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Insiders and Companies Face Securities Law Violations for Failure to Timely File Reports of Transactions and Holdings in Company Stock

September 24, 2014
Harter Secrest & Emery LLP

Officers, directors, major shareholders and issuers pay penalties totaling $2.6 million to settle with the SEC.

In a sweeping enforcement initiative, the Securities and Exchange Commission this month announced charges against 34 individuals and companies for failure to comply with the reporting requirements relating to beneficial ownership of company stock. All but one of those charged agreed to settle with the SEC without admitting or denying the charges in exchange for the payment of penalties. The SEC uncovered the violations using quantitative analytics to identify filing deficiencies in the beneficial ownership reports required by Section 16(a) and Section 13(d) or (g) of the Securities Exchange Act of 1934. Historically, enforcement in these areas has been scant, so the recent charges serve as a forceful reminder to insiders and their companies: even inadvertent deficiencies in filing are violations that can result in enforcement and penalties.

Section 16(a)

Officers and directors should be familiar with Section 16(a) of the Exchange Act, which requires them to file reports on Forms 3, 4 and 5. Certain holders of more than 10% of a class of registered stock must also file these reports under Section 16(a). These insiders must report beneficial ownership in company stock on Form 3 within 10 days after becoming an insider, and must report transactions resulting in changes to beneficial ownership within two business days on Form 4. In addition, insiders must file a Form 5 within 45 days after a company’s fiscal year-end to report any transactions or holdings that should have been reported on Forms 3 or 4 during the company’s fiscal year or that were eligible for deferred filing. The two-business day filing deadline for Form 4 is tight. Although companies typically file the Forms 4 on behalf of officers and directors, the filings are the individuals’ obligations. In the current enforcement actions, some of the insiders asserted that they had in fact timely reported the transactions to the company, but the company had neglected to timely file on their behalves. This excuse did not hold up as the SEC reiterated that “an insider retains legal responsibility for compliance with the filing requirements, including the obligation to assure that the filing is timely and accurately made.” Each of the officers and directors named in the SEC orders paid penalties of up to $100,000 to settle the charges.

Although technically the Section 16(a) reporting requirements are obligations of the officers and directors, companies have an interest in overseeing insider transactions. Item 405 of Regulation S-K requires companies to report any late filings of insiders within the prior two fiscal years in their annual meeting proxy statements and annual reports on Form 10-K. In addition, the recent SEC orders implicated publicly-traded companies both for failing to report these filing deficiencies as required and also for contributing to the filing failures of their insiders for making late filings after voluntarily undertaking to file the reports on their insiders’ behalves.

Section 13(d) and (g)

Beneficial owners of greater than 5% of a registered class of a company’s stock must file reports on Schedules 13D or 13G to report their holdings and intentions with respect to the company’s stock. Holders must report acquisitions within 10 days after purchase, and material changes require filers to make prompt amendments. The SEC charged seven investment firms and eight individual beneficial owners with violations of Section 13(d) and (g).

Next Steps

Companies and their insiders should review their disclosure controls and procedures regarding Section 16(a) filings. Timely communication is critical to meeting the filing deadlines. Companies and their insiders must also understand the types of transactions that trigger the filings. Common transactions include purchases or sales, conversions or exercises of derivative securities and compensatory awards of securities from the company. However, the reporting of some events is less straight-forward, and can involve significant analysis to ensure that reports are both accurate and timely. Thus, companies should maintain a close relationship with counsel who is well-versed in Section 16 matters. Companies also may wish to conduct training for insiders and those within the company who are responsible for filing the reports and/or communicating with counsel. Periodically and upon the hiring or promotion of officers, companies should review and confirm which officers are insiders as defined by Exchange Act Rule 16a-1(f). In addition, companies should carefully review their director and officer questionnaires, as well as the responses thereto, to help ensure that reportable information for Form 5 does not fall through the cracks. Officers and directors should be aware of the importance of thoughtfully approaching these questionnaires, and should be encouraged to bring questions and concerns to the attention of counsel.

Looking Ahead

With this recent enforcement initiative, the SEC has signaled that it is willing to pursue enforcement even for violations involving no fraudulent intent and for which the SEC has not typically flexed its enforcement muscles. The SEC’s actions are consistent with the “broken windows” enforcement policy that Chair Mary Jo White has articulated over the past year, under which the SEC will pursue seemingly minor violations. In addition, look for the SEC and outside parties to continue to leverage technology to identify and investigate securities law violations. Insiders and companies are well advised to stay on top of all disclosure requirements to avoid the increasingly sophisticated scrutiny of the SEC and other watchdogs.

If you have questions about his LEGALcurrents® or require assistance with compliance with Section 16(a) or Section 13(d) and (g), please contact a member of our Securities practice group at (585) 232-6500.

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