Trading plans and the Model Code - an opportunity for employee share plans?

The FSA is amending the Model Code to allow Persons Discharging Managerial Responsibilities (PDMRs) to buy and sell shares in prohibited periods if they have previously agreed a trading plan for those transactions.

These changes will be particularly useful for employee share plans or where directors are paid in shares. However, it is likely that plan rules will have to be amended and/or individual agreements made with PDMRs to take full advantage of these new arrangements.

So far, the London Stock Exchange has not said whether it intends to make similar changes for AIM companies.

Background

Every PDMR must comply with the Model Code. PDMRs are essentially main board directors and any senior executive or director of a subsidiary who has regular access to relevant inside information and the power to make managerial decisions affecting the group’s future development and business prospects.

It is a cardinal principle of the Model Code that PDMRs cannot normally deal in a prohibited period - i.e. when either the company is in a close period ahead of a results announcement or there exists any inside information in relation to the company. Deal has a wide meaning and, with certain exceptions, includes buying and selling shares and granting and exercising or receiving shares under options or LTIP awards.

At present, the number of close periods and uncertainty over when, and for how long, there may be inside information affecting a company means that the Model Code substantially restricts the ability of PDMRs to buy and sell shares and companies’ operation of employee share plans at senior levels.

PDMRs cannot normally acquire shares in a prohibited period other than under a regular savings scheme or as regular payment for services (e.g. as director fees), although exemptions exist for Revenue-approved all-employee plans. This affects when they can exercise options.

Disposals are permitted in a few limited circumstances, but not automatically to meet tax liabilities that arise when shares are acquired. For example, when an LTIP award vests a PDMR will have a tax liability by reference to the price on the day of vesting. If vesting occurs during a prohibited period, he will not normally be able to sell the shares until the prohibited period ends. Unless he can provide for the tax independently out of his own resources, this can lead to administrative difficulties and tax penalties. Accordingly, plan rules normally provide for vesting to be delayed in these circumstances, or use other work-arounds, neither of which is entirely satisfactory.

Trading plans

To address these and other issues, the FSA, after consultation, published the Trading Plans Instrument 2009 on 27 February 2009. This has amended the Model Code from 6 March 2009. The amended Model Code will enable PDMRs in listed companies (the changes make no difference to AIM companies) to make arrangements for shares in their company to be bought or sold on their behalf during a prohibited period by an independent third party (a trading plan).

The implications for employee share plans

• A non-executive director paid in shares can now agree that a sufficient number of shares should automatically be sold each time he is paid in order to meet his tax liability on receipt of the shares.
• A PDMR’s LTIP award can now vest in a prohibited period with shares automatically being sold in order to meet tax liabilities.
• A PDMR who wishes to sell down or increase his shareholding over a period can now agree to do so without worrying about whether or not a particular instalment will be prevented by the company being in a prohibited period.
• A PDMR can agree that shares should be acquired with his bonus or agree in advance that options should be exercised on a particular day or at a particular price, without worrying if that will be in a prohibited period.

Other opportunities may also arise. However, it should be noted that trading plans will not allow options or LTIP awards to be granted in prohibited periods.

Setting up and amending a trading plan

To set up a trading plan, a PDMR will need to enter into an agreement with an independent third party (typically the company’s broker or an employee trustee) that sets out a “strategy” for the acquisition and/or disposal of shares in the company on behalf of the PDMR during both open and prohibited periods. The FSA have confirmed to us that “plan” and “strategy” would include relatively straightforward agreements including selling shares on a single occasion. The plan must:

• specify the amount of shares to be dealt in and the price at which and the date on which the shares are to be dealt in; or
• give discretion to the independent third party to make trading decisions about the amount of shares to be dealt in and the price at which and the date on which the shares are to be dealt in; or
• include a written formula for determining the amount of shares to be dealt in and the price at which and the date on which the shares are to be dealt in. This method is most likely to be relevant for employee share plans: a PDMR could specify that sufficient shares should be sold at the then prevailing market price in order to fund the amount of tax due on vesting; and
• not permit the PDMR to exercise any influence or discretion over how, when, or whether to effect dealings.

To set up or amend a trading plan, a PDMR will need to obtain clearance from the relevant person within the company at the outset. A plan cannot be initiated or subsequently amended at a time when the company is in a prohibited period, so it would need to be entered into in advance of any proposed dealing in that period. Further clearance is not, however, needed at the time of any dealing under the plan (although there are announcement obligations - see below).

Cancelling a plan

A trading plan can only be cancelled during a prohibited period where the PDMR is in severe financial difficulty or there are other exceptional circumstances. Even in such a case, cancellation will be permitted only if the PDMR does not have inside information at the time of cancellation, obtains prior clearance from the company, and consults the FSA prior to cancellation. A PDMR who has arranged for shares to be acquired automatically with his bonus, for example, may therefore be able to cancel his trading plan during a prohibited period if he can show that he needs the cash to alleviate severe financial difficulty, but not if he has inside information, which may restrict the use of this get-out. In most other circumstances PDMRs will not be able to cancel a plan during a prohibited period.

Announcement obligations

The usual disclosure requirements apply. Whenever shares are bought or sold pursuant to a trading plan, the PDMR must notify the company and, under a new rule in the Disclosure and Transparency Rules, also notify the company of the fact that the transaction occurred under a trading plan, together with the date on which the trading plan was entered into, although in many case the company will make all the necessary arrangements for this. The company must then announce this information to the market noting that the dealing occurred in accordance with a trading plan. We understand the FSA will be changing its form TR-3 accordingly. No announcement will, however, be needed when a trading plan is simply set up (or cancelled).

Should PDMRs set up trading plans?

Many PDMRs are likely to find it useful to set up trading plans that enable them to buy shares in connection with bonus deferral plans, and to sell shares to cover tax arising in relation to directors’ fees and the vesting of LTIP awards.

In some case, relevant plan rules may need to be changed. However, these amendments are unlikely to be controversial or require shareholder approval.

To avoid any perception that PDMRs are taking unfair advantage of their position as insiders, companies should ensure that the use of bonuses to acquire shares or the timing of vesting of LTIP awards is not left entirely to the discretion of the remuneration committee or board. Instead, it would be preferable to provide in advance that LTIP awards will vest automatically, or bonuses be used to acquire shares, once results are announced or after the relevant remuneration committee meeting.

Action to be taken

Companies should:

• consider whether their employee share plans should be amended to encompass trading plans;
• consider suggesting to their PDMRs whether to set up trading plans for their employee share plans; and
• consider bringing their code of dealings into line with the amended Model Code.

Text of the new rules

The new provisions of the Model Code, and the related amendment to the Disclosure and Transparency Rules, are set out in the FSA’s Trading Plans Instrument 2009 published on 27 February 2009.