Public Companies Take Note: SEC Launches Enforcement Initiative Targeting Section 16 and Other Shareholder Filings

The Securities and Exchange Commission (SEC) recently announced charges against 28 public company officers, directors and ten percent shareholders for repeated violations of federal securities laws requiring them to promptly disclose holdings and transactions in public company stock. The targeted insiders were not the only parties receiving SEC attention related to beneficial ownership disclosures—six publicly traded companies were also charged for contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies as required by SEC rules. All but one of the individuals and companies named in the enforcement orders reached settlements with the SEC, agreeing to pay financial penalties totaling $2.6 million. In a separate case announced the same day, the SEC charged a company and one of its former officers with negligence-based fraud for allegedly failing to report the officer’s sales in the company’s stock for several years, impacting numerous public filings made by the company. 

Beneficial Ownership Reports Involved

The SEC brought charges under two separate beneficial ownership reporting regimes contained in the Securities Exchange Act of 1934, as amended (Exchange Act): Section 16(a) and Section 13(d). Section 16(a) requires corporate officers, directors and ten percent shareholders (shareholders that beneficially own more than 10% of a registered class of a company’s equity securities) to disclose their beneficial ownership and transactions in those shares. These corporate insiders are required to file Form 3s when they become subject to Section 16 and file Form 4s or Form 5s when their beneficial ownership changes. Section 16(a) requires prompt disclosure—Form 3s are generally due 10 days after a person becomes subject to Section 16, and Form 4s are generally due within two business days following a transaction. Deferred reporting on Form 5 no later than 45 days after the end of the public company's fiscal year is permissible for certain transactions not required to be reported on Form 4 (such as gifts). The primary purpose of the reporting requirements of Section 16(a) is to facilitate the enforcement of the short-swing profit disgorgement requirements of Section 16(b). Corporate insiders, not public companies, are responsible for complying with Section 16(a)’s reporting requirements. However, Regulation S-K Item 405 requires public companies to annually review the Section 16 filings made by their directors, officers and ten percent beneficial owners and disclose to investors information about late or missing filings, including the corporate insider’s name, the number of late filings and transactions and any known failure to make a required filing.

Section 13(d) of the Exchange Act requires shareholders that beneficially own more than 5% of a registered class of a public company’s equity securities to file beneficial ownership reports on either Schedule 13D or Schedule 13G. Section 13(d) was added to the Exchange Act to protect investors by requiring disclosure in connection with the accumulation of significant blocks of publicly traded equity securities. Section 13(d) generally requires the filing of a Schedule 13D within ten days of the acquisition of more than 5% of a class of securities, unless the shareholder is eligible to file a short-form report on Schedule 13G. Schedule 13G is available to qualified institutional investors and certain “passive investors,” in each case so long as they have not acquired the securities to control or change the control of the company. Schedule 13G is also available to certain other “exempt investors,” such as an investor that acquired all of its securities in a company before the company registered its securities under the Exchange Act.

Typically, public companies assist their officers and directors in making their individual Section 16 filings, but do not assist significant shareholders with their filings. Although significant shareholders were targets in the recent SEC enforcement initiative, the charges filed against the six public companies related only to the late Section 16 filings by officers and directors and the company’s own failure to disclose such filings as required by SEC rules.

A New Area of SEC Attention and New Methods for Detecting Late Filers

Although historically beneficial ownership filings have not been an area of SEC enforcement attention, comments from SEC officials suggest this was not a one-time operation. Andrew Ceresney, the SEC’s director of enforcement, noted that this is an “area that we thought did have a need for additional focus,” adding that the Staff was “seeing compliance violations when we started to look at it.”

The widespread initiative was made possible by the SEC’s adoption of innovative investigative tools. SEC officials reported the use of sophisticated computer algorithms and quantitative data sources to identify beneficial owners who repeatedly missed filing deadlines for beneficial ownership reports. Notably, these new tactics allow the SEC to keep a watchful eye on a large population of corporate filers without draining Staff resources.

What Companies Can Do To Reduce Enforcement Risk

Given the SEC’s new-found attention to this area and adoption of hi-tech monitoring tactics, beneficial owners and their respective public companies face a growing risk of SEC enforcement action for the failure to timely file required disclosures. As Director Ceresney warned, “Officers, directors, major shareholders, and issuers should all take note: inadvertence is no defense to filing violations, and we will vigorously police these sorts of violations through streamlined actions.”

In response to this recent development, companies can take the following steps to reduce the risk of facing SEC enforcement related to beneficial ownership filings:

1. Review internal compliance policies and procedures regarding reporting of beneficial ownership and transactions in securities.
2. Review the historical operation of these policies and procedures in practice, including company assistance in reporting, and identify and remediate any problem areas.
3. Consider designating a company representative as the key person for coordinating Section 16 filings with a back-up representative as well.
4. Update director and officer questionnaires annually to ensure they adequately elicit all information required to be disclosed by SEC rules, including holdings and transactions in company securities, and include representations from the director or officer that he or she is not required to file a Form 5.
5. Periodically provide educational updates and reminders to corporate insiders of their obligations to report their transactions and holdings and the company’s policies and procedures for providing assistance in complying with these obligations.
6. Request that officers and directors place the company in direct contact with their brokers to ensure prompt notification by e-mail of any trades.
7. Ensure that the company has updated powers of attorney on file for company officials so that the company may make filings on their behalf in a timely manner.

If you have any questions about beneficial ownership filing requirements or if you would like to learn more about the issues covered in this alert, please contact your Smith Anderson Securities lawyer.