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Tips for Preclearing Insider Trades

  • July 28, 2016

Insider trading policies are among the most detailed and confusing of all corporate polices. And though they are not required by any SEC or stock exchange rule, virtually every public company has one. Included in almost every policy is a “preclearance” provision, which requires designated persons to obtain approval prior to trading in the company’s stock.

The preclearance provision may be the most important section of an insider trading policy; it may also generate the most questions and cause the most heartburn. Its most significant benefit is the ability it gives a company to control the trading and reporting of its insiders, which would otherwise be outside of the company’s oversight or influence. Without preclearance, for example, a company might not otherwise be aware of a trade until the insider files a Form 4 two business days after a violation may have occurred.

Although liability for improper short-swing profits, inaccurate Section 16 reporting and illegal insider trading is primarily the insider’s problem, companies also can be liable in certain circumstances for the actions of persons “controlled” by the company and, in some cases, by being deemed to have aided and abetted the insider’s conduct. In fact, these are the types of concerns that gave rise to insider trading policies in the first place. Companies (and designated “preclearers”) also may wonder whether involvement in an insider’s trade via the preclearance process increases this type of exposure if things go bad.

The good news is that an effectively drafted and implemented preclearance provision should mitigate liability concerns. Consider the following tips:

  • Be sure the insider trading policy itself states clearly that all trading and related reporting obligations are those of the individual, not the company, and that the company assumes no liability in that regard, including if a trade is precleared or if preclearance is denied.
  • Use the preclearance process as an opportunity to confirm that a Form 4 is prepared correctly and is filed on time. While this is the insider’s responsibility, most companies “assist” in the process to be sure their insiders remain fully compliant with their reporting obligations. It’s also an opportunity to catch potential short-swing profit issues before they happen and thereby avoid the inevitable “profit disgorgement” demand from lawyers who monitor such transactions.
  • Establish a procedure to clearly define or identify the persons subject to preclearance. Executive officers and directors should be included, of course, but how far to expand the list is less clear. Typically, companies include other employees with routine access to material non-public information, which varies widely from company to company. Special circumstances (for example, a business combination) may warrant adding other employees on a temporary basis.
  • Once the list is established, be sure the people on it are aware of their (and their immediate family members’ and controlled entities’) preclearance obligation. Don’t assume they have carefully read the policy or, if they have, will remember to ask. Direct communication and annual reminders are a good practice.
  • Update the list of covered insiders at least annually to reflect changes in personnel and corporate structure.
  • Select an appropriate “preclearer.” While that is often the general counsel, it may instead be the chief compliance officer or another senior executive. It is important that the preclearer be in a position to know whether material non-public information exists and to understand the legal issues (reporting, liability and company reputation/optics) triggered by a potential trade. The person’s title is less relevant than his or her ability to effectively perform the policy’s preclearance duties. It is also a good idea to designate an alternate in case the primary preclearer is unavailable.
  • Once a trade has been precleared, impose a narrow window for its actual execution. Again, there is no set rule or widely accepted practice on how quickly the trade must occur. Timing may vary according the size and complexity of the company, the time of year and other specific circumstances. In most cases, two or three days should be enough, and rarely more than a week.