I’ve followed the topic of insider trading over many seasons and SEC enforcement actions, and the one thing that I probably find most fascinating is the “who” becomes entangled in trading violations.
In a recent episode of Bloomberg Law’s podcast ("Why Insider Trading Ensnares Them All,") Wayne State University Law School professor Peter Henning discussed how insider trading seems to entrap those who should know better. It’s a theme I have noticed over and over again - which raises a simple question - why do seemingly smart and successful people take the bait to trade on inside information when they know they shouldn’t? Think about it – recent high profile cases involve a U.S. congressman, a legendary Vegas gambler, and a former NYU business school student body president.
In a prior blog, I assumed the stance that the allure of insider trading is simply too much to overcome for some people, and that the greed aspects of human nature make it highly unlikely that insider trading will ever become a non-concern. I maintain that position, and find it congruent with Henning’s views as well. He describes a simple scenario – many insider trading cases stem from a situation where someone simply stumbles upon material non-public information and either uses it for their own benefit or passes it along to someone else. The thought of being in possession of valuable information that can lead one to avoid losing money is too much for some folks to overlook acting upon, even though it’s illegal. In many of these situations, the resulting trades aren’t life changing. There have been multiple stories of insider trading scenarios where gains (or avoided losses) were $100,000 or less. Sure - that’s some nice money. However, it’s not likely to dramatically alter the course of someone's financial future. Henning asks the question – “Would you sell your career for $100,000?” Most people wouldn’t, and yet in deciding to trade on inside information, that’s exactly what those folks are essentially doing. The threat of prosecution, jail time, and financial penalties isn’t quite enough in some cases to avoid selling out one’s career and face hefty consequences.
This brings us to the question of what can we really do to minimize the potential for insider trading? I recently came across an excellent article on this topic – “Practical Advice for Evaluating Insider Trading Compliance Programs in Light of Recent Cybersecurity Events and SEC Guidance” by law firm King and Spalding. This resource is loaded with practical advice on not only how to understand the goals of the company’s insider trading policy, but to ensure that both management and the board are aligned in supporting the philosophy behind the company’s insider trading compliance program. In addition, evaluating your company’s existing compliance practices against modern best practices is highly recommended. In particular, here are some things King and Spalding recommend:
Windows. Is the timing for opening and closing the quarterly window in connection with earnings still consistent with the timing of financial information becoming available internally? For example, has the company implemented a new internal reporting system that provides better visibility into its quarterly results earlier in the quarter? Has the list of insiders who have regular access to financial information changed?
Trading groups. Are you comfortable with how employees, officers and directors are categorized between the group subject to pre-clearance and windows, the group subject to windows but no pre-clearance and the group restricted only when in possession of MNPI? For example, have you added personnel to your legal, finance, accounting, IR or IT functions that are privy to information that historically had only been available to officers who are subject to pre-clearance?
Pre-clearance. Does your policy reflect actual practice for obtaining pre-clearance and is responsibility for preclearance in the right hands? For example, should the company consider a committee approach to pre-clearance instead of designating one individual? What documentation and recordkeeping requirements are imposed for preclearance requests? —
New means of communications, security ownership or financial instruments. Have there been developments in channels of communications or types of security ownership and financial instruments that should be expressly referenced in the policy? For example, does the policy adequately address the interplay between consumer engagement through the internet and social media channels, on the one hand, and unauthorized disclosure of MNPI and “tipping,” on the other hand? —
Relationships with Third Parties. Insider trading compliance policies typically touch other companies in two respects. First, company employees should be prohibited from trading on the basis of MNPI relating to other public companies that they obtain during the course of their work for the company. Second, policies often contain kslaw.com 5 CLIENT ALERT provisions calling on company employees to arrange for agreements with third party vendors, consultants and contractors, prohibiting these third parties from trading in company securities or disclosing MNPI. In view of new approaches to collaboration and the increased sharing of information with people outside of the company, the company may wish to consider its coverage of such third parties. —
Recurring questions. Whenever a company updates its policy, it should consider the types of recurring questions asked by employees, officers and directors. Addressing these issues in the policy should provide clarity for the workforce, improve consistency and reduce the burden of administering the program.
Lastly, putting together a strong insider trading compliance program is only part of the equation, and perhaps the easiest part. The administration of a compliance program can be the most challenging part of managing trades by insiders. There are too many tips to list in today’s blog (I highly encourage a read of the King and Spading article for more administration information), but I’ll leave you with some their recommendations on things to consider from an administration angle:
Establish processes for adding and removing individuals from pre-clearance and window groups, as well as for periodically confirming that the approach to classification is appropriate
Craft succinct communications for the opening and closing of windows, expected trading calendars, reminders, special blackouts etc.
Consider whether the company should obtain periodic certifications of compliance from employees, officers and directors, as well as certifications when an insider trades within a window or requests pre-clearance
Ensure that the company has proper recordkeeping for its insider trading compliance program, and consider what the records would show if the company were required to produce its records in an enforcement proceeding
Consider whether there are metrics that suggest insiders either are or are not complying with the company’s policy. Do the numbers of inquiries about the policy or requests for pre-clearance suggest that insiders are complying with the policy?
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