The SEC this week announced a mass action against 34 defendants for alleged violations of federal securities laws regarding reporting of stock holdings. As the Wall Street Journal reported, the action “is part of the ‘broken windows’ strategy” – i.e., where “even the smallest infractions” are pursued – announced by SEC Chairman Mary Jo White in 2013.
While that is true, the significance of the action goes much further. Here are five takeaways for market participants.
- This may be the first action arising from the Enforcement Division’s new Center For Risk And Quantitative Analytics
In 2013, the SEC Enforcement Division’s established the Center for Risk and Quantitative Analytics, which would “employ quantitative data and analysis to profile high-risk behaviors and transactions and support initiatives to detect misconduct, increasing the Division's ability to investigate and prevent conduct that harms investors.” According to the SEC’s press release announcing the new mass action, the individuals and companies targeted were identified “[u]sing quantitative analytics.” And our review of the 34 administrative proceedings that make up the mass action confirms that the SEC reviewed, processed and analyzed a large amount of trading and other data in order to identify these defendants (and their alleged filing delinquencies).
The SEC’s having hit pay dirt (34 defendants and $2.6 million in civil penalties) from the application of quantitative analysis portends further, future applications (including in the area of financial fraud, where the SEC has already announced that it is applying quantitative analytics to review SEC filings).
- They could do this again, and do it fast
The press release announcing the mass action intimated that it may not be a one-off: “we willvigorously police these sorts of violations through streamlined actions.”
In addition, one of the more noteworthy aspects is the speed with which the SEC moved here. As noted above, SEC Enforcement first began applying quantitative analysis in 2013. Moreover, there are many references in the administrative proceeding documentation to the SEC’s first having contacted several of these defendants in 2014 (including as late as May 2014).
- This is a shot across many bows
Rare is the SEC action aimed at so many constituencies at one time. The 34 defendants named here fell into four categories: officers and directors, shareholders, “investment funds” and issuers. Unlike most cases or even most “sweeps,” here, the SEC did not signal out one type of market participant. Rather, in the words of Andrew J. Ceresney, Director of Enforcement: “Officers, directors, major shareholders, and issuers should all take note.”
- If you don’t file on time (or at all), you have little to no defense
Mr. Ceresney also noted that “inadvertence” to the filing requirements “is no defense to filing violations.” The individual administrative proceedings bear this out, and more. Many defenses asserted by those charged were unavailing:
Not knowing you had to file: At least one defendant argued that he had not filed (for seven years) because he had never been informed by his employer that he was subject to the reporting requirements of Section 16. The SEC did not excuse his violations: “Respondent served in a position specifically designated in the definition of “officer” under Exchange Act Rule 16a-1(f) and an insider retains legal responsibility for compliance with the filing requirements.”
Reliance on your employer or your broker: For example, the proceedings contain repeated mentions of officers and directors who claim that their delinquent filings resulted from the failure of their employer to make timely filings on their behalf. Other defendants pointed to the failure of their broker to timely notify their employer. Each time, the SEC asserted that the individual’s reliance “does not excuse his violations because an insider retains legal responsibility for compliance with the filing requirements, including the obligation to assure that the filing is timely and accurately made” and alleged, in many instances, that the individuals nonetheless “took inadequate and ineffective steps to monitor whether timely and accurate filings were made” on their behalf.
Reliance on counsel: Likewise, the SEC rejected several “reliance on counsel” defenses: “reliance on its outside counsel does not excuse the violations because an insider retains legal responsibility for compliance with the filing requirements.”
- Issuers that assist their insiders have a two-fold responsibility
Six of the defendants in the mass action were issuers. The mass action reminds issuers that they have a choice whether or not to assist their insiders with Section 16(a) filings and illustrates that that choice has consequences. Insiders, not issuers, have the legal responsibility for the insiders’ Section 16 filings. However, the SEC has previously encouraged issuers to “help their [officers and directors] or submit the  filings on their behalf . . . [in order] to facilitate accurate and timely filing.”
The mass action illustrates that an issuer who volunteers to assist insiders with their filings takes on some legal responsibility for those filings. Specifically, an issuer who offers assistance “and then act negligently in the performance of those tasks may be liable as a cause of Section 16(a) violations by insiders.” Five of the six issuers, including one where the SEC acknowledged the affiliated insiders’ filings were timely more than half the time, were sued on this basis for allegedly causing their insiders’ violations.
Whether or not an issuer chooses to assist insiders with their filings, the issuer itself has disclosure obligations arising out of the insiders’ filings. Specifically, Item 405 of Regulation S-K requires reporting issuers to disclose information regarding delinquent Section 16(a) filings by insiders. Five of the six issuers named in the mass action were sued for making misstatements or failing to disclose delinquent filings by insiders.
In sum, the mass action’s cases make clear that the SEC is determined to pursue “broken window” cases involving relatively minor failures to file disclosure documents against a wide variety of targets, will bring “big data” to bear to investigate and prove violations, and will be undeterred by explanations of inadvertence or reliance on others. This should serve as a wake-up call to filers and those who assist them: file timely and file correctly.