Briefing Note 15 January 2009
On 9 January 2009 the FSA made clear that any security granted by directors of quoted companies over their shares in those companies must be disclosed to the market. This was prompted by the notification (after consultation with the FSA) by David Ross in December 2008 that he had granted various types of security over the shares in four quoted companies of which he was a director, and by the large number of subsequent enquiries made to the FSA. Prior to such clarification, a number of law firms had advised that such security need not be disclosed. Our analysis of the position follows. There are several important points to note. Summary Official List companies Those directors and certain other senior managers (PDMRs) of Official List companies who grant security over their shares in them must: obtain prior clearance in accordance with the Model Code; and then notify the grant of such security to the company under DTR 3.1.2 R in chapter 3 of the Disclosure Rules and Transparency Rules (DTR3) as soon as possible, but in any event within 4 business days. The required information must be announced to the market by the company under DTR 3.1.4R as soon as possible, but in any event by no later than the end of the next business day. The obligation to notify the company also applies to the connected persons of a PDMR. Any PDMR (or one of his/her connected persons) who has granted such security but has not notified it to the company under DTR3, must now do so by no later than 23 January 2009 to avoid risk of enforcement action by the FSA. The notification must contain the information specified in DTR3.1.3R. However, the FSA's clarification does not make clear how the requirement to notify the "price" of the transaction will apply in relation to a grant of security. Following enquiries made to the FSA, we can provide guidance on this. AIM companies Although DTR3 does not apply to AIM companies, directors who grant such security must notify the company under AIM Rule 31 (and the company must then disclose this to the market under AIM Rule 17). Directors must also seek appropriate clearance under their company's share dealing code before granting such security. Margin calls and enforcement of security As the recent announcement by JJB Sports illustrates, a PDMR holding 3% or more of the voting rights in a quoted company may have an additional notification obligation under chapter 5 of the Disclosure Rules and Transparency Rules (DTR5) if he/she loses the right to vote some or all of his/her shares. DTR5 applies to both Official List and UK-incorporated AIM companies. Rights to vote are often lost if the security becomes enforceable (for example, if a margin call is not satisfied). This obligation is in addition to the obligation to notify under DTR3. Such a notification may well be required before any transfer of the shares to the relevant lender takes place and each form of security should be reviewed carefully. Action required Company secretaries should check with their PDMRs whether any disclosures must be made before the 23 January 2009 deadline and draw these requirements to their attention. A PDMR who does not comply with these obligations is liable to public or private censure, civil fines and, in a severe case of a breach of the DTRs, criminal penalties.
For a link to the FSA statement on disclosure requirements for directors who grant security over their shareholdings, click here. Background Disclosure requirements under DTR3 In recent years a number of banks have marketed loans to PDMRs of quoted companies secured over shares in the company as a way of raising funds without selling the shares. It is now clear that such security arrangements must be notified to the company under DTR 3.1.2R and then disclosed by the company to the market under DTR 3.1.4R. It is likely that a number of PDMRs will give notice of existing arrangements by 23 January 2009 to avoid the risk of enforcement action by the FSA. The notification given by a PDMR (or one of his/her connected persons) must contain the information set out in DTR3.1.3R and, save for any existing arrangements, be made as soon as possible, but in any event within 4 business days of the date the transaction occurred. The notification must include the names of the PDMR and the issuer, the reason why notification is being made, a description of the financial instrument and the nature, date, place, price and volume of the transaction. It is currently unclear whether the requirement in relation to price should be interpreted to mean that the amount of the loan secured will have to be notified. Prior FSA clarification (in the September 2005 edition of "LIST!") had made clear that, in addition to the acquisition and disposal of shares, the acceptance of share awards, grants of options over or gifts of shares and the exercise of such options were all caught by DTR3. Clarification was given that the placing of a spread bet relating to the share price is also caught. However, the FSA had not previously specifically stated whether the grant of security was caught. This appears to have led to a degree of uncertainty in the market. A number of law firms had commented to the effect that DTR3 did not apply to such grants as, in their view, variously, the grant of security was not a "transaction" within the meaning of the Market Abuse Directive; a pledge of shares does not materially impact on the PDMR's interest in them as contemplated by the earlier FSA clarification in "LIST!"; regulators in France and Germany had given guidance that pledges of shares were not considered, by them, to fall within their equivalent provisions of DTR3; and, as noted above, the precise information which must be disclosed relating to a grant of security is not clear. Our views Given the variety of different security arrangements used by various banks and the absence of specific guidance on the point, we had previously been of the view that there was no appropriate 'one size fits all' advice that could be given that notification of a grant of security was not required. As discussed below, the differing forms of security in use have differing legal effects and implications. DTR 1.2.4G makes it clear that consultation with the FSA is required if there is doubt as to how the DTRs apply to a particular situation. Indeed, we were also aware that a number of arguments could be made that DTR3 applied generally. Firstly, as regards whether the grant of security is a relevant "transaction", DTR3.1.2R implements Article 6(4) of the Market Abuse Directive and Article 6(1) of the relevant Implementing Directive. Article 6(1) states that "Member States shall ensure that all transactions related to shares are notified to the competent authorities". The use of the words "shall" and "related to" imply a mandatory and wide-ranging obligation. Further, Recital 7 of the Implementing Directive makes clear that the purpose of Article 6(1) is to provide information to the market and to enable the FSA to supervise it (and, in our view, enables the FSA to determine what information must be disclosed for these potentially wide-ranging purposes).
Secondly, as the FSA made clear, security is given in different ways and with differing effects in different European jurisdictions. The FSA's clarification applies to security in all forms (including mortgages, charges and pledges) and it is seeking to agree a common approach with its European counterparts. Under English law a mortgage (whether legal or equitable) transfers ownership in the assets concerned (subject to the equity of redemption) whereas a charge does not. It seemed unlikely to us on public policy grounds that a mortgage, which is strictly a disposal of ownership of the shares, and would therefore be caught by DTR3, if a charge would not be caught when the effect for investors could be said to be broadly similar. Note that a pledge of registered shares is not thought to be effective under English law. Only bearer securities can effectively be pledged under English law. Thirdly, when considering whether the interest of a PDMR in the shares is materially impacted, it should be noted that his/her key shareholder rights (i.e. to transfer, vote and receive distributions) can all be fettered by the grant of security depending on the lending bank's documentation (which in our experience varies considerably between them). Further, the security will normally contain the grant of a conditional right of sale over the shares to the third party lender and, if a mortgage is granted, ownership of the shares will also be transferred to it. Indeed, even before the security becomes enforceable, the borrower will not normally be able to sell the shares without the lender's consent. Fourthly, in paragraph 3.27 of the FSA's Policy Statement (05/03) relating to the implementation of the Market Abuse Directive, issued in March 2005, the FSA made clear its view that transactions caught by paragraph 16.13(c) of the 'old ' Listing Rules were also caught by DTR3. That paragraph covered, amongst other things, the grant of any right, whether present or future, conditional or unconditional, to dispose of shares. Similar wording is included in the definition of "dealing" in the AIM Rules. As security of this type normally includes a right of sale granted to the lender, many market commentators take the view that the grant of security over shares by a director of an AIM company is disclosable under AIM Rules 31 and 17. Fifthly, Listing Rule 9.2.10R appears to imply that all dealings for which clearance is required under the Model Code should generally be disclosed by the company under DTR 3.1.4R, even if that rule does not expressly cover all dealings (the text being limited to dealings in exceptional circumstances during close periods when they would normally be prevented). The Model Code The Model Code requires PDMRs of an Official List company to obtain prior clearance before dealing in the shares of that company. The Model Code does not impose an express obligation on the company to disclose the relevant information to the market. The FSA's clarification makes it clear that all forms of security are caught by the Model Code and that prior clearance must always be obtained. We believe it would be helpful for the FSA to update the text of the Model Code to make clear on its face that paragraph 2(f) of the Model Code (which, if taken literally, exempts all dealings if the beneficial interest in the security does not change), only applies to transfers of shares to bare nominees and the like (and not to the grant of some security interests, such as charges, under which no beneficial interest is transferred). Disclosure requirements under DTR5 PDMRs of Official List companies and directors of UKincorporated AIM companies who grant security must also be mindful of their obligations under DTR5 (even after notifying the company under DTR3). This is a particular concern at the present time given the fall in the market and high levels of share price volatility generally.
Many loans collateralised by quoted shares enable the lender to call for cash or other additional security on short notice if the assessed value of security provided falls below a required multiple of the loan known as a 'margin call'. If a margin call is not satisfied, the borrower often loses his/her right to vote (and to the dividend on) the shares. The lender will then, almost invariably, also become entitled to sell the shares immediately without further notice even if the borrower would not otherwise be in financial difficulties or wish to sell them. If a shareholder PDMR holding more than 3% of the voting rights loses those rights over some or all of his/her shares, he/she will generally need to notify the company and the FSA under DTR 5.1.2R(2) as soon as possible, but in any event within 2 trading days (or 4 trading days for a non- UK issuer). The information required is set out in DTR 5.8 (and is different to that required under DTR3). The notification must make clear how many voting rights (if any) the shareholder PDMR is then still able to exercise. The company must then disclose the information to the market under DTR 5.8.12R.
Contacts If you have any queries in relation to this note or would like guidance on its application, please get in touch with your usual Osborne Clarke contact, or: Adrian Bott Partner Head of Corporate t +44 (0)20 7105 7458 adrian.bott@osborneclarke.com Jonathan King Partner Corporate t +44 (0)20 7105 7046 jonathan.king@osborneclarke.com Julian Gamble Partner - Corporate t +44(0)20 7105 7464 julian.gamble@osborneclarke.com James Massy-Collier Partner Corporate t +44 (0)20 7105 7264 james.massy-collier@osborneclarke.com The material contained in this briefing note is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken. osborneclarke.com Regulated by the Solicitors Regulation Authority