On May 22, 2009, the chairman of the U.S. Securities and Exchange Commission outlined measures that were designed to strengthen the Commission’s internal compliance program with respect to inappropriate employee securities trading. It is unlawful under the federal securities laws for any person to engage in any act, practice or course of business conduct that constitutes fraud in connection with the purchase or sale of any security. After learning about potential weaknesses in the Commission’s internal compliance program, Chairman Schapiro directed that immediate action be taken to strengthen the Commission’s internal systems. The new measures are noteworthy for securities practitioners and internal compliance officers of companies that have securities registered under the federal securities laws or are otherwise subject to SEC regulation.
The Commission’s current rules prohibit employees from engaging in the following activities, among other things:
- carrying securities on margin;
- engaging in options or futures transactions;
- holding a security interest in broker-dealers and registered investment advisers;
- speculative trading (by requiring employees to hold stock for at least six months); and
- failing to report all trades within five days of receiving confirmations.
The new measures mandated by Chairman Schapiro include the following:
new internal rules that will require pre-clearance by employees of all trades;
- a bar against employees trading in securities of companies under investigation by the Commission;
- a prohibition against trading in securities involved in an IPO or by employees with access to nonpublic information about a company’s registration statement;
- consolidated responsibility for oversight of employee securities transactions within the Office of Government Ethics;
- contracting with an outside firm to develop a computer compliance program to track and audit employee securities transactions;
- a bar against employee ownership of publicly traded exchanges and transfer agents;
- requiring employees to authorize their brokers to provide duplicate trade confirmation statements; and
- requiring employees to certify before any trade that they do not possess any non-public information about the company being traded.
As part of the Commission’s new pre-clearance and compliance program, supervisors will be required to conduct periodic reviews of employees’ work projects. Although under the present rules, pre-clearance of trades is not required, it will be under the new regime. Furthermore, the current rules will be expanded to include on the “prohibited securities trading list” all companies being investigated by the Commission.
The new rules are intended to bolster the Commission’s internal compliance program with respect to existing laws that prohibit anyone from trading securities of a company on the basis of material, nonpublic information about that company.
Here are some lessons that may be helpful to securities practitioners and internal compliance personnel. First, give careful consideration to the scope of a company’s internal compliance program. The Commission has, for obvious reasons, included all staff employees, any of whom might learn material, non-public information about a company in the course of their daily routine. Where practicable, a company’s compliance program should be designed to cover all employees. A possible variation from the Commission’s proposed measures that might be suitable for some companies would include a general policy prohibiting trading by any employee of a company’s (or a third party’s) securities if the employee possesses material, non-public information about the company, and a requirement that all managerial employees pre-clear all trades with a designated officer of the company.
The SEC has determined that it will rely on its supervisory personnel as well as a coordinate government office to oversee its internal compliance program with respect to employee securities transactions and reporting. In a corporate setting, where one size seldom fits all, the compliance officer should focus on designing a system of reporting and compliance checks that are practical and effective. For example, a company that has multiple offices should consider structuring a compliance and reporting program for each office, with appropriate reporting to the compliance officer. If this is not practicable, then thought should be given to computerizing aspects of the compliance program and perhaps engaging an outside service provider to assist in monitoring the program. In appropriate cases, all three methods should be employed as part of one integrated compliance system.
Companies should consider requiring employees to certify – before making a trade – that they do not possess material, non-public information about the company being traded; this requirement should probably be included in any internal compliance program for several reasons. A certification requirement will prompt most employees to review the company’s policy before trading in securities. An employee who does not understand the policy or its possible application to a particular trade will be more likely to ask a supervisor or the designated compliance officer for clarification. Finally, employees will take more care not to inadvertently execute a trade in violation of the federal securities laws.
The internal compliance program should include a “restricted list,” which should err on the side of being over-inclusive. For example, a company that is engaged in a growth strategy through acquisition should maintain and update records that include the names of all targets and potential merger partners. In addition, companies should implement procedures that explain to all employees as well as to management the methods by which material, non-public information is to be gathered, stored and protected.