Earlier this month, the Securities and Exchange Commission announced enforcement charges against 28 officers, directors and significant shareholders, including hedge funds and large financial institutions, for failing to timely file reports of their transactions in company stock. The SEC also charged six publicly traded companies for failing to report their insiders’ filing delinquencies or for contributing to the insiders’ filing failures. Public companies and their insiders should review and  revise their compliance procedures to ensure that they do not get ensnared in the SEC’s web.

What happened?

The SEC conducted an unprecedented enforcement sweep using “quantitative analytics” and sophisticated algorithms to identify those insiders and public companies with a high rate of filing delinquencies. Caught in the SEC’s net were CEOs, CFOs and general counsels as well as registered investment advisors and financial institutions providing investment management services. The violators filed reports that were on average six months late disclosing transactions with a market value ranging from $1 million to $182 million.

Given how egregious the violations were, public companies and their insiders may be tempted to ignore the SEC’s action; however, that would be a mistake. The SEC assessed $2.6 million in penalties ranging from $25,000 to $120,000 per insider and $75,000 to $150,000 per public company in settling all but one of the charges, which will now be adjudicated in an administrative proceeding.

What do I need to know?

Officers, directors and “beneficial” owners of more than 10% of a U.S. public company (“insiders”) who buy and sell their company’s stock within any six-month period are presumed to have traded on inside information and are required to disgorge their “short-swing” profits. The SEC has developed a comprehensive reporting system in order to police the trading activities of insiders. An insider must:

• file with the SEC an initial statement on Form 3 disclosing his or her equity holdings of the subject company within 10 days of becoming an insider.
• report subsequent transactions in the company’s securities to the SEC on a Form 4 within two business days of the execution of the transaction.
• file an annual statement on Form 5 within 45 days of the company’s fiscal year-end to disclose certain transactions not likely to have involved insider trading, such as a gift, and any transaction that should have previously been reported during the year.

These filings are the insider’s responsibility, not the company’s. It is a common practice for a public company to assist their insiders in making these SEC filings. Indeed, many of the insiders charged claimed that they had relied on the company to make the necessary filings on their behalf. In rejecting this defense, the SEC noted that an insider retains legal responsibility for compliance with the reporting obligations.

A public company must review the insider filings and is required to disclose in its annual report or annual proxy statement any instance in which an insider failed to make a required filing or was late in doing so. The company must identify the insider by name and set forth the number of late reports and the number of transactions reported late. In the settlements, the SEC dissected the annual disclosure made by the company and demonstrated how it was inaccurate. In addition, the SEC noted that a company that undertakes to assist insiders with their filings and then does so negligently can be held liable for causing the filing violations.

In addition to the short-swing reporting system, any beneficial owner of more than 5% of a U.S. public company is required to file a Schedule 13D with the SEC within 10 days of crossing the 5% ownership threshold. The Schedule 13D, designed to alert the public to significant share accumulations, requires the disclosure of the identity of the owner, how the owner financed the purchases and any plans the owner has regarding the acquisition of additional shares or seeking board representation or otherwise influencing control of the company. A Schedule 13D must be amended “promptly” following any “material” change to the information previously disclosed. In instances where the beneficial owner is “passive” and does not seek to influence control over the company, instead of filing a Schedule 13D, a short form Schedule 13G may be filed. The Schedule 13G must be amended (i) annually within 45 days of the year-end if there are any changes to the information previously reported and (ii) promptly if there has been an increase or decrease in beneficial ownership by 5% or more. A beneficial owner filing a Schedule 13G must switch to a Schedule 13D (i) promptly upon changing his or her passive investment intent to seek to exercise control or (ii) within 10 days of crossing the 20% ownership threshold. 

Through the use of sophisticated surveillance mechanisms, the SEC uncovered instances where there were significant discrepancies between an insider’s short-swing filings and the Schedule 13D or Schedule 13G filings. It is imperative that insiders be mindful of both filing obligations.   

What do I need to do?

For public companies:

• Since most public companies assist officers and directors with their short-swing reporting on Forms 3, 4 and 5, public companies should review and revise their reporting processes and procedures. Companies should be proactive and communicate often with their officers and directors regarding their reporting obligations. Companies should also confirm with their insiders quarterly in writing whether there have been transactions that should have been reported.
• Public companies should review the procedures employed in preparing their annual reports to ensure that the disclosure of insider delinquencies in the filing of Forms 3, 4 and 5 is accurate and complete. While certain steps such as fact-finding can be performed by line employees, the evaluation of those facts must be made by knowledgeable officers, who should be responsible for ensuring that the company’s disclosure is accurate and complete.

For officers and directors:

• Be aware of and actively participate in complying with your SEC reporting obligations, independent of their company’s action in this area. Notwithstanding that public companies prepare these filings for officers and directors, it is the officers and directors who bear ultimate responsibility for the accuracy and completeness of these filings.

For insiders, particularly those who are significant shareholders:

• Regularly consult your counsel to refresh your understanding of your SEC short-swing and Schedule 13D reporting obligations. Insiders should consult counsel before initiating any transaction or taking any steps that could be seen as seeking to influence a company. In this regard, common sense should reign: how does the significant shareholder’s dealing with the company differ from that of the average investor?     

It remains to be seen whether the SEC will extend its enhanced technical tools to the  more subjective realm of Schedule 13D reporting and bring action against those significant shareholders who change their passive investment posture without timely disclosure.