28 January 2019
There is widespread agreement that illegal insider trading has a much broader effect than any single criminal transaction may imply. Illegal insider trading can ultimately undermine investor confidence in the fairness and integrity of the entire marketplace, dissuading non-insiders from wanting to join what seems like a rigged game. The Securities and Exchange Commission (SEC) holds this position strongly and has made the detection and prosecution of illegal insider trading one of its top priorities.
In response to the dangers inherent in illegal insider trading, the SEC requires corporations to file insider reports. An insider report presents all transactions in the shares of a company made by officers, directors and individuals holding 10% or more of the company’s stock. These reports are submitted each month to the SEC so as to allow administrators the opportunity to monitor the trades placed by company insiders and to gauge whether these trades seem to have been made with material, nonpublic information. Ultimately, the SEC makes this information available to the public. These reports may also serve as the basis for investigations involving ownership issues.
According to the SEC, officers who must file these reports include: the president, principal financial officer, principal accounting officer or controller; the vice president of any principal business unit, division or function; and any officer or person who performs policy-making decisions for the company.
Insider Trading Reporting Is Just the Beginning
In many corporations, insider trading reporting is just one facet of a much larger insider trading compliance program. While such programs are not specifically required for public companies that are not broker-dealers or investment advisers, following the many insider trading scandals of the 1980s and the passage of the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), insider trading compliance programs have become de rigueur, and for good reason.
Under the regulations set forth by the ITSFEA, “controlling persons” may be liable for three times the damages caused by insider trades if such persons fail to take appropriate steps to prevent illegal activity. Controlling persons may be considered corporate officers and other executive decision-makers. So, in effect, this law throws the responsibility for insider trading back on the organization as a whole, making it part of the company’s duty to provide an environment in which insider trading is discouraged, both through policy and enforcement. In the eyes of the U.S. Justice Department, the presence of an effective trading compliance program will likely impact its decision to prosecute organizations for the illegal activity of their employees.
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Impact of Insider Trading Reporting
According to King & Spalding, establishing a clear and comprehensive insider trading compliance program has three immediate effects for an organization.
- Protection for the Company and Other Controlling Persons. Creating an environment in which legal insider trading is reported accordingly and any illegal trading is discouraged in as many ways as possible can help protect corporate officers from being connected to any illegal actions taken by their employees. An effective compliance program will not only make it more unlikely that illegal activity occurs, it can reduce the exposure for the company and help reduce the cost and distraction of an investigation should an illegal trade take place.
- Protection for the Company’s Workforce. A well-maintained compliance program can help to educate the broader workforce so that each employee understands his or her responsibility if they come into possession of material, nonpublic information. At the same time, employees can be confident in knowing that they are free to trade their own shares of the company in a legal manner without becoming the subject of a criminal investigation.
- Protection of the Company’s Reputation. Any time a company, one of its officers or one of its employees becomes involved in illegal activity, the company’s reputation is at stake. Potential clients or investors may pass on working with that company so as to avoid the stain of criminal intent. Defending against this sort of damage, or trying to win back customers or investors, is often an expensive and time-consuming endeavor.
In addition to the mandatory insider trading reports, industry experts suggest the following steps for establishing a robust trading compliance initiative:
Present a clear and comprehensive company policy. As noted above, these policies are not mandatory, but no publicly traded organization should be without one. Policies should focus on governing all trades by employees, officers, directors and anyone else who might be in possession of material, nonpublic information.
Take measures to monitor trades during times of market sensitivity.
Today, many entity management services offer technology that makes it possible for companies to keep tabs on trades in light of particular changes in the market. Such monitoring applications can be customized and automated, such that they will record the details of all transactions made in response to a specific set of triggers. The presence of such monitoring services not only dissuades would-be cheaters from trying to work the system, they make investigating such actions much less time-consuming and onerous.
Establish pre-clearance requirements and blackout dates for trades.
Pre-clearance requirements would mandate that certain employees would need to seek pre-approval from corporate officers in order to trade company stock. Employees who should be subject to such requirements are all employees who, in the course of their duties, come into possession of material, nonpublic information. The pre-clearance process would make it possible for the company to block a sale if the officers determined that the sale was being influenced by the nonpublic information.
In addition to pre-clearance requirements, organizations should set up general blackout dates for company insiders. Such blackout dates might include dates up to 30 days before the end of the quarter and up to two days after the quarter’s end. This would prevent insiders from profiting on any knowledge of quarterly earnings reports. Such pre-clearance requirements and blackout dates can further bolster the protection of corporate officers and the company at large as they lessen the likelihood of inadvertent insider trading and allow companies access to real-time information on the activities of their corporate insiders.
Develop a Comprehensive Compliance Program
The insider trading report is an important first step in safeguarding an organization against the dangers of illegal insider trading. To ensure further protection, organizations should establish a comprehensive insider compliance program. For more information about how entity management can aid in this endeavor, contact a Blueprint representative. We’re always looking to help.