November 24, 2014

SEC Enforcement Actions on Stock Transaction Reporting May Drive Corporate Housekeeping

Arnold & Porter Advisory

In September 2014, the US Securities and Exchange Commission ("SEC") announced enforcement actions against 28 officers, directors, or major shareholders for failing to promptly report information about their holdings and transactions in company stock.  The charges stem from an SEC enforcement initiative focusing primarily on the reporting of beneficial ownership under Section 16(a) of the Securities Exchange Act of 1934, as amended ("Exchange Act").1  These enforcement actions are consistent with prior announcements by SEC Chairman Mary Jo White that she intended to adopt a "broken windows" theory of enforcement that "no infraction was too small to be uncovered and punished," an approach championed by former New York City Mayor Rudy Giuliani.2

This coordinated enforcement action was intended to send a clear message to the securities professionals, directors, officers, and public companies about the need to step up compliance in Section 16(a) reporting.  Indeed, in announcing the enforcement actions, SEC Director of Enforcement Andrew Ceresney warned "Officers, directors, major shareholders, and issuers should all take note: inadvertence is no defense to filing violations, and [the SEC] will vigorously police these sorts of violations through streamlined actions."3

Against this backdrop, public companies should consider revisiting procedures relating to Section 16(a) reporting.  This advisory discusses several actions that might be taken. 

Background On Enforcement Actions

Pursuant to Section 16(a) and Rule 16a-3, enumerated officers, directors and more than 10% stockholders ("insiders") are required to file initial statements of holdings on Form 3 and keep this information current by reporting changes in their holdings on Forms 4 and 5.  Specifically, within 10 days after becoming an insider, an insider must file a Form 3 report disclosing his or her beneficial ownership of all securities of the issuer.4 To keep this information current, insiders must file Form 4 reports disclosing transactions resulting in a change in beneficial ownership within two business days, except for limited types of transactions eligible for deferred reporting.  Transactions required to be reported on Form 4 include purchases and sales of securities, exercises and conversions of derivative securities, and grants or awards of securities from the issuer.  In addition, insiders may be required to file an annual statement 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 most recent or prior fiscal years, as well as any transactions eligible for deferred reporting.  Under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in annual reports or proxy statements, issuers are required to identify annually each person who failed to file on a timely basis reports on Forms 3, 4, or 5 during the most recent fiscal year or prior fiscal years.

The enforcement actions filed earlier this year named thirteen individuals who were officers or directors of public companies, five individuals who were beneficial owners of publicly-traded companies, ten investment firms, and six companies for contributing to filing failures or failing to report filing delinquencies.  Several aspects of the enforcement actions are notable.

First, the SEC enforcement staff used "quantitative data sources and ranking algorithms" to identify individuals who repeatedly filed late.

Second, the staff pursued the enforcement actions even if the individuals did not know of their reporting obligations, announcing that "the failure to timely file a required report, even if inadvertent, constitutes a violation."5  For example, in a proceeding against a corporate controller, the SEC concluded that the officer violated Section 16(a) on multiple occasions by failing to timely file reports.  From public sources, it appears that each of the missed filings occurred at a time when the officer did understand he was subject to the reporting obligations.  Once informed, the company assisted the officer with reporting all late transactions.  In addition, the company disclosed the number of late filings and transactions in its proxy statement and noted that it had failed to timely advise the officer of the reporting obligations.  Despite these unusual circumstances and remedial efforts, the SEC focused on the officer's title, concluding that the officer's reliance on the company did not excuse the violations because "the Respondent served in a position specifically designated in the definition of 'officer' under Exchange Act Rule 16a-1(f) and an insider retains legal responsibility for compliance with the filing requirements."6

Third, in a separate proceeding against the corporate controller's company, the SEC focused on the disclosures in the company's proxy statements regarding missed Section 16(a) filings by insiders.  Item 405, adopted in 1991, is designed to help address compliance with Section 16(a) by requiring issuers to disclose information about delinquent Section 16(a) filings, including the name of the insider, the number of delinquent reports, the number of transactions not timely reported, and any known failure to file a report (including a delinquency from a prior year that just became known).7 Even though the company appears to have disclosed the prior delinquencies once they became known, the SEC found that company made misstatements and failed to disclose failures to file on a timely basis to the extent required by Item 405.  Those misstatements and omissions centered on the company's statement that "all Section 16(a) filing requirements applicable to its Directors, executive officers and greater than 10 percent beneficial owners were complied with for the most recent fiscal year" when, in fact, during that year the company was required to (but did not) disclose that the officer had failed to file Section 16(a) reports.  As a result, the SEC found that the company failed to comply with its disclosure obligation to the extent required by Item 405 and violated Section 13(a) of the Exchange Act and Rule 13a-1 thereunder.8

Fourth, in proceedings against five other companies, the SEC concluded that while it "encourages the practice of many issuers to assist insiders in complying with Section 16(a) filing requirements, issuers who voluntarily accept certain responsibilities and then act negligently in the performance of those tasks may be liable as a cause of Section 16(a) violations by insiders."9 Although the Section 16(a) reporting obligation belongs to the individual officer, director or stockholder, many issuers have adopted "best practice" compliance programs to help officers and directors comply with their Section 16(a) reporting obligations.  These programs are not legally required but offer administrative and practical benefits, including helping to prevent inadvertent violations of Section 16(a) and potentially embarrassing disclosures required by Item 405.  This action suggests that when companies voluntarily have adopted such programs and officers and directors violate Section 16(a), the companies can be held liable.

Compliance Considerations

In the face of these enforcement actions, public companies should consider revisiting procedures relating to Section 16(a) reporting.  Actions that might be taken include:

1.    Review Section 16(a) Reporting Procedures.

The SEC has raised the stakes for issuers that help insiders file Section 16(a) reports.  Although the Section 16(a) filing obligation had traditionally been viewed as the officer or director's responsibility, the SEC's recent findings make clear that there is also legal risk to the issuer.

As a practical matter, it can be unrealistic to expect officers and directors to assume filing responsibility for Section 16(a) reports.  Particularly in connection with compensatory equity awards, insiders often have provided powers of attorney to company personnel to prepare and file forms on a timely basis.  Consideration should be given to the adequacy of the procedures by which the personnel who file the Section 16(a) reports can obtain timely information.  Personnel responsible for reporting, for example, should be kept informed about the dates on which the compensation committee or board will make equity awards so that they can file promptly following confirmation of the necessary approvals.  It can also be helpful to evaluate the nature of any routine equity awards, so that adequate form "templates" can be prepared in advance and then populated with the actual data.  For an insider who engages in open market transactions, a pre-clearance procedure, typically in conjunction with the insider trading policy, can be an invaluable tool to gather information. 

2.    Refresh compliance practices and trading policies.

An issuer should review its compliance programs and insider trading policy to see whether revisions might be appropriate.  An issuer's programs and policies cannot remain static. Programs and policies should be updated from time to time to address legal developments and take into account changes in the company's structure and operations.  For example, has the company adopted a policy relating to hedging of company stock by directors and officers?  Have covered persons read and reaffirmed adherence to the company's compliance programs?  There is not a "one size fits all" approach and the programs and policies must be tailored to fit the needs of the particular company.

3.    Clearly identify and appoint the Section 16(a) reporting officers.

For purposes of Section 16, the term "officer" includes the:

·        president,

·        principal financial officer,

·        principal accounting officer (or, if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division or function (such as sales, administration or finance),

·        any other officer who performs a policy-making function, or

·        any other person who performs similar policy-making functions for the issuer.

This definition is based largely on the definition of "executive officer" in Rule 3b-7 under the Exchange Act, except that unlike Rule 16a-1(f), Rule 3b-7 does not expressly include the principal accounting officer or the principal financial officer.

For many issuers, the principal financial officer also serves at the principal accounting officer.  In that situation, the issuer's "executive officers" will be the same group as the Section 16(a) reporting officers.  If the accounting role is separated from the principal financial officer role, then it is important to include the principal accounting officer or controller as a Section 16(a) reporting person.  As a consequence, the controller can be an "officer" for Section 16(a) purposes, but not an "executive officer" for whom other disclosures might be required.

In addition to the specific titles identified above, Rule 16a-1(f) includes persons who have no title but perform "significant policy-making functions."  As part of its review, an issuer should consider whether any other person plays a policy-making role.  The determination is based on all of the particular facts and circumstances but the SEC has stated that a "proper focus" in determining whether a person is an officer should be on whether the person performs important executive duties that likely would provide access to material nonpublic information.10

4.    Have the board of directors designate the Section 16(a) reporting officers.

A note to the definition of officer in Rule 16a-1(f) provides that persons designated by the issuer as executive officers under Item 401(b) of Regulation S-K are presumed to have been so designated by the board of directors and are presumed to be the only officers of the issuer subject to Section 16 (other than the principal financial officer and the principal accounting officer, if not designated as executive officers).  Accordingly, a person who does not otherwise fall within one of the enumerated titles above may be protected from liability under Section 16 if the board of directors specifically identifies the issuer's Section 16 officers on an annual basis.

  1. Five of the named five individuals also settled charges relating to the timely filing of beneficial ownership reports or amendments under Regulation 13D-G.

  2. Implications of Recent Developments in SEC Enforcement: A Six Month Review of Chairman Mary Jo White's Tenure (October 2013) and Recent Developments in SEC Enforcement: A Review of Mary Jo White's First Year (May 2014).

  3. Andrew J. Ceresney, Director of the SEC's Division of Enforcement, SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt Reporting of Transactions and Holdings (Sept. 10, 2014)


  4. In addition, a Form 3 must be filed on or before the effective date of the Section 12 registration of the class of equity security.

  5. In the Matter of Alan M. Schnaid, Release No. 34-73042, at 3 (Sept. 10, 2014).  Mr. Schnaid settled the proceedings without admitting or denying the SEC's findings.

  6. Release No. 34-73042, at *4.

  7. Ownership Reports and Trading by Officers, Directors and Principal Security Holders, SEC Release 34-28869 (Feb. 21, 1991); 17 C.F.R. § 229.405.

  8. In the Matter of Starwood Hotel & Resorts Worldwide, Inc., Release No. 34-73041 (Sept. 10, 2014).  Starwood settled the proceedings without admitting or denying the SEC's findings.

  9. See Press Release, supra note 3.

  10. See Release No. 34-28869, supra note, at 4.7.

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