On September 10, 2014, the Securities and Exchange Commission (SEC) announced charges against 28 officers, directors and major stockholders of public companies for violating Section 16(a) and/or Section 13(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act). These rules require prompt reporting about holdings and transactions in the stock of publicly traded companies. Six public companies were also sanctioned for contributing to filing failures by insiders or failing to report their insiders' filing deficiencies. A total of 33 out of these 34 individuals and companies agreed to settle charges and pay financial penalties totaling $2.6 million.1
SEC's "Broken Windows" Strategy and "Quantitative Analytics" Tools Prompt New Look at Issuers' and Insiders' Filing Obligations
These sweeping actions are another step in the SEC's initiative to "fix broken windows," as described by SEC Chair Mary Jo White in her public remarks on October 9, 2013. White explained the SEC's efforts to ensure that its enforcement program is pursuing all types of violations of the federal securities laws, big and small, thus "casting its nets wider, and into smaller spaces, paying attention to violators and violations regardless of size."2 She noted that the SEC is streamlining its investigations, particularly those involving strict liability where there is no need to prove intent, such as in the case of Exchange Act Section 16(a) and Section 13(d) reporting violations. This is a noteworthy change in that these types of reporting violations, by themselves, traditionally have not been a source of significant SEC enforcement interest in the absence of other alleged violations or bad facts.
In announcing these charges, Andrew Ceresney, Director of the SEC's Division of Enforcement, noted that the SEC brought these actions together to send a clear message about the importance of abiding by the reporting requirements of the federal securities laws. Ceresney issued a stern warning: "Officers, directors, major shareholders and issuers should all take note: inadvertence is no defense to filing violations and we will rigorously police these sorts of violations through streamlined actions."3
It is important for public companies to understand the SEC enforcement staff's use of quantitative data sources and ranking algorithms to identify individuals and companies with notably high rates of filing deficiencies. In particular, Ceresney pointed to using "quantitative analytics," which allow the staff to make allegations on a broad scale with limited resources.4 This is consistent with White's previous statements that the SEC would harness the power of enhanced technologies as a "force multiplier" in the SEC's effort to let market participants know that it is "looking and pursing charges in all directions."5
What the Rules Require When Officers, Directors and Major Stockholders Trade
Section 16(a) and the rules promulgated thereunder require each officer, director and greater-than-10% stockholder (collectively, insiders) of a public company to file Forms 4 with the SEC within two business days after the date of certain transactions resulting in a change in beneficial ownership of the company's equity securities. Forms 5 must be filed with the SEC within 45 days after the end of each fiscal year for certain types of stock transactions that the SEC has designated as eligible for a Form 5 filing, rather than a Form 4 filing. In addition, insiders must also report on a Form 5 all transactions that occurred during the fiscal year that should have been, but were not, reported earlier on a Form 4.
In general, Section 13(d) and the rules promulgated thereunder require that any person or entity (or group of persons or entities acting together) who makes an acquisition of common stock which results in such person or group owning more than 5% of the outstanding shares of common stock of the company must report the ownership of company securities by filing either a Schedule 13D or Schedule 13G with the SEC.
One principal function of Sections 16(a) and 13(d) is to enable information to rapidly enter the public market about insider transactions and significant changes in stock ownership. Violations of Sections 16(a) and 13(d) do not require a showing of intentional conduct, and a failure to timely file a report, even if inadvertent, constitutes a violation.6
SEC Holds Insiders Responsible for Failing to File, Even Where Companies Took Responsibility for Preparing Reports
The SEC's orders with respect to individuals and investment firms generally alleged violations of Section 16(a) of the Exchange Act for failing to timely file reports of transactions on Forms 4 and annual statements of beneficial ownership on Form 5, and of Exchange Act Section 13(d) for failing to file timely reports of beneficial ownership of more than 5% of a company's stock. The penalties for these violations ranged from $25,000 to $120,000. The SEC's enforcement division will litigate the charges against one individual.7
The SEC was not persuaded by the defense raised by many insiders that their delinquent filings resulted from failure on the part of the public company issuer that took on responsibility for the preparation or filing of these reports. The SEC consistently stated in its findings that "the failure by an issuer to inform an insider that he or she is subject to Section 16, and the failure of company personnel to make timely filings on an insider's behalf after being timely informed of such transactions by the insider, does not excuse an insider's violations of reporting requirements. An insider retains legal responsibility for filing requirements, insuring the obligation to assure that the filing is timely and accurately made."8 In some cases, the SEC specifically noted that respondents took inadequate and ineffective steps to monitor whether timely and accurate filings were made on their behalf.
SEC Also Takes Public Companies to Task for Failing to Timely Report
Despite confirming that the responsibility for timely filings ultimately remains with the insider, the SEC also levied fines against six publicly traded companies for (1) being the cause of filing failures by insiders and/or (2) failing to report their insiders' filing deficiencies. In particular, the SEC alleged that these companies voluntarily accepted certain responsibilities for insiders' Section 16 filings and then acted negligently in the performance of those tasks, holding such companies liable as a cause of Section 16(a) violations. The SEC noted in almost all of these cases that the issuer had voluntarily agreed with officers and directors to prepare and file reports, but repeatedly failed to perform the agreed-upon tasks on a timely basis and employed procedures that were insufficient and negligent.
The SEC also charged these companies with a failure to comply with Form 10-K and/or proxy statement disclosure requirements regarding late or missing Section 16 filings, which are set forth in Item 405 of Regulation S-K. As a means of increasing compliance by insiders with their reporting obligations under Section 16(a), the SEC's rules require all public companies to disclose in their proxy statements and annual reports on Form 10 K the names of all insiders who failed to file timely reports during the previous fiscal year, and the number of late or unfiled reports by each such insider. False or misleading Item 405 disclosure can constitute a violation of Section 13(a) of the Exchange Act and Rule 13a-1, which require issuers to include specified information in their annual reports in conformity with SEC requirements. As with Section 16(a) and 13(d), violations of Section 13(a) do not require a showing of intentional conduct. The penalties for these violations ranged from $75,000 to $150,000.9
Issuers and insiders are advised to heed the warnings of White and Ceresney and be proactive in establishing and following procedures for compliance with Sections 16(a), 13(a) and 13(d) and the Form 10-K and proxy statement disclosure requirements in Item 405:
- Insiders bear ultimate responsibility for the timeliness of their filings and must ensure timely and accurate processing and reporting of transactions, even when relying on the assistance of issuers or brokers with respect to such reporting.
- Issuers that assume responsibility for preparing, processing and/or filing reports for insiders must ensure that they have sufficient policies and procedures in place to timely and accurately complete such filings.
- Issuers must ensure that they have in place policies and practices to facilitate accurate, timely and complete disclosure of late Section 16(a) reports in their annual reports and proxy statements.
- While insiders and issuers always have been advised to make their required filings on time, the SEC now appears more focused on these types of reporting violations than in the past, regardless of whether or not they are linked with other alleged violations.
- More broadly, these actions reflect the SEC's ability to leverage technology to target an area of concern, and market participants and practitioners should expect to see other examples. Prior to these actions, the SEC had touted such acronyms as MIDAS (Market Information Data Analytics System), ABAP (Advanced Bluesheet Analysis Program), CAT (Consolidated Audit Trail), API (Aberrational Performance Inquiry), AQM (Accounting Quality Model) and NEAT (National Exam Analytics Tool) as tools to help the SEC and its staff comb through a variety of information to detect a range of potential illegal activities from insider trading to accounting and disclosure fraud.10 These efforts reflect the SEC's strong commitment to significant investment in sophisticated technology to enforce the federal securities laws.
1 "SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings," SEC Press Release No. 2014-190 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678. In a separate release on the same day, the SEC also announced that it had charged ACT Biotech and its former CEO with violating, among other things, the anti-fraud provisions of the securities laws for misleading statements in annual reports and proxy statements about compliance with the reporting provisions of Section 16(a). The CEO agreed to pay a $175,000 penalty and ACT Biotech agreed to pay a $375,000 penalty and retain an independent consultant to conduct a review of its Section 16(a) reporting and compliance procedures. "SEC Announces Fraud Charges Against Biotech Company and Former Executive Who Failed to Report Insider Stock Sales," SEC Press Release No. 2014-191 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542903208.
2 See Mary Jo White, Remarks at Securities Enforcement Forum 2013, Washington D.C., Oct. 9, 2013, available at www.sec.gov/News/Speech/Detail/Speech/1370539872100.
3 "SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings," SEC Press Release No. 2014-190 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678.
4 Richard Hill, "33 Insiders, Companies Settle Late Reporting Allegations in SEC Sweep," Bloomberg BNA Daily Report for Executives, (September 10, 2014).
5 See Mary Jo White, Remarks at Securities Enforcement Forum 2013, Washington D.C., Oct. 9, 2013, available at www.sec.gov/News/Speech/Detail/Speech/1370539872100. White also identified incentivizing whistleblowers, leveraging the SEC exam program, collaborating with criminal and other regulatory authorities, and focusing on gatekeepers as other force multipliers.
6 "SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings," SEC Press Release No. 2014-190 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678. Also see SEC v. Forsyth, Release No. 73059 (September 10, 2014), fn. 4.
7 "SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings," SEC Press Release No. 2014-190 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678.
8 See SEC v. Arling, Release No. 73058 (September 10, 2014), fn. 5, available at www.sec.gov/litigation/admin/2014/34-73058.pdf.
9 "SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings," SEC Press Release No. 2014-190 (September 10, 2014), available at www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678.
10 See Mary Jo White, Remarks at Securities Enforcement Forum 2013, Washington D.C., Oct. 9, 2013, available at www.sec.gov/News/Speech/Detail/Speech/1370539872100, and Elisse Walter, Chairman, SEC, "Harnessing Tomorrow's Technology for Today's Investors and Markets," (Feb. 19, 2013), available at www.sec.gov/News/Speech/Detail/Speech/1365171492300.