Certain organizations that hold or invest in publicly traded securities may gain material nonpublic information regarding an issuer of those securities by virtue of the terms of the investment in the issuer, such as through a contractual right to receive certain information or to designate a director of the issuer, or by virtue of a business relationship with the issuer, such as providing services to the issuer.  Such an organization (an “insider-shareholder”) is justifiably concerned with the risk of improper trading of the securities it owns while in possession of material nonpublic information regarding the issuer of those securities, and the insider-shareholder may address that risk by adhering to the issuer’s insider-trading policy or adopting a Rule 10b5-1 plan for trading in the securities.  The insider-shareholder should also be concerned, however, about the risk of improper personal trading of securities of the issuer by, or resulting from the individual actions of, the insider-shareholder’s directors, managers, managing partners, or employees (collectively, “agents”).  That risk includes, among other things, adverse publicity to the insider-shareholder as well as monetary penalties that could be imposed by the Securities and Exchange Commission on the insider-shareholder, as a controlling person of an agent who improperly trades, or tips another person who trades, while in possession of the insider-shareholder’s material nonpublic information.

An insider-shareholder can address this risk by adopting its own written insider-trading policy regarding the securities of other issuers that it holds.  Such a policy, to which the insider-shareholder’s agents (and their family members and affiliates) would be subject, would normally be similar to the typical insider-trading policy of an issuer to which that issuer’s directors, officers, and key employees are subject regarding the securities of that issuer.  The principal terms and provisions of the insider-shareholder’s policy would:

describe insider trading, with definitions of “material information” and “nonpublic information” and provide relevant examples;

  • describe the scope of the activities that are improper, including trading and tipping other persons who trade;
  • identify the persons subject to the policy;
  • grant authority to a compliance officer who will be responsible for implementing and administering the policy;
  • impose a pre-clearance requirement for any proposed trade by a person subject to the policy;
  • state that each person subject to the policy has individual responsibility for his or her actions and will individually bear the consequences of those actions; and
  • indicate the adverse effects or consequences of a violation of insider-trading law and of the policy.

Unlike a typical issuer insider-trading policy, such an insider-shareholder’s policy:

  • would require the maintenance of a current (as updated from time to time) database or list of securities owned or traded in by the insider-shareholder, often referred to as a “restricted list”; and
  • may not provide for established “blackout periods” or “trading windows,” unless the insider-shareholder has a predictable pattern of receiving, or not having, material nonpublic information regarding the issuers of securities it holds.

In the absence of any established “blackout periods” or “trading windows,” the implementation of an insider-shareholder’s policy would depend primarily on the prohibition of trading in any securities on the restricted list, which is typically disclosed to its agents subject to the policy, and on the pre-clearance of any proposed trading by any agent.  With respect to pre-clearance, the compliance officer’s knowledge of, and judgment regarding, the insider-shareholder’s securities holdings and related activities and its possession of or access to material nonpublic information about the issuers will be critical to the policy.

The existence of an effective insider-trading policy would make it difficult for the SEC to hold an insider-shareholder liable as a controlling person of an agent who individually engages in improper trading or tipping activity.

OUR TAKE: An organization that holds and trades in publicly held securities should adopt its own insider-trading policy to address its risk from any improper trading in the same securities by any of its agents.