The insider blackout period
24 April 2008
The recent consultation paper on the Listing Rules by the Stock Exchange of Hong Kong Ltd (SEHK) includes a proposal to rebase the blackout period on directors' dealings in their companies' shares.
Currently, under Rule A.3 of the Model Code in Appendix 10 of the Listing Rules, a director cannot deal within 1 month before the announcement date of results. This obviously gives directors, who control the release date, an incentive to delay the results in order to have more time to deal on inside information. That absurd rule has featured in our Listing Loopholes page since Webb-site.com was founded in 1998, along with the solution which SEHK is at last proposing.
Another perverse effect of the rule is that, although companies only have to disclose the results date at least "7 clear business days" before the meeting date (Listing Rule 13.43), they must either know the date 1 month ahead of time in order to enforce the blackout, or they have to delay the results if someone deals.
The solution is to rebase the blackout period by reference to the end of the financial period, and prohibit dealings until the results are released. This will give directors an incentive to get their company's results out faster so that they have longer periods of the year in which they can deal, and will remove the incentive to keep investors in the dark.
When we say "by reference to", there is nothing magic about whether the blackout should start the day after the financial period, or at some point earlier than that. It could certainly be argued that any CEO or finance director who has no idea of his company's financial performance until the period has ended isn't doing his job properly. That is particularly true if the company does not report quarterly, because the end of each period is 6 months after the previous period ended, so a huge information gap opens up between insiders and outsiders regarding the company's performance.
Right now, for example, some companies have yet to report their results for 2007, and the best information the public has is half-year results for 30-Jun-07, a period which began 16 months ago and ended 10 months ago. Unless the directors are asleep, they know much more than you do, but they could have been dealing in the shares until 31st March if they set their results date on the deadline of 30th April.
So SEHK's proposal in paragraph 18.13 of the consultation paper, a proposal which is specifically endorsed by the Listing Committee, is a simple one. Start the blackout on the day after the financial period ends, and end it when results are announced. We strongly support this.
Predictably, listed companies and their directors are opposing this move. They whinge that it will deter companies from listing in HK in the first place, or that it will deter people from becoming directors - as if insider dealing is one of the perks of the job! We disagree, and more importantly, we say that keeping the status quo deters investors from investing here or paying as much for shares as they would otherwise, because they cannot expect a level playing field.
Listed companies choose markets where they can get the best price for their shares, so building a regulatory framework which attracts investors to pay more is consistent with that. If we deter a few cowboys from listing here, those who would rather benefit from loose rules on insider dealing at the expense of other shareholders, then that is a good outcome.
Opponents of change also point to the law that prohibits insider dealing on price-sensitive information, and claim that this is sufficient. The hole in that argument is that it is far harder and costlier to prove insider dealing to a standard of a civil tribunal or a criminal court - evidence of what the directors knew, when they knew it, and whether it was price-sensitive (relative to market expectations) are all hard to obtain. That's why we have very few insider dealing cases in HK and have yet to see a completion of a civil case in the Market Misconduct Tribunal or a criminal case in the courts since the Securities and Futures Ordinance came into effect on 1-Apr-03, over 5 years ago. 3 MMT cases and 1 criminal case are now underway.
By comparison, the Model Code in the Listing Rules can provide a clear-cut prohibition on dealing during periods when a director could reasonably obtain an information advantage simply by looking at the latest monthly management accounts of the group (as they all should, if they run their boards well). By the end of a 6-month period he should at least have access to 5 months of extra information.
These same issues are currently playing out in Australia, where governance research firm Regnan, which represents institutional investors, recently found that directors of 23 of Australia's largest 200 companies traded shares between books-close and results-release dates, prompting articles like this one in the Sydney Morning Herald.
In the UK Model Code, the blackout period for annual results starts from the end of the accounting period or 60 days before the results announcement, whichever comes later. In practice, since most companies announce their results within 60 days, it is the period-end which forms the base. For half-year results, the UK blackout starts from the end of the half-year period, because the Rules require interim results within 2 months anyway.
Company directors should not be regularly dealing in their shares anyway. Their job is to run the company to generate long-term shareholder value, not to punt in and out of the shares. It should be more than sufficient that they have several months of the year in which they can invest on the basis of fresh results available to all shareholders. If they are slow to report results, then they should not be allowed to benefit from that by insider dealing.
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