It is easy to become complacent about Section 16 reporting. Sometimes it seems that the only people paying any attention to Forms 3, 4 and 5 are plaintiffs’ attorneys looking for short-swing profit transactions. Does the SEC even notice, or care, if the reports themselves are filed or are late? Isn’t it enough to simply disclose the late filings in the Company’s next proxy statement (pursuant to Item 405)? And anyway, isn’t this the insider’s, rather than the company’s, responsibility?
Recent enforcement actions against three directors for Section 16 violations serves as a reminder that the SEC is, in fact, watching.
SEC enforcement actions.
Last month, the SEC brought enforcement actions against three executives of Medient Studios, Inc. and later Moon River Studios, Inc., alleging that they schemed to make false and misleading statements in press releases and company filings regarding progress toward completing a “studioplex.” The SEC also alleged unjust enrichment and misappropriation of company funds.
At the same time, the SEC charged three of the company’s directors with failing to timely report transactions in company stock in accordance with Section 16. According to the SEC, two of the directors were significantly late in filing Forms 3 and 4, and one of the directors never filed at all.
The most interesting aspect of the actions against the directors is the SEC’s acknowledgement that they were not in any way involved in the alleged fraud by the executives. In other words, the SEC decided to bring administrative actions against the directors solely for violating Section 16. The two late-filing directors received cease and desist orders and civil penalties in the amount of $25,000 each. The non-reporting director remains subject to a public hearing as to his alleged violations.
Company liability for Section 16 violations.
You may recall that back in 2014, the SEC announced charges against six public companies for contributing to their insiders’ failure to properly file Form 4s or for violating the Item 405 proxy disclosure requirements for late insider filings. In addition to issuing cease-and-desist orders, the SEC imposed fines ranging from $75,000 to $150,000 per company.
As highlighted in this Doug’s Note, this was newsworthy because:
- The SEC’s charges seemed to kick off the SEC staff’s use of “quantitative data sources and ranking algorithms” to root out repeat Section 16 offenders and impose penalties.
- It was likely the first time the SEC held a company responsible for an insider’s Section 16 reporting. Noting that it is common practice among companies to prepare and file these reports for their insiders, some of the orders stated that the company caused the violations due to its negligence in performing filing-related tasks it had voluntarily agreed to do.
- Item 405 requires specific proxy statement disclosure of any late filing or non-filing of Forms 3, 4 or 5 known to the company based on its review of its insiders’ filings. The orders emphasized that boilerplate disclosure based on inadequate due diligence or non-specific disclosure (for example, “some of our insiders filed late”) does not pass muster.
What does this mean?
Companies may derive some comfort from the fact that virtually all SEC Section 16 enforcement actions involved egregious violations, rather than occasional oversights. Nevertheless, it is good to be reminded from time to time of the importance of effective Section 16 reporting and proxy disclosure processes.
As I noted before:
- Companies should periodically confirm that their compliance programs include effective preparation and filing of insider stock ownership reports.
- Insiders should be regularly reminded of the importance of timely and accurate report filing and of the possibility of individual liability.
- Be sure that your proxy statement preparation process includes a review of insider EDGAR filings in order to catch obvious filing violations.
- Update the company’s list of Section 16 insiders at least annually to be sure it reflects any changes in management structure, and be sure to notify all such persons that they are on that list.