On September 10, 2014, the U.S. Securities and Exchange Commission announced settlements with officers, directors, and significant shareholders for violating federal securities laws requiring information about their transactions in company stock. In addition, publicly-traded companies settled charges with the SEC for contributing to filing failures by insiders and failing to report their insiders’ filing delinquencies. Notable for its departure from the SEC’s previous practice of generally bringing such charges only in cases in which insiders were also being charged with other violations, these actions signal increased attention by the SEC on the compliance obligations of insiders and large shareholders of reporting companies. In addition, the actions send a strong message to insiders that any defenses they may rely upon regarding the untimely reporting of holdings or transactions in company stock may not be sufficient to prevent them from being subject to an action against them by the SEC and the imposition of a substantial monetary penalty.
SETTLEMENTS BY INSIDERS
The SEC charged public company insiders with violations of the federal securities laws, specifically violations of Sections 16(a), 13(d) and 13(g) of the Securities Exchange Act of 1934, as amended (“Exchange Act”).
In those actions, the SEC set forth the underlying legal framework for Section 16(a) of the Exchange Act:
•srerrdoenltnFm 5n5srersl-do rrtyrsrstde,twre,rrdnFrm3r4grstrtlr.Frm5yoedsrtfarrdrrgr.
Similar to Section 16(a), Sections 13(d) and 13(g) also require certain disclosures regarding securities holdings:
•nnol,aeGrtodeeGyglwrpfrrn0rtfasfrsdtrrry deeGnrgrrgslwrpyrenertf e.
Description of Settlements
The SEC’s cases naming company insiders included cease-and-desist proceedings against officers, directors, and major shareholders. Such officers included CEOs, CFOs, Presidents, General Counsels, and Vice
Presidents. Major shareholders charged were individuals, registered investment advisors, and entities providing investment management services to investment vehicles. The charges against these company insiders revealed significant delinquencies in terms of filing the required Forms 4, Forms 5, Schedules 13D, Schedules 13G, or applicable amendments.
The details of each case and the degree of non-compliance with the beneficial ownership reporting requirements varied significantly. For example, insiders were charged with the untimely filing of between nine and 70 Forms 4 and 5, with an average number of 30 untimely filings. Regarding the degree of untimeliness, Forms 4 were generally filed approximately six months late in the cases brought by the SEC, but some forms were filed up to four years late. Late-reported transactions had aggregate market values of between $1 million and $182 million. The SEC proceedings also addressed several instances in which beneficial owners failed to file required amendments to Schedules 13D and 13G disclosing changes in beneficial ownership.
For corporate insiders settling these violations with the SEC, monetary penalties ranged from $25,000 to
$120,000, with the average penalty being just over $72,000 among the 28 insiders. Larger penalties—ranging from $60,000 and up—were associated with a greater number of missing reports (for example, 25 untimely beneficial ownership reports being filed) and/or extreme untimeliness in filing (for example, filing a required report three years late).
Officers and directors charged with violations of Sections 16(a), 13(d), and 13(g) of the Exchange Act by the SEC often claimed that the violations were the result of the failure of their publicly-traded issuer employer to file beneficial ownership reports and required amendments on their behalf. In turn, their publicly-traded issuer employer often blamed such violations on lack of internal staffing or the late receipt of necessary information from the corporate insider. The major shareholders charged by the SEC indicated that the violations were the result of the failure of outside counsel to correctly advise them on their reporting obligations.
When such defenses were brought by corporate insiders, the SEC noted in the cease-and-desist orders that reliance on an employer, outside personnel, or counsel to make the required beneficial ownership filings or provide correct advice does not excuse the charged violations, as an insider retains legal responsibility for compliance with the filing requirements.
Such defenses proved unpersuasive to the SEC and ultimately unsuccessful to the charged insiders because there is no state of mind requirement for violations of Sections 16(a) and 13(d) and the rules thereunder. The failure to timely file a required report, even if inadvertent, constitutes a violation.
SETTLEMENTS BY COMPANIES
Item 405 Disclosure Cases—Legal Framework
In addition to the actions brought against executives and investors, the SEC brought actions against six companies in connection with Section 16 matters. In those actions, the SEC set forth the underlying legal framework:
•m5rrsnroyyehrodoean()rrtna ysrgetrtlrrrrlrsdtrherferr,e rfrrdr,dynreo
•em 5rsreoednersrwfr’Frs3d4drge trtlr,dFrs5dwhrtoetrtlr.
•A“”reoe,tstd,areoeaFrm3dareoearm5n eefarnrrntoFrm5srr,seresto Fm5srr
Description of Item 405 Settlements
In a series of settlements, the SEC issued cease-and-desist orders against, and collected fines from, reporting companies for misstatements in, and failures to include, the required Item 405 disclosures. The misstatements and omissions were violations of Section 13(a) of the Exchange Act and Rule 13a-1 thereunder. In each matter, the SEC noted that the reporting company “was required to review the forms filed and identify by name each such insider who failed to file on a timely basis and set forth the number of late reports and the number of transactions that were not reported on a timely basis.” Further, the SEC listed the annual disclosures by each company and then stated the facts which showed the inaccuracy of those disclosures. For example, the settlements noted the following improper disclosures in response to Item 405:
•“dynawfhrrsdsrordosdnrrsfrnfhrsrrgrwrpfCn,eeto rndoeyhrrtnaysrg,ttwnerrdwo syrgrrtdyeC,eydtyeeFrm4rrt rn6r]hrtoeef5rsrwhestlr” eCd,rgelrsrdner,lfesrsrrsdyFs
directors or executives filed late.” The SEC noted that, during each of the fiscal years described in the disclosure, there were multiple failures by insiders to file reports on a timely basis.
•“DrgelrdDr,,rDrr,ersdrsfrenrtfrnkdwhlen()gr”eC d,rghfelrsrdner,rereersyrs oerrsnay.
•“ln()grrseosDrr,ersdrrn0rlrswredhretrtlr”eCd,ghfe lrsrdner,esrlgrdoerrd n()rr.eyrdterlgrdtde rr,gt“eeydoyeerlgr]twstoerrgrsfn6nsnsfgr.
•“lr,rrsd%lwr,wnoeC,dydrdrs rrglrpfCyr,dynrwfFdFrs3d4 rdoeC”eCd,ghfelrsrdner, rewreersyrsoerrsnay.
Description of Section 16 Settlements
In bringing actions against public companies for causing violations of Section 16(a) by their insiders, the SEC noted that—while it encourages issuers to assist insiders in complying with Section 16(a) filing requirements— companies that voluntarily accept certain responsibilities and then act negligently in the performance of those tasks may be liable for causing Section 16(a) violations by insiders. In each matter, the SEC noted that the company had voluntarily agreed with its insiders to perform certain tasks in connection with the filing of Section 16(a) reports on their behalf, including the preparation and filing of all such reports. After noting that the companies had received the required information in a timely manner, the SEC stated that company personnel responsible for tasks relating to the preparation and filing of Section 16(a) reports repeatedly failed to perform on a timely basis the tasks the company had agreed to perform. The number of untimely filings ranged from 35 untimely filings over three years to 75 untimely filings in a single year. The amount of the fines in these matters ranged from $75,000 to $150,000.
The SEC’s charging of a publicly-traded issuer and corporate insiders for violations of Section 16(a) of the Exchange Act in separately announced settlements demonstrates the SEC’s focus on these activities and the potential for fraud charges if these violations continue.
The SEC charged a biotech company and its former CEO with defrauding investors by failing to report his sales of company stock. Given the CEO’s failure to file initial and annual beneficial ownership reports on Forms 3 and 5, respectively, the degree of untimeliness of the filing of several Forms 4 (up to 26 months late), and the significant value of the late-reported sales, the SEC order found that the CEO’s “sales would have been viewed by a
reasonable investor as significantly altering the total mix of available information given, among other things, his position as CEO, the frequency with which he was selling [company] stock, and the size of his sales.” Due to his conduct, the CEO was charged with violating Section 16(a) of the Exchange Act, as well as various federal securities law provisions relating to committing fraud upon investors as a result of the CEO’s certification of annual reports and signing of a proxy statement, which all included material misstatements regarding his compliance with Section 16(a) of the Exchange Act.
Related to the CEO’s violations of Section 16(a), the issuer was charged with failing to provide the disclosures required by Item 405 of Regulation S-K in annual reports, in violation of Section 13(a) of the Exchange Act, and with various federal securities law provisions relating to committing fraud upon investors as a result of such action.
Both the publicly-traded issuer and its former CEO settled with the SEC, and agreed to the imposition of significant monetary penalties, in the amounts of $175,000 for the CEO and $375,000 for the issuer.
KEY OBSERVATIONS AND CONSIDERATIONS
The actions undertaken by the SEC as discussed above give rise to a number of important observations, as well as considerations for insiders, investors, and public companies.
Although the filing obligation ultimately rests with the individuals, the SEC actions make clear that public companies who undertake to assist their insiders with Section 16 obligations will also be held responsible for significant failures in Section 16 compliance. Accordingly, public companies must maintain a robust compliance system reasonably designed to avoid late or missed Section 16 filings.
•efesdatwhnrderdcytsfn()ferstf,s.eCkentrdeyde-drsferssygoen() rrsfrsrsdsnaydrer,rges lrsdrysed.strseCs
that the failure to file timely reports, and a company’s related materially inaccurate Item 405 disclosures, can serve as the basis of a fraud charge.
•eCdertsef“earsdrgr”oy er.efsdnrsssrgefrcso yl.toerersdsrdrme.