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Stock Compensation Meets SecuritiesLaws: Keeping Executives and EmployeesOut of Jail
Bruce Brumberg, [email protected]
Sue Morgan, Perkins Coie [email protected]
WorldatWork 48th Annual ConferenceMay 12, 2003 San Diego
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All the financial scandals involve securities lawviolations and sales of stock by insiders. The stock
sold, either from options or restricted share grants, orfounders stock, was often part of equity compensation.
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Topics to Keep Your Execs and
Employees Out of Trouble Insider Trading
Rule 10b5-1 Plans
Section 16 Sarbanes-Oxley Act:
CEO/CFO Certifications of SEC Filings;
Executive Loans; Pension Plan Blackouts;Non-Audit Services
Other CurrentIssues
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The investigations,stories and accusations
continue.
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Will ads for insider trading lawyers crowd outads for personal injury and medical malpractice
lawyers?
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What is insider trading?
You know material confidential information abouta public company (whether your company oranother company).
You trade on that information or tip others aboutit before the information is released publicly.
Insider Trading
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Insider Trading
Civil Penalties: any profit made or loss avoidedand penalty of up to three times this amount.Bar for serving as D&O of public company.
Individuals face up to 25 years in prison forsecurities fraud and fines of up to $1 million.Mail and wire fraud, tax evasion andobstruction of justice. Corporations face
penalties. Controlling persons liability for managers
New disgorgement penalty for restatements
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Insider Trading
Material information: news that canaffect a companys stock price,
for better or worseThis includes knowledge of:
takeover accounting problems dividend change blockbuster product earnings better or worse than
expected
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Insider Trading
MYTHsOnly a companys insiders or employees can commit insider
trading. Need to trade and be caught in the act.
TRUTHs The law applies to anyone who knows material nonpublic
information at the time of the trade or tip
Applies to trades of stock in customers, suppliers, clients
Tipping, even without the tipper trading, is illegal Most cases based on circumstantial evidence
These rules are separate from the Section 16 rules forsenior executives and directors
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Insider Trading
The ImClone case
What is the material nonpublic information and whendoes it become public?
Senior executives sell; CEOs family members sell
Martha Stewart: What did she know? When did sheknow it? Who gave her information?
What constituted obstruction of justice and falsestatements to government investigators?
Can brokers use information that senior executives arebuying or selling? Check your plan providers rules.
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Insider Trading
How does insider tradingapply to stock options?
Grant or exercise of stock options is not atrade
Cashless exercise/same-day sale raisesquestions of insider trading
Rules apply during post-termination exerciseperiod
Rules also apply to company stock in 401(k)
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Insider Trading
Insider trading harms the goals ofemployee ownership
Employee ownership culture encourages information-sharingand boasting about company.
Even well-intentioned actions can be illegal.
Destroys the financial link between employees andshareholders. Damages reputation of equity compensation.
Investors interpret insider trading investigation as sign thatcompany has undisclosed financial or accounting troubles.
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Insider Trading
Prevention Procedures
Blackout Periods vs. Quarterly TradingWindows
Pre-clearance for Senior Executives andDirectors. Rule 10b5-1 plans as defense.
Ongoing Education: Seminars, Videos (e.g.,Think Twice), Reminders, Press Clippings
Substantive prevention efforts, internalinvestigations and cooperation with SECand DOJ can reduce corporate liability
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For more detailsand questions oninsider trading,see Articles and
FAQs onmyStockOptions
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10b5-1 Plans What are Rule 10b5-1 trading plans?
How they help
How they work
FAQs
How you can help implement
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10b5-1 Plans How 10b5-1 plans help
Permit advance planning for orderly dispositionor to meet special needs
Sales can take place even when insiders areaware of material nonpublic information
Companies can manage public perception ofinsiders sales
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10b5-1 Plans How 10b5-1 plans work
Provide an affirmative defense against insidertrading claims if
When not aware of the inside information, theinsider must
Enter into a contract to sell (or purchase),
Instruct another person to sell for the insiders
account, or
Adopt a written plan for trading securities
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10b5-1 Plans The written trading plan must
Specify amount, price and date of sales,
Provide formula, algorithm or computerprogram for determining amounts, pricesand dates, or
Not permit the insider to exercise any
subsequent influence over how, when orwhether to effect the sales
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10b5-1 Plans Whose plan is it?
Agreement between insider and broker
Brokers usually supply form Company should review
To avoid controlling person liability
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10b5-1 Plans When should the plan be signed?
Generally, during a window period
When should sales start?
Hiatus before trading starts: two weeks,30 days, three months, after next earnings
release
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10b5-1 Plans What if your insider is always aware of
inside information?
SEC advice equivocal Rule says before becoming aware of the
information
Alternative: insider must not be aware of
inside information when plan commences Mechanisms: long hiatus before sales start
(six months); other officer signs off whentrading can begin
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10b5-1 Plans Should the plan be in writing?
Two of three affirmative defenses do not
require Best practice is to have written plan
Certainty of terms
Use as evidence in judicial proceedings
Summary judgment phase
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10b5-1 Plans Should the plan have a fixed term?
Not required
Best practice is to have fixed term Typically six months or one year
Two years at outside
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10b5-1 Plans What factors influence trading
instructions?
Impact on market Size of transactions
Multiple insiders
Two-day Section 16 reporting
Frequent sales, barrage of Forms 4 Ease of implementation
Keep it simple
Cashless option exercise issues
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10b5-1 Plans
What should cause the plan toautomatically suspend or terminate?
Insiders death, bankruptcy, termination ofinsider status, expiration of stock options
subject to plan
Announcement of merger, tender offer
Withdrawal of companys lack of objectionto plan
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10b5-1 Plans
When can insider terminate the plan?
Can be when aware of inside information
Does not violate Rule 10b5-1 because it isnot illegal not to trade (SEC informaladvice)
Issue of good faith if pattern or practice
Should be hiatus before start new plan
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10b5-1 Plans
When can insider modify the plan?
Only when not aware of inside information;
must wait for open window Can trades be made outside a plan?
Called parallel trading
Would not invalidate trading plan (SEC
informal advice)
On its own, trade must not violateRule 10b-5
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10b5-1 Plans
Should the company make a publicannouncement of the 10b5-1 plan or
program?
Press release
Form 8-K (SEC may require)
Form 10-Q
Company Web site
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10b5-1 Plans
What should be disclosed?
Existence of program (selling or buying)
Names of insiders Number of shares
Percentage of holdings (vested andunvested)
Duration, other terms
Whether insiders will trade outside plan
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10b5-1 Plans
Sample disclosureFour of the companys executive officers currently have in effect
Rule 10b5-1 sales plans for shares of the companys common stock.
In accordance with the requirements of Rule 10b5-1, the plans wereestablished at times when the officers were not aware of material
nonpublic information. The plans specify the trading periods, which
range from six months to one year, the numbers of shares to be sold
and the prices at which shares may be sold. If all conditions of the
plans are met, the aggregate number of shares that may be sold
under the plans would be ________, which would equal
approximately __% of the aggregate number of shares, includingrestricted shares and vested and unvested option shares, held by
the officers as of _______, 2002. The officers may amend the trading
plans and may sell additional shares of common stock outside of the
trading plans, provided they are not aware of material nonpublic
information at such time.
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10b5-1 Plans
What other laws impact plans?
Controlling person liability
Rule 144 Timing of filings
Attestation
Exclusive broker?
Section 16 Section 13(d)
State law
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10b5-1 Plans
How you can help implement plans
Designate 10b5-1 committee or compliance
officer Establish guidelines all plans must meet
Establish procedures for review andapproval
Vet plans of one or more brokers
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10b5-1 Plans
Process for approval
Committee reviews plan for compliancewith company's guidelines
Dialogue takes place between committee,broker and insider
Committee makes any requests for
changes and approves or rejects plan Committee works with broker
to generate required paperwork (e.g.,stock option exercise forms)
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10b5-1 Plans
Reporting transactions
Broker files Form 144
Pre-signed forms placed with broker Broker reports transaction details to
compliance officer--same day by phone,then confirmed by same-day fax or email
Compliance officer prepares Form 4 forinsider's signature--two-day filing unlessexact date not specified
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10b5-1 Plans
Sample guidelines
General plan requirements
Discretionary plans will not be permitted
Modification/voluntary termination of plan canonly take place during an open window
Company has discretion to terminate plan forcertain events
Automatic termination/suspension events
Plan intended to comply with Rule 10b5-1
Purpose, e.g., to permit orderly disposition oracquisition
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10b5-1 Plans
Insider representations that
Insider is not aware of material nonpublicinformation
Insider is entering into plan in good faith, andnot as part of a scheme to evade the purposeof the rule
Insider will not hedge against the trading plan
Insider will comply with Rule 144 and Sections16 and 13(d)
Insider will exercise no control over brokersactions
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10b5-1 Plans
Broker representations that
It will not seek instructions or advice frominsider
It will not deviate from the plan It will not execute if aware of material
nonpublic information
Company representations that
It has reviewed (or approved) trading plan
It has no objections to the plan
The plan does not violate the companys insidertrading policy
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Section 16
Provisions under securities laws andSEC rules that require SEC filings bysenior executives and directors for theircompany stock transactions, and alsomatching of trades within six-monthperiod
Forms 3, 4 & 5 Short-swing profit liability
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Section 16
Form 4
Filed two days after company stock transactions
Previously reported on Form 5: Option grants,
transactions with the company, including optionissuances, cancellations and repricings
Company procedures in place for assisting insiders withfilings
Interacting with outside stock plan service providers
and brokers Coming soon: Filings must be made on EDGAR and
simultaneously posted on your company's Web site
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Section 16
Issues Raised Late filings reported in proxy statement: New meaning
about corporate governance and compliance
Re-examine which officers are Section 16 officers: Nolonger prestigious. SEC definition includes president,CFO, chief accounting officers, VPs of principal businessunits and any person with significant policymakingfunction.
Changes in compensation design: Deferred comp; M&A
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Section 16
Short-Swing Profit Rules Senior officer and director who realize any profit from
the purchase and sale, or sale and purchase, of any
company shares within any period less than six monthsmust return this profit to the company
Extends to transactions made by your spouse and otherfamily members and to trusts set up for their benefit
Section 16(b) plaintiff's lawyers actively monitorsecurities trades for these violations because they sharein any profits paid back to your company
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Section 16
Danger: The six-month danger period runs both backwardand forward from the date of a transaction. Best matchapplies!
Down market example:
Sold stock on January 1 at $15. Stock executivepurchased two years ago. Stock drops to $5 over nextfour months. Buys stock on May 1 to show market that
confident in company future. We have a match! $10 per share profit on the May 1
purchase paid back to company. Window period andblackout rules no defense.
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Section 16
Option and Restricted Stock Grants
Grants of shares and stock options under employee
benefit plans will normally be exempt, assuming thatthe necessary shareholder or board approvals are givenin advance.
Any sale of shares is still matchable against any open
market purchase of shares within the six-month zone.Watch out for cashless exercise.
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Section 16
Example With Options
If you exercise a stock option and sell the stock
on January 1 when market price is $15, yourexercise is exempt from Section 16(b) matching.The sale of the stock is not. Thus, any gainsresulting from a match with a purchase sixmonths before this date or six months after will
be a short-swing profits violation. Purchase ofstock in November at $12 is matched for $3 pershare.
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Sarbanes-Oxley Act of 2002
CEO and CFO certifications
Ban on personal loans
Prohibition on trades during pension planblackout periods
Prior audit committee approval of non-audit
services
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CEO/CFO Certifications
Sarbanes Section 302: CEO/CFO of public companyrequired to submit a statement with certain filingscertifying that
Has reviewed the report
Based on CEO/CFOs knowledge, the report does not containany untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, inlight of the circumstances under which such statementswere made, not misleading with respect to the period
covered by the report
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CEO/CFO Certifications Along with other certifying officers
Are responsible for establishing and maintainingdisclosure controls and procedures
Have designed such disclosure controls and proceduresto ensure that material information is made known tothem, particularly during the period in which the periodicreport is being prepared
Have evaluated the effectiveness of the disclosurecontrols and procedures as of a date within 90 days prior
to the filing date of the report
Have presented in the report their conclusions about theeffectiveness of the disclosure controls and proceduresbased on the required evaluation as of that date
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CEO/CFO Certifications
Sarbanes Section 906: Requires CEO/CFO of publiccompany to submit a statement with certain filingscertifying that the filing fully complies with theExchange Act reporting requirements and fairly
presents in all material respects the companysfinancial condition and results of operations.
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CEO/CFO Certifications
What does this have to do with me?
Flow-down certification
Recent survey of large U.S. multinational companies
Two-thirds require subcertifications
Average of 18.6 additional executives
Including heads ofHR and Compensation
Participation in disclosure practices committee
Criminal penalties for CEO/CFO
HealthSouth first criminal certification case
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CEO/CFO Certifications
CEO/CFO not just certifying financial information
Most of proxy statement is incorporated byreference into PartIII of the Form 10-K
Executive compensation tables
Beneficial ownership table
Certain relationships and related transactions
Section 16 compliance Item 201(d) executive compensation plan information
table
Also financial statement equity compensation note
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CEO/CFO Certifications
Sample subcertification of proxy statement1. I understand that the Chief Executive Officer and Chief Financial
Officer of ABC Corp. will rely on this certificate, along with other
review procedures, in providing to the Securities and Exchange
Commission pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 and 302 of the Sarbanes-Oxley Act of 2002, a certification
in connection with ABC Corp.s annual report on Form 10-K, which
incorporates by reference certain sections of ABC Corp.s proxy
statement for its 2003 annual meeting.
2. I have reviewed the proxy statement.
3. Based on my knowledge, the proxy statement does not contain anyuntrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading as of the
date on which the proxy statement was filed.
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Ban on Personal Loans Section 402: Bans personal loans to directors
and executive officers
Broker-assisted cashless exercises
Probably okay if
Regular T+3 settlement
Choice among approved brokers
Relocation
Residential loans probably not okay; alternatives:
Company buys and sells old residence, or
Company buys new house and rents to executive
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Ban on Personal Loans
Loan forgiveness
Partial loan forgiveness not okay if modification of agrandfathered arrangement
Total loan forgiveness may not be okay--depends onstatus of arrangement before forgiveness
Bonuses okay if not tied to repayment and otherwisejustifiable compensation as sign-on or retention bonuses
401(k) plan loans
Probably okay but inadvisable
DOL guidance: restrictions on pension plan loans toofficers of the plan sponsor do not violate ERISA loanrules (Field Assistance Bulletin 2003-1)
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Pension Plan Blackouts
New SEC Regulation BTR (Blackout TradingRestriction)
Prohibits directors and executive officers from trading during
pension plan blackout periods What is a blackout?
When at least 50% of participants in all individual accountplans cannot trade securities held in individual accounts formore than three consecutive business days
Exceptions for regularly scheduled blackout periodsincorporated into plan documents and disclosed toemployees and for merger transactions
Exemptions for DRIPs, certain 10b5-1 plan transactions, tax-qualified plan transactions other than discretionary
transactions, formula grants, gifts
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Pension Plan Blackouts
How does BTR affect insiders?
Restricts trading only of securities insiders acquired inconnection with their employment or service
Includes trades by family members
Insiders cannot acquire or dispose of securities acquired inconnection with employment or service as an insider
Includes receiving discretionary equity awards
Any profit realized by a director from a prohibitedtransaction is recoverable by the company
If company fails to act, shareholders can bring derivative action
Insiders also subject to civil injunctions, penalties and ceaseand desist proceedings, as well as possible criminal liability
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Pension Plan Blackouts
What do you have to do to implement BTR?
Include notification of regularly scheduled tradingsuspensions in plan documents
Notify plan participants at least 30 days in advance ofblackouts (per DOL regulations)
Applies to all individual account plans, regardless ofwhether hold company stock
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Pension Plan Blackouts
What do you have to do . . .
Notify insiders of blackouts at least five business days aftercompany receives notice from plan administrator
If no notice from plan administrator, notify insiders atleast 15 calendar days before start of blackout period
Limited relief possible
File notice with SEC on Form 8-K no later than date by whichnotice must be given to insiders
Requirements differ for foreign issuers Further information:
http://www.perkinscoie.com/resource/business/blackout.htm
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Non-Audit Services
Be aware when establishing perquisites forexecutives that the audit committee mustpre-approve, or establish policies and proceduresfor pre-approval of, non-audit services by the
companys auditing firm Includes provision of personal financial services to
executives by companys auditors
Sprint is a cautionary tale:
Two top executives were fired after their participation ina tax shelter for option exercise gains set up by thecompanys auditors left the executives with millions inpotential tax liability and a potential conflict with theauditors
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The new accounting board is expectedto issue more guidance and limits onconsulting and tax advice for audit
clients.
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Other CurrentIssues
NYSE/Nasdaq proposed rules will affect yourrelationship with the compensation committee
NYSE: compensation committee of independent
directors must Approve CEO compensation
Have sole authority to hire, fire and set feesof compensation consultants
Have written charter specifying purpose,duties and responsibilities
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Other CurrentIssues
Nasdaq: committee of independent directors ormajority of the independent directors must
approve CEO and executive officercompensation
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Other CurrentIssues
NYSE/Nasdaq proposed rules will affectavailability of equity and plan design
Shareholders must approve all equity
compensation plans
Also material amendments to plans
Discretionary broker voting on equity plans iseliminated
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Other CurrentIssues
Other things to watch out for: S-8 registrations must be effective before restricted stock
is granted
Expect new SEC guidance on Item 201(d) executive
compensation plan information table 906 certifications may be required for 11-Ks
Changes in accounting for equity compensation requireheightened awareness
New world of SFAS 123 accounting.
Impact on your Sarbanes-Oxley subcertifications forvaluation model used and its assumptions
Interpretations in state of flux
Liquidity accounting is variable
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References and FurtherReadingSarbanes-Oxley Acthttp://news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302.pdf
Securities and Exchange CommissionRegulatory Actionshttp://www.sec.gov/spotlight/sarbanes-oxley.htm
NYSE Corporate Governance Proposalshttp://www.nyse.com/abouthome.html?query=/about/report.html
NASDAQ Corporate Governance Proposalshttp://www.nasdaq.com/about/ProposedRuleChanges.stm
Perkins Coie LLPClient Updateshttp://www.perkinscoie.com/new.htm
myStockOptions.com--Insider trading, Section 16, Rule 144, 10b5-1content for executives and employees, along with tools and content onoptions, restricted stock and ESPPs
http://www.mystockoptions.com