Canada: Automatic Share Purchase and Disposition Plans May Protect Against Charges of Illegal Insider Trading

Given the focus on corporate ethics, many public companies have instituted extensive blackout periods during which insiders are prohibited from trading in securities of the company. Blackout periods usually span quarter-ends, year-end and other periods during which there may be material information about the company that is undisclosed. Insiders who purchase or sell securities with knowledge of undisclosed material information are guilty of illegal insider trading. Although trading during a blackout period is not illegal if the insider has no knowledge of undisclosed material information, it can be a risky practice and therefore is prohibited by most public companies.

Many insiders would like to establish a plan that would permit their broker to effect trades based on a prearranged set of instructions notwithstanding that the insider later becomes aware of undisclosed material information. The regulations to the Securities Act (Ontario) provide a safe harbour from insider trading liability if the purchase or sale was made under an automatic dividend reinvestment plan, share purchase plan or other similar automatic plan. Because dividend reinvestment plans and share purchase plans are established by the company (and not the insider), there has been uncertainty about whether the safe harbour is available for a structured purchase or disposition plan that is prearranged by an insider. Recent interest in these plans has prompted staff of the Ontario Securities Commission to outline its views on these plans (but it cautions that these views may not be valid under the laws of the other provinces). The OSC guidance is intended to be temporary while the Canadian Securities Administrators develop a common position on automatic plans. The CSA guidance is expected to also cover managed accounts, over which the account manager has full discretionary authority for trading. The OSC guidance does not apply to those kinds of accounts.

When a broker sells securities owned by the insider (or purchases securities for the insider’s account) under instructions that were prearranged under a truly "automatic" plan, the sales (or purchases) should not be illegal if carried out when the insider has subsequently become aware of material information that has not been generally disclosed. OSC staff will accept that the plan is automatic if

• the insider cannot make discrete investment decisions under the plan;

• the insider does not have any material undisclosed information about the company when he or she enters into the plan (the company must provide a certificate to the broker confirming that the insider does not have any such knowledge);

• the trading parameters and other instructions are set out in a written plan document when the plan is established;

• the plan contains meaningful restrictions on the insider’s ability to vary, suspend or terminate the plan, and any variation, suspension or termination should be reported to the company and the public;

• the plan provides that the broker cannot consult with the insider regarding sales (or purchases) and the insider cannot disclose any information to the broker that might influence the execution of the plan; and

• the plan is entered into in good faith and not as part of a scheme to evade the insider trading prohibitions.

Staff expresses no explicit view on whether the company should disclose the establishment of an automatic plan. However, it suggests that the establishment of the plan could be (a) a material change (if established by the company), which would necessitate issuing a news release and filing a material change report; or (b) a material fact (if established by the insider) which would have the effect of prohibiting trading by those who have knowledge of the plan until the existence of the plans has been publicly disclosed.

In most circumstances, we expect that the establishment of a plan would not constitute a material change or material fact requiring disclosure. However, disclosing the establishment of the plan would, in our view, be a good practice both because it demonstrates good faith and because it may pre-empt questions about trading by an insider during periods when he or she may have had access to undisclosed material information.

If the plan involves a change in control or direction over the company’s securities or a change in the insider’s economic interest in a security of the company or the insider’s economic exposure to the company, insider reporting would be required when the plan is established. Generally, we expect that an insider report would be filed upon the establishment of the plan to reflect that the insider has transferred control or direction over the securities to his or her broker. Staff also believes that an insider report should be filed if the plan is varied, suspended or terminated.

The insider must file insider reports each time there is a sale (or purchase) under the plan. Accordingly, the broker administering the plan must report trading to the insider on a timely basis. It would be a good practice to note on the insider report that the transaction took place under an automatic plan.

A copy of OSC Staff Notice 55-701, Automatic Securities Disposition Plans and Automatic Securities Purchase Plans, can be found on the OSC’s website at:
www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part5/sn_20060602_55-701_auto-securities.jsp

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.