Disclosure obligations of listed company directors who grant security over their shares

On 9 January 2009 the FSA, in its role as the UK Listing Authority, confirmed that, in its view, where a director of a listed company grants security over any shares in the company he must notify the company and in turn the company must announce details to the market.

The FSA’s statement follows the publicity surrounding the announcement by Carphone Warehouse on 8 December 2008 that it had received notification from David Ross, a director, that between 2006 and 2008 he had used more than 136.4 million ordinary shares in the company as security for personal loans. It is understood that the announcement was made after advisers to Mr Ross approached the FSA for guidance on whether such a transaction was caught by paragraph 3.1.2 of the FSA’s Disclosure and Transparency Rules (DTRs).

Under that rule, which derives from the European Market Abuse Directive, persons discharging managerial responsibilities (PDMRs) and their connected persons must notify their company in writing of the occurrence of all “transactions conducted on their own account in the shares of the issuer”. The notification must be given within four business days, and there is an associated obligation on the issuer to publicly announce the information notified to it under DTR 3.1.2. PDMRs are directors and senior executives who have regular access to inside information and the power to make managerial decisions affecting the future development and business prospects of the issuer.

Although many advisers thought the scope of DTR 3.1.2 was uncertain, Mr Ross found himself obliged to resign from Carphone Warehouse and other listed companies of which he was a director. Subsequently, a number of companies have announced similar transactions by their directors, although others are thought to have been awaiting the publication of more formal guidance by the FSA.

The FSA’s statement says that PDMRs who have granted security over their shares should disclose this to the market as soon as possible and certainly no later than 23 January 2009. But (perhaps acknowledging the uncertainty over whether the Directive is intended to cover such transactions) the FSA is not intending to take enforcement action in respect of prior failures to notify the market of grants of security.

Separately, the FSA is categorical that such a transaction is clearly caught by the Model Code on Directors’ Dealings (annexed to chapter 9 of the Listing Rules) and therefore requires advance clearance by the chairman or other designated director. The FSA “expect[s] listed issuers to deal with Model Code breaches by their directors.” In some cases, a breach of the Model Code may constitute a breach of the director’s service contract or letter of appointment.

DTR 3: directors to notify company of “transactions” conducted on their own account

As noted above, under DTR 3.1.2 PDMRs and their connected persons must notify the issuer in writing of the occurrence of all “transactions conducted on their own account” in the shares of the issuer. In turn, the issuer must announce details to the market. The rule is derived from the European Market Abuse Directive, which was implemented in the UK on 1 July 2005, and is designed principally to provide investors with information that may be valuable to them, and to help regulators supervise the market (including monitoring for potential market abuse).

The expression “transactions conducted on their own account” is taken from the Directive, and is not further defined in the Directive or the DTRs. The FSA has not previously published any guidance as to whether any of the different types of security that can be granted over shares would constitute a “transaction” for this purpose.

It is now clear that the FSA regards the grant of security over shares in an issuer by a PDMR or connected person as a transaction that is caught by this rule. However, the FSA notes that some other Member States interpret the Directive differently, “based in part on local practices and structures or procedures for granting security over shares, including the circumstances in which legal title to shares transfers”. It is therefore seeking to reach a common understanding with the European Commission and the Committee of European Securities Regulators on how the Directive requirement should be understood. European-level guidance could be published in due course.

Model Code: clearance required for “dealings”

Under the Listing Rules, all PDMRs are required to comply with the Model Code (or a code of dealings that is no less onerous). Broadly this prohibits a PDMR from dealing in the securities of the issuer without obtaining prior clearance from the Chairman or other designated director, and there are certain circumstances in which clearance should not be given (for example, when the company is in a close period). The purpose of the Code is to ensure that PDMRs do not abuse, and do not place themselves under suspicion of abusing, inside information which they may have in relation to their company.

Paragraph 1(c) of the Model Code states that “dealing” includes “using as security, or otherwise granting a charge, lien or other encumbrance over the securities of the company”. On the face of it, therefore, any grant of security over a director’s shares (including where share certificates are deposited with a lender) is subject to the provisions of the Model Code.

Some types of dealings are exempt from the Code. For example, the Code does not apply to any dealing “where the beneficial interest in the relevant security of the company does not change” (paragraph 2(f)). As a technical legal matter, where a person grants a charge over shares, as distinct from a mortgage, it may be arguable that such a transaction does not constitute a change in the beneficial interest in the shares for the purposes of the Code - although paragraph 1(c) of the Code seems clearly designed to catch all forms of security.

It is now clear that the FSA regards the grant of security over shares in an issuer by a PDMR as a transaction that requires clearance under the Code.

DTR 5: obligation to notify company where holding of “voting rights” moves through 3% or any whole percentage above this

DTR 5 broadly requires any person who comes to hold, directly or indirectly, 3% or more in aggregate of the voting rights in a listed company to notify the FSA and the company of that fact as soon as possible, and in any event within two trading days. Once the 3% threshold has been reached, notification must also be made of any subsequent change in the person’s holding which increases or decreases it through a whole-number percentage point. In each case, the company must announce the information to the market as soon as possible, and in any event by the end of the next trading day.

Where a PDMR owns 3% or more, the question arises as to whether the grant of security over his shares could require any notification and announcement to be made. Where a charge is created (as distinct from a mortgage), legal title to the shares will remain with the borrower. Normally no notification obligation will arise under DTR 5 in these circumstances either for the borrower or the lender.

But where (less commonly) a legal mortgage is created, the lender may acquire legal title to the shares and the voting rights attached to them. Under DTR 5.1.3(5), voting rights attaching to shares held by a “collateral taker under a collateral transaction which involves the outright transfer of securities” can be disregarded provided the collateral taker does not declare any intention of exercising (and does not in fact exercise) those voting rights. Usually, therefore, the lender will not need to make a notification where it acquires legal title to shares under a mortgage. From the director’s point of view, if the number of shares legally mortgaged is sufficient to move the director’s aggregate holding through a whole percentage point, a notification is potentially required. But if the director retains control over the voting rights by means of a voting rights agreement or similar arrangement, arguably the director should be treated as the indirect holder of the voting rights. (By analogy, under DTR 5.2.1(h) a director is treated as the indirect holder of shares where he is appointed as proxy with complete discretion over the exercise of the voting rights attached to the shares.) If the director is treated as the indirect holder of the shares, there will be no change to the aggregate percentage of voting rights held by him directly and indirectly, and no notification will be needed.

FSA statement

The FSA’s statement can be found here.

The related press release can be found here.