In response to COVID-19, US companies have been forced to make major changes to their businesses in a short period of time. Demand has collapsed; supply chains have been disrupted; and transactions have been put off. This upheaval has generated a significant increase in the amount of potentially material, nonpublic information (MNPI) in the hands of corporate insiders. Given recent public statements by US regulators, corporate executives and directors should understand the risks of being accused of trading while in possession of MNPI and prepare themselves for considerable scrutiny of trades made during the crisis.1
Regulators Are Focused on Insider Trading
US regulators have signaled that they will remain vigilant in pursuing illegal conduct arising out of the COVID-19 crisis. The zeal in recent weeks with which they have announced their focus on these issues contrasts with the criticism leveled against these same regulators for lax oversight of trading practices in the run-up to the financial crisis of 2007–2008.2 On March 23, 2020, the Co-Directors of the SEC Division of Enforcement made an announcement focused on the heightened risks of insider trading during the crisis.3 They reminded executives and directors to be mindful of their obligations to comply with prohibitions on illegal trading of securities.4 Along the same lines, FINRA announced that it remains fully operational and will continue to operate its market surveillance and enforcement programs.5 Given their recent activism on securities issues, and state-level statutes available for such purposes (e.g., New York State’s Martin Act6), state attorneys general may engage in trading investigations in the coming months as well.
Increase in Potentially Material, Nonpublic Information
The antifraud provisions of the securities laws prohibit the buying or selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of MNPI concerning that security.7 They also prohibit the “tipping” of such information, which occurs when a “tipper” provides MNPI to a “tippee,” who then trades on the basis of that nonpublic information.8
The COVID-19 crisis is creating a deluge of information, some of which may potentially be MNPI. Executives and directors are learning information about their own business and, by virtue of their responsibilities, about other companies and counterparties on an accelerated basis. As the SEC explained, “in these dynamic circumstances, corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances.”9 And because of the need to involve greater numbers of team members in responding to the crisis, more employees within public companies may be obtaining access to potential MNPI. Some examples of types of information being generated by the crisis that may be MNPI depending on a company’s particular circumstances include
- plans to materially downsize, furlough or hire employees or to issue pay cuts;
- an anticipated bankruptcy of another participant in your supply chain (e.g., a supplier, distributor or customer);
- a pending announcement by a manufacturer that it intends to convert production lines to produce ventilators, PPE or other products to address the crisis;
- information regarding an issuer’s or a significant supplier’s or a customer’s liquidity situation, including, where applicable, pending loan applications under certain stimulus plan provisions; and
- a plan to temporarily suspend certain significant operations in light of shelter-in-place orders.
Bear in mind that MNPI can be obtained from other companies. Trades in other companies’ shares can still be problematic under the “misappropriation theory,” whereby an outsider may be liable when she misappropriates confidential information in breach of a fiduciary duty owed to the source of that information.
Of course, as with any analysis of nonpublic information, much depends on whether the information was material—i.e., there was a substantial likelihood that a reasonable investor would have considered it to have significantly altered the “total mix” of information made available. It is quite possible, for example, that given the information currently available about the market’s effects on a company’s performance, certain downsizing plans or employee furloughs might not significantly alter the total mix of information. Nevertheless, materiality arguments rarely forestall the opening of an investigation and can require considerable extrinsic evidence to work as a defense.
Key Considerations Prior to Trading
Executives and directors who are contemplating making trades during the crisis should keep the following in mind:
- Adhere to the Company’s Trading Policy. Confirm that any contemplated trades are consistent with the company’s trading policy, and obtain any approvals required thereunder.
- Remember That Open Trading Windows Are Not Safe Harbors. Even scrupulous adherence to an “open” trading window may not prevent an investigation. Remember that an insider’s personal knowledge at the time of the transaction will be assessed individually, taking into account the facts and circumstances bearing on the investment decision.
- Recognize That MNPI Can Be Obtained From Other Companies. Think about whether you have obtained confidential information about other companies before trading. As noted above, the misappropriation theory can make trading in other companies’ shares while in possession of those companies’ MNPI problematic.
- Exercise Caution Before Modifying a Rule 10b5-1 Plan. Note that the SEC staff has been skeptical of terminations and revisions to Rule 10b5-1 plans. Any modifications or terminations should be done in a manner consistent with the company’s insider trading policy. Counsel should be consulted to help ensure that the timing of any contemplated trades following any modification is appropriate, and with respect to termination, that any new plan is entered into after an appropriate period of time has passed.
- Avoid Unnecessary Discussion About Trading. Although spousal communications may be privileged, conversations with other immediate family members are not ordinarily subject to a privilege. Conversations about specific trades (and the reasons for them) or about possible exposure may be subject to discovery in an investigation or litigation.
Key Considerations When Facing Potential Scrutiny
Individuals who already have traded in the securities of their own or other companies in circumstances where it may be claimed that they had access to MNPI should be prepared for regulatory scrutiny surrounding those trades and should consider the following steps:
- Preserve the Relevant Documents. Individuals should consider preserving any materials that would be potentially relevant to an investigation, especially key documents that bear directly on major securities transactions (e.g., transaction preclearance communications with corporate compliance or legal personnel and communications with financial advisors or brokers). This includes text messages or other forms of communication besides email. Individuals who fail to preserve relevant materials may be subject to criminal anti-spoliation statutes and could potentially face obstruction of justice charges. The deletion of electronic communications and records of calls and meetings can be especially problematic.
- Collect the Relevant Materials. The first step of an investigation often involves a request for documents. To respond efficiently to these requests (and to potentially head off additional, more burdensome requests), individuals should consider working with counsel to ready existing materials for expedited production. Such materials may include existing materials that relate to the investment decision and/or recommendation that led to the transaction; Rule 10b5-1 trading plans; trading authorizations reflecting preclearance and/or compliance with approved trading windows; investment management contracts; trust arrangements that confer discretion to trade; any applicable preclearance applications and approval notifications; the company’s securities trading policy and attestations of compliance; and SEC Forms 3 and 4, including accompanying notes and explanations.
- Retain Separate Counsel to Represent Your Individual Interests. Understand that a company’s general counsel and legal department ordinarily do not represent any individual personally. Although communications with the legal department may be privileged, and it may be required or advisable to inform the company’s legal department of any governmental inquiry, the company is typically free to disclose any information it receives to government regulators. For this reason, insiders may want to retain their own separate counsel to represent their interests in an inquiry.
- Avoid Early Interviews Prior to Retaining Counsel. Exercise caution before agreeing to any immediate interview request from the SEC, FINRA or DOJ, especially without counsel. It can be a crime to provide a false statement to a regulator or law enforcement, even when the statement is not made under oath, and a mistaken recollection can be misinterpreted as an intent to deceive.
- Appreciate Your Company’s FINRA Obligations. Recognize that issuer listing agreements may compel cooperation with FINRA in investigations of potential insider trading. These listing obligations can raise challenging issues as to how individuals should respond to requests from the company or FINRA to provide information and/or documents about specific trades.
- Exercise Caution Before Preparing a Factual Chronology. In responding to an investigation, individuals should be mindful that notes and chronologies not prepared for or at the request of counsel may not be privileged and thus may be subject to production to the government.
- Recognize That Web Searches May Become Evidence. Bear in mind that web searches may become evidence, including web searches that are made after an inquiry commences. The government can obtain this information and may use it as evidence of knowing misconduct.10
For more specific guidance on these or other related securities issues, please contact any of the authors of this alert.