October 3, 2014
Practice Groups:
Corporate/M&A
Corporate
Governance
Capital Markets
By David C. Lee
In an enforcement sweep recently brought by the U.S. Securities and Exchange Commission
(“SEC”),
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28 officers, directors and major shareholders were charged with violations of the reporting requirements relating to equity transactions by corporate insiders (Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”)) and, in some cases, the reporting requirements relating to the ownership of shareholders beneficially owning more than 5 percent of the equity securities of public companies (Sections 13(d) and 13(g) of the
Exchange Act). Five public companies were charged with contributing to the failures of these insiders to file their Section 16(a) reports. On the same date, in a settled action, the SEC also charged a company and its former CEO with fraud and reporting violations in connection with the failure of the former CEO to either timely report his sales of the company’s stock or report stock sales at all. Substantially all of the individuals and companies that were charged in these actions settled with the SEC, agreeing to pay penalties in connection with such settlements. The actions taken by the SEC are consistent with a speech given in October
2013 by SEC Chair Mary Jo White, which outlined an enforcement strategy of pursuing even the smallest infractions relating to the federal securities laws (the so-called “broken windows” strategy).
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The SEC actions against both corporate insiders and public companies evidences the SEC’s view that this type of reporting is of significance to the public markets, and that repeated violations of these reporting requirements risk the possibility of an SEC enforcement action.
Section 16(a) of the Exchange Act requires executive officers, directors and beneficial owners of more than 10 percent of a class of equity securities registered under Section 12 of the Exchange Act (collectively, “Reporting Persons”) to file reports on Form 4 to report certain equity transactions that change a Reporting Person’s beneficial ownership of a company’s equity securities.
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Forms 4 are due within two business days of the date of the
transaction.
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See www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678
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See www.sec.gov/News/Speech/Detail/Speech/1370539872100
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Form 3 is the initial form required to be filed by Reporting Persons, and Form 5 is an annual form for transactions that are not required to be reported on Form 4 but can be reported on an annual basis within 45 days after fiscal year-end.

Sections 13(d) and 13(g) of the Exchange Act require a person or group that beneficially owns more than 5 percent of a class of equity securities registered under Section 12 of the
Exchange Act to report its/their beneficial ownership on a Schedule 13D unless such person or group qualifies for reporting on a short-form Schedule 13G. An amendment to Schedule
13D is required upon a material change to such beneficial ownership (including the acquisition or disposition of one percent or more of the class of equity securities), and an amendment to Schedule 13G is generally required (1) on an annual basis if there are changes to the information previously reported or (2) within 10 days after the end of the first month where a Schedule 13G filer’s beneficial ownership exceeds 10 percent of the class of equity securities or upon an increase or decrease of more than 5 percent of such class of equity securities.
An important purpose underlying the requirements of both Section 16(a) and Sections 13(d) and 13(g) is to provide the public markets with information regarding transactions by insiders, which may be viewed by some investors as relevant information regarding a company’s prospects.
The individuals that were charged by the SEC in these actions generally had numerous instances of either failures to file Section 16(a) reports or untimely Section 16(a) reports.
Similarly, individuals or entities that were charged with violations of Sections 13(d) and
13(g)’s reporting requirements generally had significant failures to file Schedules 13D/13G on a timely basis or to timely amend such reports.
The companies that were charged in these actions were generally charged with two types of violations. First, the SEC charged companies with violations of Section 13(a) of the
Exchange Act in cases where they failed to comply with issuer disclosure requirements, i.e.,
Item 405 of Regulation S-K, which requires disclosure of known instances of a corporate insider’s failure to file, or untimeliness regarding, Section 16(a) reports. Item 405 disclosure is typically included in proxy statements. Second, although Section 16(a) reports are the legal responsibility of Reporting Persons, the SEC charged some companies with causing
Section 16(a) violations in cases where such companies voluntarily agreed to undertake certain tasks in filing Section 16(a) reports on behalf of Reporting Persons but acted negligently in performing such tasks.
The Sections 16(a), 13(d) and 13(g) enforcement actions reinforce the concept that
Reporting Persons (and their companies) must be conscientious as to compliance with
Section 16 and, as applicable, Section 13(d) and 13(g) filings. Repeated failures to comply with the federal securities laws, even of what some may perceive to be “minor” provisions of the federal securities laws, may nevertheless lead to an SEC enforcement action, as SEC
Chair White warned in her “broken windows” speech. Moreover, the SEC mentioned in its press release announcing the Sections 16(a), 13(d) and 13(g) enforcement actions that it used quantitative analytics in identifying violations of Sections 16(a), 13(d) and 13(g). It seems likely that the specific reference to quantitative analytics, which presumably provides the SEC with a greater ability to discover violations, was a message to would-be violators that the SEC is using resources that may help them more easily find violations.
Some practical considerations that Reporting Persons and their companies should take note of include the following:
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Often, companies provide their Reporting Persons with memos addressing Section 16 requirements, but a memo in and of itself may not effectively educate them as to Section
16(a) reporting requirements. Companies should consider conducting mandatory Section
16 training, which could be done along with any training relating to the company’s insider trading policy. Such training should reinforce the concept that Reporting Persons are ultimately responsible for Section 16 filings, even if the company is assisting them.
Moreover, in addition to concerns with respect to SEC scrutiny, private plaintiff law firms carefully scrutinize filings made by Reporting Persons in order to see whether a Reporting
Person must disgorge “profits” under Exchange Act Section 16(b), i.e., short-swing profit recovery. Conducting training sessions can also help educate Reporting Persons as to how to avoid short-swing profit recovery issues.
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If a company undertakes to assist Reporting Persons with their Section 16 reports (which many public companies do), the company will need to receive accurate and timely information from the Reporting Person and/or his/her advisors regarding any equity transactions. Accordingly, the company and its Reporting Persons should establish procedures (or fine-tune existing ones) pursuant to which this information will be timely and accurately conveyed to the company. Moreover, it is to the benefit of Reporting
Persons to provide the company with a “heads-up” regarding upcoming future equity transactions, particularly where such transactions may be complex and require analysis as to how such transactions need to be reported in a Form 4 filing. In this regard, the company will also need to have adequate and appropriate resources to prepare and file such reports, including having persons who are knowledgeable with respect to Section 16 matters. Section 16 reporting can be complicated, and thus, it may be necessary to consult with experts, such as securities lawyers.
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With respect to companies’ proxy statements, companies should carefully review all
Section 16 reports filed by their Reporting Persons in order to have an appropriate basis for their Item 405 disclosures. This includes calculating due dates for any known Section
16 reports and confirming, if true, that such reports were timely filed.
Author:
David C. Lee david.lee@klgates.com
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