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INSIGHT: How to Stay SEC-Compliant After Virus Brings Bad Market News

April 14, 2020, 8:00 AM

Many public companies are facing a familiar problem after the market decline caused by the coronavirus pandemic: How to handle material nonpublic information when the company has bad news.

Bad news, especially at a time of general market uncertainty, presents a heightened risk that companies will run afoul of their obligations under Regulation Fair Disclosure (preventing selective disclosure) and that insiders will violate the insider trading laws.

These risks will be especially pronounced this earnings season, particularly given ongoing employee nervousness around Covid-19. As Securities and Exchange Commission Chairman Jay Clayton told CNBC March 30, “We’re going to have an earnings season that’s anything but typical.”

The SEC has already provided public companies conditional relief that enables them to delay their required filings in certain circumstances. Recognizing the unique risks presented by the crisis, the co-directors of the SEC’s Enforcement Division recently took the unusual step of issuing a statement emphasizing that the risks inherent in material nonpublic information are especially pronounced during the Covid-19 pandemic.

Unique Challenges of the Weeks Ahead

The existence of material nonpublic information poses two primary risks.

First, Regulation FD prohibits companies from disclosing inside information, either positive or negative, to brokers, analysts or holders of the company’s securities unless the information has previously been widely disseminated (or is promptly widely disseminated following an inadvertent disclosure).

Although the SEC does not bring cases under Regulation FD often, many of these cases have been based on allegations that a company used calls to analysts or investors to give these key constituents advance warning of the impending news.

A second risk that arises when undisclosed news will negatively impact the company, and therefore its share prices, is that corporate insiders will sell stock before the news is publicly announced. This risk is pronounced if an insider has a large stake in the company. When insiders trade right before disappointing news, the SEC (and Department of Justice) will not hesitate to investigate and, if appropriate, bring charges.

Unique features of the coronavirus pandemic will exacerbate the difficulties corporations already face in navigating these risks. This earnings season, as the co-directors of the SEC’s Enforcement Division noted in their statement, “corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances.” The value of the insider information will only go up if companies delay their earnings reports or required SEC filings.

The SEC also recognized that there is a risk that “a greater number of people may have access to material nonpublic information” given the current “dynamic circumstances.” With companies scrambling to adjust to fast and furious developments, nonpublic information (e.g., projected sales or cancelled contracts) is being disseminated throughout companies rapidly, widely, and in atypical ways (including in video conferences).

How to Avoid the Potential Pitfalls

The coming weeks present a high-stakes test of public companies’ ability to manage material nonpublic information and ensure a culture of compliance.

While the risks are somewhat mitigated by the fact that investors expect a heavy dose of disappointing news, the enforcement co-directors’ statement puts companies on notice that their conduct will be closely reviewed.

In meeting this challenge, companies should consider taking the following actions.

Emphasize Compliance With Existing Policies

The first step is to emphasize compliance with existing policies and message to employees the importance of compliance.

The co-directors’ statement urged public companies “to be mindful of their established disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD and selective disclosure prohibitions to ensure to the greatest extent possible that they protect against the improper dissemination and use of material nonpublic information.”

Keep Legal, Compliance Personnel in the Loop

A company would also be well served to ensure that the legal and compliance personnel responsible for enforcing their policies are kept in the loop on fast-developing information.

Although information may be widely disseminated at some companies, the ad hoc nature of communications during a crisis can lead to important people being left out of the loop. Public companies should ensure the personnel responsible for considering whether or not to pre-approve trades or to impose trading blackouts are aware of all relevant information.

Communicate Importance of Compliance

Depending on a public company’s situation, it should also consider taking additional steps to message the importance of compliance with these polices. For example, if unreported bad news is shared with a wider group than normal, the company should emphasize the company’s policies on insider trading and remind employees of the serious consequences associated with insider trading violations.

This emphasis could take the form of an impromptu training, a widely distributed reminder on the companies’ policies, or even a frequently asked questions document specifically tailored for these unique times.

Prevent Abuse of Rule 10b5-1 Plans

Finally, to the extent that a company permits its executives to enter into Rule 10b5-1 plans in order to dispose of stock when the executive might otherwise be prohibited from doing so, special care must be taken to make sure that such plans are not abused.

If used properly, such plans can allow insiders to create orderly mechanisms to liquidate a portion of their holdings that afford those insiders a safe harbor from liability and permit sales while they are in possession of material nonpublic information.

But such plans can bring scrutiny if they result in large dispositions shortly after a plan is implemented or when executives enter into frequent amendments to the plan. In addition, in times of volatility, it is particularly important that companies take steps to ensure that insiders are not in possession of material nonpublic information when entering into plans.

Although no company can eliminate the possibility of any violation, taking the right precautionary steps can reduce both the chance that a violation will occur and the consequences faced by the company for such a violation. Thus, to the extent that companies redouble their efforts at compliance, this will help them meet the challenges of this unique earnings season and position them well even after the current pandemic passes.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Charles D. Riely, a partner in Jenner & Block’s Investigations, Compliance and Defense Practice, is a former assistant regional director for the Division of Enforcement for the SEC with significant experience in all aspects of the federal securities laws.

Reid J. Schar is co-chair of the firm’s Investigations, Compliance and Defense Practice and represents clients in a variety of complex commercial litigation and securities-related matters.

Jeffrey R. Shuman, a partner in the firm’s Corporate and Securities Practice, advises clients with respect to a variety of types of public and private securities offerings.

The authors would like to thank Allison N. Douglis, a Jenner & Block associate, for her contributions to this article.