The SEC announced last week that it had charged, in settled administrative proceedings, 28 individuals and investment firms that failed to “promptly report information about their holdings and transactions in company stock” and six public companies that contributed to “filing failures by insiders or fail[ed] to report their insiders’ filing delinquencies.” See SEC Press Release: “SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings.” The SEC obtained a total of $2.6 million in civil monetary penalties as a result of the filed charges. The individual amounts ranged from $25,000 to $150,000. These cases are the latest example of the SEC’s focus on strict liability violations of the federal securities laws.
All of the charges arise under Sections 13(d), 13(g), and 16(a) of the Securities Exchange Act of 1934. These sections require certain forms to be filed, irrespective of profits or the reasons for engaging in the stock transactions. Although the SEC does not need to establish that an individual or company engaged in insider trading (nor was there any finding that would suggest such) in order to prove any of the charged violations, legislative history indicates that Section 16(a) was motivated by a belief that “the most potent weapon against the abuse of inside information is full and prompt publicity” and by a desire “to give investors an idea of the purchases and sales by insiders[,] which may in turn indicate their private opinion as to prospects of the company.”
Pursuant to Section 16(a) and Rule 16a-3, company officers, directors, and certain beneficial owners of more than 10% of a registered class of a company’s stock (“insiders”) are required to file initial statements of holdings on Form 3 and to keep this information current by reporting transactions on Forms 4 and 5. Specifically, within 10 days after becoming an insider, the insider must file a Form 3 report disclosing his or her beneficial ownership of all securities of the issuer. To keep this information current, insiders must file Form 4 reports disclosing purchases and sales of securities, exercises and conversions of derivative securities, and grants or awards of securities from the issuer within two business days following the execution date of the transaction. In addition, insiders are required to file annual statements on Form 5 within 45 days after the issuer’s fiscal year-end to report any transactions or holdings that should have been, but were not, reported on Form 3 or 4 during the issuer’s most recent fiscal year and any transactions eligible for deferred reporting (unless the corporate insider has previously reported all such transactions).
Beneficial owners of more than 5% of a registered class of a company’s stock must use Schedule 13D and Schedule 13G to report holdings or intentions with respect to the respective company. According to legislative history, Section 13(d) is a key provision that allows shareholders and potential investors to evaluate changes in substantial shareholdings. The duty to file is not dependent on any intention by the stockholder to gain control of the company, but on a mechanical 5% ownership test. A Schedule 13D must be filed within ten days of the transaction, and a Schedule 13G must be filed within 10 to 45 days of the transaction, depending on the category of filer and the percentage of acquired ownership. Importantly, Section 16(a) also requires an investment adviser to file required reports of behalf of funds that it manages when the fund’s ownership or transactions in securities exceed the statutory thresholds.
Under Section 16(a), public companies are required to disclose in their annual meeting proxy statements or in their annual reports, “known” Section 16 reporting delinquencies by its insiders. This disclosure is commonly referred to as the Item 405 disclosure. The Item 405 disclosure of any late filings or known failures to file must (i) identify by name each insider who failed to file Forms 3, 4, or 5 on a timely basis during the most recent fiscal year or prior fiscal years and (ii) set forth the number of late reports, the number of late-reported transactions, and any known failure to file. An issuer does not have an obligation under Item 405 to research or make inquiry regarding delinquent Section 16(a) filings beyond the review specified in the item. Although insiders remain responsible for the timeliness and accuracy of their required Section 16(a) reports, the SEC has encouraged companies to assist their officers and directors to submit their filings, or even to submit the required form on the insiders’ behalf to ensure accurate and timely filing.
These actions make clear, however, that reliance on the company does not excuse violations as the insider retains ultimate responsibility for the filings. The majority of the charged individuals told the SEC that their delinquent filings resulted from the failure of the company to make timely filings on their behalf. In one case, disclosures in the company’s annual proxy statements relating to Section 16(a) compliance revealed that the filing of the insider reports was late because of “lack of staffing,” “late receipt of necessary information,” and “a change in the processing of these forms and delays caused by an email server malfunction.” The SEC still charged the insider because the insider took “ineffective steps to monitor whether timely and accurate filings were made” on his or her behalf by the company.
Without providing any details, the SEC claimed that it used “quantitative analytics” or algorithms to identifyindividuals and companies with especially high rates of filing deficiencies. The SEC’s filing of these actions underscores its willingness to devote resources to pursuing strict liability violations. It also demonstrates the SEC’s efforts to use quantitative analysis and algorithms to identify violations and to streamline the investigative process.