The NASPP Blog

In late September, the SEC announced enforcement actions against dozens of companies and their insiders for failures and violations of Section 16 and Item 405 of Regulation S-K (see the blog entry: SEC Enforcement Actions for Section 16 Reporting Violations). At that time, I recapped “what” had happened, but didn’t have all the details about the “why” (what triggered the SEC actions). Now, as more is known about the practices that brought the scrutiny, it’s time to look at processes in this area to minimize your company’s risk. Alan Dye and Peter Romeo addressed this topic in their session “Section 16 & Insider Considerations in Today’s Market” at this year’s NASPP Annual Conference (definitely worth a listen to the audio if you want to hear more of their opinions and insights). In today’s blog I’ll catch you up on some of the key things to know about the SEC’s renewed interest in these disclosures.

Low Hanging Fruit

Prior to the recent actions, the SEC was basically dormant for the past 12 years in pursuing stand alone enforcement actions for Section 16(a) and Item 405 violations. We can speculate as to why scrutiny in this area was in hibernation for so long, but at the end of the day it doesn’t really matter. What matters is that technology has advanced – a lot – in recent years. Tracking trading activity, comparing multiple types of data from different sources, and overall monitoring has become more sophisticated and easier for the SEC. With these advancements, it’s become simple to track Section 16(a) filings and analyze that data. So if you’ve been thinking that the enforcement actions in this area may have been a one shot deal, think again. Untimely or missing filings are now easily exposed, and have become low hanging fruit for the SEC. The message: take compliance seriously.

No Excuses!

Many of us come from a practical mindset. That mindset may have us thinking that sometimes oversights occur, and there was no mal intent involved. After all, we are human, and humans aren’t perfect. Makes sense, right? It does make sense, but don’t count on that thought process buying freedom from SEC penalties. One insider subject to the recent actions was never notified by his company that he was subject to Section 16 reporting (case of Alan Schnaid, corporate controller for Starwood Hotels), and filings were not made on his behalf for several years. The company and the insider both were in agreement on the facts pertaining to this oversight. One may think that the SEC may have forgiven the insider for not filing Section 16 Forms, since he was not informed. They did not. He was personally fined $25,000 for failing to file timely Forms 3 and 4 and also was subject to a cease and desist order.

If you have occasional Section 16 reporting violations, you are not alone. It’s said that approximately 48% of Russell 3000 companies have had at least one late filing each year. Clearly oversights happen. However, the SEC reiterated that “the failure to timely file a required report, even if inadvertent, constitutes a violation.” The message here is to drop the complacency and step up compliance practices. If your insiders have occasional or repeated violations, review the processes involved and make changes. Even an inadvertent or occasional violation can bring SEC sanctions.

Gray Area

There is at least one gray area when it comes to Item 405 disclosures. Alan Dye and Peter Romeo suggested that this is an area where practice and advice differ more than any other area of Section 16, and more guidance from the SEC is needed. People often ask things like whether a correction to a previously timely filed Form 4 needs to be disclosed under Item 405.  There is no uniform answer to that question. Some counsel may guide companies to disclose the corrected Form 4 as late, since the initial filing did not have the complete picture. Others may arrive at the conclusion that disclosure is not required, since the original Form 4 was filed timely. When in doubt, talk to your counsel. Whatever practice is adopted, you’ll want to be consistent.

Think Outside the Box

Often late filings can be triggered by out of the box scenarios. Some of them include situations where the Section 16 reporting insider’s beneficial ownership changes. For example, the insider marries an employee (and now the new spouses’ company stock holdings are also counted as part of the insider’s beneficial ownership). Or, the insider was trustee of the family trust, but is no longer the trustee (thus the beneficial ownership in the trust may no longer be associated to the insider). There are many scenarios where simple life changes can trigger reportable Section 16 transactions. It would be best to brainstorm some of these possibilities internally and with counsel to determine proactive monitoring processes for these situations in order to avoid late or missed Section 16 filings.

I’d love to hope that we’ve seen the last of enforcement actions in this area, but it’s more likely that’s not the case. It’s time to take a look at Section 16 reporting practices to ensure the maximum effort is expended to avoid incorrect or late filings.

-Jennifer