Public Companies, Corporate Insiders and Investment Firms Should Review Their Section 13 and Section 16 Compliance Policies in Light of Increased SEC Enforcement

On September 10, 2014, the Securities and Exchange Commission (SEC) announced enforcement actions against 28 public company insiders for violating federal securities laws requiring prompt reporting about their holdings and transactions in company stock.1 The 28 public company insiders included 13 corporate officers or directors, five individuals and 10 investment firms in connection with beneficial ownership of securities of public companies. Six public companies were charged for contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies. Twenty-seven of the 28 corporate insiders and all six public companies have agreed to settle the charges and pay financial penalties totaling $2.6 million.

The enforcement actions related to the failure to timely file reports required by Section 13(d), Section 13(g) and Section 16(a) of the Securities Exchange Act of 1934, as amended (Exchange Act). Sections 13(d) and 13(g) of the Exchange Act generally require beneficial owners of more than 5 percent of a class of equity securities registered under the Exchange Act to report their ownership of and transactions in such securities on Schedule 13D or Schedule 13G. Section 16(a) of the Exchange Act generally requires that directors, officers and beneficial owners of more than 10 percent of a class of equity securities registered under the Exchange Act report their beneficial ownership of and transactions in such securities with the SEC on Forms 3, 4 and 5.

The Section 16(a) enforcement actions primarily related to the failure to file transaction reports on Form 4, which must be filed within two business days after a transaction involving the subject security. According to the SEC, its “enforcement staff used quantitative data sources and ranking algorithms to identify [the charged] insiders as repeatedly filing late” Section 16(a) reports. The transaction reports of the charged insiders were delayed by weeks, months, or even years; in at least one instance an insider had never filed a Section 16(a) report before being contacted by the enforcement staff. The SEC also charged certain corporate insiders with failing to timely file or amend reports on Schedules 13D or 13G in circumstances related to their alleged Section 16(a) violations, as well as in circumstances not related to transactions in the issuer’s securities, such as being nominated to the issuer’s board of directors.

Of particular interest to insiders and public companies is that certain corporate insiders charged by the SEC claimed that their delinquent Section 16(a) reports resulted from the failure of issuer personnel to file such reports on their behalf following timely notification to the issuer by the corporate insiders of the reportable transactions. In its orders, the SEC stated that although the SEC has encouraged issuers to help their officers and directors with, or submit on their behalf, Section 16(a) reports to facilitate accurate and timely filing, the responsibility for complying with the Section 16(a) reporting requirements remains with the insider; an insider’s reliance on the issuer does not excuse a violation of Section 16(a).

Notwithstanding that the responsibility for complying with the Section 16(a) reporting requirements remains with the insider, the SEC charged five of the six public companies against which it brought enforcement actions with causing violations of Section 16(a) by their respective insiders. In its orders, the SEC stated that “issuers who voluntarily accept certain responsibilities and then act negligently in the performance of those tasks may be liable as a cause of Section 16(a) violations by [their] insiders.”

The SEC emphasized that the reporting requirements under Section 13(d), Section 13(g) and Section 16(a) apply irrespective of profits or a person’s reasons for acquiring holdings or engaging in transactions and that the failure to timely file a required beneficial ownership report, even if inadvertent, constitutes a violation of these rules.

The six public companies were also charged with violating Section 13(a) of the Exchange Act and Rule 13a-1 thereunder for failing to comply with the disclosure requirements of Item 405 of Regulation S-K, which requires that issuers disclose in their proxy statement or annual report information regarding delinquent Section 16(a) filings by the issuer’s corporate insiders.

In light of these enforcement actions and the SEC’s statement that it “will vigorously police these sorts of violations,” which have not generally been the subject of enforcement actions absent fraud or other intentional violations, public companies, corporate insiders and investment firms should review and update their Section 13 and Section 16 compliance policies. Specifically:

  • Public companies that file Section 16(a) reports on behalf of their insiders should take steps to ensure that insiders report transaction information to multiple persons on the issuer’s legal, compliance and financial reporting staffs, designate staff members to follow-up on the status of pre-cleared trades if the transactions are not subsequently reported to the issuer and include Section 16(a) compliance as part of the issuer’s annual compliance training to officers and directors; particular concern should be taken to ensure that proper reporting is designed when 10b5-1 trading plans are established;
  • Corporate officers, directors and major shareholders who rely on issuers to file their Section 16(a) reports should take steps to ensure that such reports are filed in an accurate and timely manner and that all transactions in an issuer’s securities are promptly reported to the issuer, including, if applicable, directly by the broker responsible for such transactions; and
  • Investment firms should review their internal reporting mechanisms to ensure that transactions that may require amendments to the firm’s Schedule 13D or 13G filings are promptly reported to the firm’s legal and compliance departments.