The Securities and Exchange Commission (SEC) recently took an unprecedented step in regulatory enforcement: It is now using sophisticated data analysis to target and charge insiders that have been chronically or materially delinquent in filing required securities transaction disclosures.
In a September 10, 2014 press release, the SEC announced the results of a mass enforcement initiative by the New York Regional Office, which netted 28 officers, directors, investment firms and major shareholders, as well as six publicly traded companies that failed to report insider transactions in company securities. The release noted that 33 of the 34 targets promptly agreed to settle charges by paying fines ranging from $25,000 to $150,000 per offender, totaling $2.6 million. The SEC press release can be found at: http://bit.ly/SEC92014A
“Using quantitative analytics, we identified individuals and companies with especially high rates of filing deficiencies, and we [brought] these actions together to send a clear message about the importance of these filing provisions,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division. He added that “inadvertence is no defense to filing violations, and we will vigorously police these violations through streamlined actions.”
In another press release on the same day, the SEC announced a settlement with a Massachusetts biotechnology company and its former CEO that failed to report insider stock sales. The company and its former officer agreed to settle charges of fraud by paying penalties of $375,000 and $175,000, respectively. The SEC also required the company to engage a compliance consultant, certify in writing that it adopted the consultant’s recommendations, and conduct mandatory training for its officers and directors. This settlement is particularly noteworthy as the SEC concluded 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 [the company’s] stock, and the size of his sales,” and that the company’s misleading Regulation S-K Item 405 disclosure violated certain antifraud provisions of the Securities Act of 1933 in connection with a securities offering on Form S-8. See the SEC press release at: http://bit.ly/SEC92014B
“It is not merely a technical lapse when executives fail to report transactions in company stock because investors are consequently denied important and timely information about how an insider is potentially viewing the company’s future prospects,” said Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office, which conducted the latter investigation.
KEY LEGAL PROVISIONS
At the heart of these recent enforcement actions were reporting obligations that apply to officers, directors, investment advisers, brokers, and major shareholders under Sections 13(d), 13(g), and 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”). Reporting obligations that apply to companies under Regulation S-K were also at issue.
Under Section 13 of the Exchange Act, a person or a group must file a Schedule 13D or 13G report with the SEC within 10 days after the person or group acquires “beneficial ownership” of more than five percent (5%) of any voting class of equity securities registered under Section 12 of the Exchange Act (the Exchange Act registration section applicable to almost all public securities). A person or group has beneficial ownership of a security if they can directly or indirectly exercise voting rights or certain other decisions with regard to the security.
Under Section 16 of the Exchange Act, every person who is directly or indirectly the beneficial owner of more than ten percent (10%) of an issuer, or who is a director or an officer of an issuer, must file statements regarding certain transactions in an issuer’s stock on Forms 3, 4 or 5, as applicable.
Item 405 of Regulation S-K requires public companies to disclose any reporting violations by company insiders, including any officers, directors and shareholders subject to transactional reporting requirements. The SEC charged six companies in its recent sweep, alleging that they contributed to filing failures by insiders, either by failing to promptly file reports as the companies had undertaken to do, or by failing to report insider filing delinquencies, as required, in annual reports or proxy statements.
In this new era of more aggressive SEC enforcement, public companies can help themselves and their officers, directors, and sizeable shareholders by taking the following steps:
- Conduct periodic compliance and training programs, especially for new hires, explaining securities reporting obligations and penalties for non-compliance.
- Institute proper protocols and procedures to insure that people with reporting obligations are furnishing the SEC and their affected companies with timely information, providing regular prompts and reminders to insiders and their brokers or intermediaries as needed.
- Ensure that disclosure forms are properly amended periodically to reflect material changes in beneficial ownership (some of the SEC’s recent targets timely filed their initial transactional reports but failed to amend them).
More broadly, companies that choose to assist their insiders with Section 16 reporting – which is not required but which most companies choose to do – should understand that they may be held accountable for significant Section 16 filing violations by the insiders. Similarly, insiders should understand that although their public companies may assist them with Section 16 reporting, it is the insiders’ responsibility to make the filings, and they may be held accountable for their own significant Section 16 filing violations.
SECTION 13 REPORTING
Sections 13(d) and 13(g) of the Exchange Act require certain transactional reports by large shareholders. In general, a shareholder or investment group must file a Schedule 13D report with the SEC within ten (10) days of any transaction that results in the person or group having more than five percent (5%) of any voting class of a company’s registered equity securities.
Schedule 13D also requires the reporting stock owner to disclose any other person having voting power or certain transactional authority with regard to the securities. Advisers and brokers who are empowered with certain discretion over accounts they hold for clients may be required to file transaction reports under the Exchange Act as well.
Schedule 13D generally requires the following disclosures:
- Information regarding the type and class of security purchased and the contact information for the owner.
- Information about the source and amount of funds used for purchase.
- Information about the purpose of the transaction;.
- Details about any special relationship between the stock owner and the company.
- Certain specified materials to be filed as exhibits, such as letters to management in the event of a hostile takeover.
Regulations permit some reporters to file a less detailed Schedule 13G, including:
- Qualified institutional investors, which include investment advisers under some circumstances.
- Certain exempt investors, such as those who acquired their securities prior to the issuer ’s Initial Public Offering (or otherwise registration under the Exchange Act).
- Passive investors owning less than twenty percent (20%) of any class of security, provided the securities in question are not being acquired or held for the purpose of changing or influencing control of the issuer, and further provided the acquisition does not have that effect and was not performed in connection with any transaction having such purpose or effect.
SECTION 16 REPORTING
Section 16 of the Exchange Act requires certain transactional reports on Forms 3, 4 or 5 by so-called insiders, such as officers, directors and any person who is directly or indirectly the beneficial owner of more than ten percent (10%) of a company.
An insider of an issuer that is registering equity securities for the first time under Section 12 of the Exchange Act must file Form 3 no later than the effective date of securities registration. A new insider – one hired by a company or who becomes a stockholder or acquires additional shaeres after the company has first registered shares – should also use Form 3 to report within ten (10) days of becoming an officer, director or ten percent (10%) owner for the first time.
Insiders must report any subsequent changes in their security ownership to the SEC on Form 4 within two (2) business days of a transaction with limited exceptions for specified transactional categories.
Investors subject to Section 16 can use Form 5 to report transactions that are eligible for deferred reporting or to report transactions that should have been reported earlier.
Since June 30, 2003 the SEC has required insiders to submit all forms electronically through the SEC’s EDGAR system with limited exceptions. The SEC also now requires that companies post the forms on their websites by the end of the next business day after filing with the SEC.