, he or she must pay no less than fair value when buying securities in the company and must receive no more than fair value when selling them.
The court had reason to visit these provisions recently in Fong v Wong, a case which arose when the parties agreed to dissolve their commercial relationship in a private, unlisted company.
The minority shareholder of the company (a trust associated with Wong) agreed to sell its shares to the majority shareholder (a trust associated with Fong) at “fair market value”. But when an independent expert applied a 30 percent discount to the final value of the shares to reflect their minority nature, Mr Wong refused to proceed with the transaction.
Mr Wong argued in a summary judgment application heard by the High Court that, notwithstanding the earlier arrangement between himself and Mr Fong, section 149 meant Mr Fong’s trust could not acquire the shares for less than their fair value. The argument relied upon a Court of Appeal decision in Thexton v Thexton. Asher J analysed the Thexton judgment and concluded that section 149 could indeed be used to put aside an express agreement between parties as to the mode of valuation or value of shares.
His Honour was not dissuaded by the fact that the two parties had similar levels of knowledge in the business and affairs of the company. Nor did Asher J view the fact that the shares were being sold and purchased by two trusts (rather than by the directors in person) as a barrier to his conclusion. That one of the named purchasers was a director of the company was sufficient to conclude that section 149 could operate, irrespective of the fact that the director was named in his capacity as a director of a trust.
The finding indicates that where parties have pre-agreed methods by which securities are to be valued, such as in a shareholders agreement, section 149 may override such agreement if either, or both, the purchaser or seller is a director of the company in which the securities are to be transferred. Holding securities in a trust will not pre-empt section 149.
Asher J noted that there was no magic formula to determine fair value. Rather, it is to be assessed objectively, case-by-case, after an examination of all relevant circumstances. Relying on English authority, Asher J held that shares are not to be discounted to reflect their minority nature where a company meets each of the following three criteria:
- the company is formed on the basis of a personal relationship involving mutual confidence
- there is some form of agreement or understanding that some or all of the shareholders of the company will participate in the conduct of the business, and
- the shareholders have agreed to certain restrictions on the transfer of securities.
Security dealings by directors in listed companies are governed by the insider conduct provisions of the Securities Markets Act 1988. Changes to these provisions were implemented on 29 February 2008. The regime is now based on the concept of market fairness, which holds that all investors should have equal opportunity to obtain and evaluate information relevant to their trading decisions, and on the threat that insider trading poses to the market’s integrity and to investor confidence.
Section 8C of the Securities Markets Act prohibits an “information insider” of a public issuer from trading securities in that public issuer. A person, including a director, is deemed to be an information insider if that person has information which he or she knows or ought reasonably to know is material to the share price and is not generally available to the market.
Publicly-listed companies generally have policies and procedures in place to ensure directors (and senior employees) do not fall foul of the insider conduct provisions. Such policies ensure directors are trading only when the market is fully informed of all material information in relation to the public issuer, and include share trading approval processes and "trading windows" when directors may trade or "black-out" periods when they may not.
In addition, information insiders are prevented under sections 8D and 8E of the Securities Markets Act from disclosing the inside information to a third party where they know or reasonably ought to know that the third party may use that information for trading purposes, and from advising or encouraging another person to trade in the securities.
Interestingly, the fact that both parties to a transaction have “equal information” is a defence to any contravention of section 8C (the insider trading regime). But as Fong v Wong illustrates, this isn’t relevant to an application of section 149 of the Companies Act.
The restrictions, whether via section 149 of the Companies Act or via section 8C of the Securities Markets Act, highlight that directors must take care when trading securities of the company in which they are a director.
If the company is unlisted, directors must ensure they are paying no less, or receiving no more, than fair value for those securities, irrespective of any arms-length agreement. And if the company is listed, directors must ensure they are not information insiders before they undertake any trading.