Shedding Light on Blackout Periods
Public Company Forum: Summer 2012
July 26, 2012
It is no secret that federal agencies are pursuing insider trading violations with much greater frequency and vigor than in years past. The unpleasant consequences of insider trading, such as damage to a company’s reputation, loss of business and increased legal costs, have driven compliance professionals and legal counsel to re-examine some of the more common components of insider trading policies.
Blackout periods, which are designed to prevent trading in a company’s securities by insiders when they are most likely to possess material non-public information, are a universal feature of insider trading policies. In this article, we revisit blackout period basics, provide some practical tips for their design and implementation and clarify some common points of confusion.
What are the blackout period basics?
Two types of blackout periods are generally found in insider trading policies:
- Quarterly. Pre-established, routine periods associated with a company’s quarterly release of financial results. Designed to keep insiders out of the market at times when they are most likely to be in possession of earnings information, the quarterly blackout period limits trading to times when the market is best informed about the company's financial performance.
- Event-Specific. Blackout periods that are established in connection with non-routine events outside of the financial reporting cycle. These events may include consideration of major strategic transactions (e.g., acquisitions, dispositions, joint ventures), product developments, interim earnings or sales releases, significant legal proceedings and other circumstances that potentially implicate material non-public information.
What should you consider as you review your policy’s blackout period provisions?
Designated Insiders. Review the list of individuals who are subject to quarterly blackout periods. The list should include directors, officers and any employees or associates with regular access to the material non-public information that may be incorporated into the company’s quarterly releases and reports. If it is difficult to determine exactly who those individuals are, it may be prudent to extend quarterly blackout periods to a broader group (e.g., all finance, accounting, internal audit, legal and tax personnel).
Remember that blackout periods protect your valued employees from inadvertent violations, so building a list conservatively and casting a wider net is often prudent. Also, companies should contemplate providing express authority to the policy’s administrator to add or subtract individuals from the quarterly blackout group, as appropriate, to adjust for specific circumstances (e.g., reorganization or restructuring of management, departments or processes).
Length of Blackout Period. The timing of quarterly blackout periods will vary by company based on fiscal quarter-ends and the internal audit process. However, the objective is to begin the blackout period when the company’s quarterly earnings are likely to be sufficiently certain that they could be considered material non-public information and end when the company’s financial results have been fully absorbed by the market. The beginning of the blackout period can range anywhere from 30 days before the end of the quarter to a day or two after the end of the quarter.
When setting your blackout period, be mindful of your internal processes. Based on your business operations, how quickly is quarterly financial information collected? How widely are preliminary results circulated internally? If information is collected relatively quickly or distributed to a wide working group, an earlier blackout period start is best. When looking at timing of quarterly periods you should consider that, although insiders would naturally favor shorter blackout periods to avoid unnecessary limitations on their ability to trade, a longer period provides the company and insiders with more protection from liability and negative market perceptions.
Public Dissemination. A blackout period should end only after information has been publicly released and the securities markets have the opportunity to fully absorb the information. This is typically referred to as “public dissemination.” Although it is a facts and circumstances analysis based on how quickly information released by a company will penetrate the market, the general rule of thumb is that information has been publicly disseminated after two full trading days following release. However, we note that the recent trend for large, widely-followed companies is to open the quarterly trading window after only one full trading day since the market would likely absorb information from such a company more quickly.
Note that, whatever number of trading days you choose, the window would not open until the next trading day due to the existence of after-market trading. For example, if your company’s blackout period ends two trading days after release of the material information, the trading window would open on the third trading day after the release.
Exceptions. Think about whether to provide for exceptions to blackout periods upon the written approval of the policy administrator. This may be useful in addressing unforeseen circumstances. However, before approving an exception the policy administrator would need to be confident that the insider did not possess material non-public information and that the exception would not create a perception of noncompliance. In any case, allowing for exceptions could become problematic if permission is seen as too readily available or if it is difficult for the policy administrator to manage from a political perspective.
What are some general blackout gotchas?
Open Window Comfort. Beware of trading comfort when blackout periods end. Even where there is an open window, individuals may not trade while in possession of material non-public information. A common feature of insider trading policies is to require pre-clearance of trades by certain insiders (directors, executive officers and key personnel) regardless of whether the window is open. In this case, before a trade is cleared the policy administrator should confirm that the insider is not in possession of material non-public information. With regard to those individuals that are not subject to pre-clearance but are subject to the policy, and possibly to blackout periods, regular training sessions should emphasize the point that open windows should not lull employees into a false sense of security when trading and that they should always be mindful of their possession of material non-public information or the perception that they have such information.
10b5-1 Plans. Rule 10b5-1 plans allow insiders to make trades pursuant to a preset schedule set forth in the plans and, accordingly, provide them with an affirmative defense to a claim of insider trading. Trades under Rule 10b5-1 plans are not subject to blackout periods. The SEC has noted that insiders may be misusing Rule 10b5-1 plans by entering into, amending and cancelling the plans on short notice, thereby effectively trading on inside information. Consider whether your insider trading policy should prohibit the entrance into or amendment or cancellation of a Rule 10b5-1 plan during a blackout period. If it does not, be wary of any such change to a 10b5-1 plan during a blackout since the insider is prohibited from having material non-public information at the time of any such change.
Certain Transactions. If your insider trading policy does not prohibit company securities from being held in a margin account as collateral for a margin loan or pledged as collateral for a loan, the policy administrator should be mindful of these transactions as an insider has no control over the timing of sales. For instance, company securities held on margin may be sold by a broker without the insider’s consent during a blackout period if the insider fails to meet a margin call. Securities pledged as collateral for a loan may be sold in foreclosure during a blackout period if the insider defaults on the loan. At a minimum, companies should consider instituting a policy requiring insiders wishing to engage in such a transaction to prove their financial capacity to repay the loans without resorting to the sale of company securities.
Similarly, standing and limit orders create heightened risks for insider trading violations since there is no control over the timing of purchases or sales that result from standing instructions to a broker and the broker could therefore execute a transaction during a blackout period. Accordingly, companies should discourage such orders and, in the rare case where such a transaction will be effected, encourage the insider to limit the order to a short duration.