Risky business: limiting director exposure to margin borrowing

29 April 2008 Topics: Compliance and corporate governance

Margin borrowing is a popular way of maximising exposure to shares and other financial products. Put simply, the advantages can be enticing. The ability to maximise exposure without fully capitalising the investment and the tax deductibility of interest payments are two such drivers. However, when company directors become involved in margin borrowing, the stakes are raised.

As experience with ABC Learning, Centro, MFS and Allco Finance has shown, the consequences of director exposure to margined shares can be significant. While senior management will be conscious of the correlation between director margin calls and share price movement, with media spotlight heavily focused on good corporate governance, boards should also be alert to the damage that margin calls can cause to a company’s reputation and goodwill.

In this sense, limiting director exposure to director margin calls is more than simply risk management. It is a factor which drives long-term share price stability. In the current market, even more so than ever, companies should consider whether their board policy appropriately addresses the risks associated with director margined shares.

Organisational developments

Engineering and management company, United Services Group is a good example of the upside that conservative management of director margin loans can deliver. In March this year, its chief executive, Richard Leupen reduced his shareholding from 4.9 million to 2.4 million shares to eliminate the risk of a margin call affecting his holding in the company. In a press release, Mr Leupen commented that the sale was “in the best interests of the company” and reduced the potential for “speculative trading” in the company’s stocks.

In a similar story, Goodman Group directors sold down $290 million in stock to eliminate the risk of future margin calls. Put simply, Greg Goodman said that given current market conditions, the facilities were no longer in the best interests of security-holders.

In a recent article in the Australian Financial Review, BHP Billiton chairman Don Argus was quoted as saying that while as a general rule there is nothing wrong with directors using their shares as security for traditional loans, using BHP Billiton shares as security for margin loans is a “different kettle of fish”.

Legislative position

Under section 191 of the Corporations Act 2001, directors are compelled to “disclose to the company material personal interests on a matter relating to the company”. Invariably a director must disclose margin loans to the company. However, whether the company will be required to disclose margin loan arrangements to the market is less certain.

Under ASX listing rule 3.1, companies must disclose margin loans that are “material”. In deciding the “materiality” of a director’s margined interest, factors such as liquidity, company size and levels of short selling may be taken into account. Should the director’s margin loan fall within the materiality threshold, best practice would be to reveal:

  • the number of securities involved;
  • any rights of the lender to sell unilaterally; and
  • trigger points.

However, in deciding to disclose or not to disclose director margin loans, companies should be aware that disclosing too much can actually have a deleterious effect on share price. For example, if a company discloses the trigger points of a director’s margin loan, hedge funds and other short sellers can firm their position by selling down to force a fire-sale by margined directors.

Companies with highly-geared directors must walk this tightrope every day. There is no clear directive under which margin loans must be disclosed. This is perhaps for good reason – there are simply too many shades of grey.

Good corporate governance – a value proposition

Ultimately, the best method of minimising fallout from director-related margin loans is prevention. Clear and focused protocols on director shareholdings should form the basis of any good corporate governance policy. Board policy should address how and when directors can margin company shares and the disclosure processes when doing so.

While micromanaging the personal affairs of directors should never be the intention of good corporate governance policies, the benefit of developing strategies on director related borrowing is clear. Implementing effective guidelines early in the piece will militate against short-term volatility and pay dividends in the long-run. And that, of course, will always be in the best interests of the company.

If you would like to know how Cooper Grace Ward can help your business develop effective policies on corporate governance, please contact David Grace on 07 3231 2421.

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