SEC Enforcement of Section 16 Reporting

For companies with a fiscal year that corresponds to the calendar year, it’s time to once again review your Section 16 compliance. This review is particularly important this year, in light of an ongoing SEC enforcement initiative.

Late last year, the SEC announced charges in an ongoing enforcement sweep under Section 16. The charges were brought against five companies and six individuals. All agreed to cease and desist orders and civil penalties ranging from just under $70,000 to $200,000.

How Often Do Section 16 Enforcement Sweeps Occur?

Not that often. The last significant Section 16 enforcement sweep was almost ten years ago, in 2014. At that time, the SEC brought proceedings against 34 respondents, considerably more than in the current sweep.

The SEC has brought other Section 16 reporting enforcement actions since then, but most have been in connection with other enforcement actions. A sweep of 13D reporting failures in 2015 also included charges relating to Section 16 filings and there have been a number of one-off enforcement actions brought in the context of cases alleging other, more significant violations. Section 16 Updates found that between 2014 and 2018, the SEC sanctioned 98 insiders for reporting violations (see the December 2019 issue).

The SEC’s announcement of this sweep indicates that this is an ongoing investigation. We thought the sweep in 2014 might herald more Section 16 enforcement, but that didn’t really happen. Now, however, perhaps we will see more enforcement in this area.

Why Are Companies Charged in Section 16 Enforcement Actions?

Section 16 imposes an individual obligation on corporate insiders (officers, directors, and 10% shareholders) to file reports with the SEC, so it might seem odd that companies comprise almost half of the respondents to the enforcement actions brought so far under the investigation. The SEC brought two types of charges against the companies:

• Incorrect or omitted item 405 disclosures
• Failure to timely file Section 16 reports on behalf of company insiders after agreeing to perform this service for them

Item 405 Disclosures

When insiders file Section 16 reports late, item 405 of Regulation S-K requires the company to disclose the filing delinquencies in its proxy statement for the year. Companies must disclose both late filings and any known reporting failures (i.e., situations where insiders should have reported transactions during the year but have not done so as of the end of the year).

Three of the five companies included in the sweep were charged with item 405 disclosure failures. In all cases, the failures occurred in multiple years, sometimes as many as four years. There were three types of failures:

• Omitting item 405 disclosure when there were filing delinquencies that should have been disclosed.
• Stating that all Section 16 reports were filed on a timely basis when they were not or failing to include all filing delinquencies in the disclosure.
• Including the item 405 disclosure but failing to include all the required information about the reported delinquencies.

In all cases, the failures were egregious. We’re not talking about just a handful of filing delinquencies. The respondent companies each failed to correctly report anywhere from 75 to 150 delinquencies over multiple years, often involving transactions in the companies’ stock plans (transactions the companies were clearly aware should have been reported).  

How to Correctly Disclose Section 16 Filing Delinquencies

If your company insiders have Section 16 filing delinquencies that must be reported in your company’s proxy statement, the disclosure must be made under the caption “Delinquent Section 16(a) Reports” and must include the following information:

• The names of the insiders involved
• The number of transactions each insider reported late
• The number of forms the insider filed late
• Any known failures to report

It is not necessary to disclose how late the reports were filed or the reasons for the late filings, although this information may be voluntarily disclosed.

If a company does not have any Section 16 reporting delinquencies, it is not necessary to disclose this. When this is the case, the SEC encourages companies to simply omit the disclosure but doesn’t prohibit companies from affirmatively disclosing that their insiders had no reporting delinquencies.

Late Filings

This is the second time that the SEC has brought charges against companies who have agreed to take on the responsibility for submitting Section 16 filings for their insiders and then failed to do so (the first time was during the 2014 sweep). In two cases, the SEC brought charges against both the company that submitted the late filings and one of the insiders for whom the filings were submitted late (double-dipping on the penalties, so to speak).

One company explained, in its item 405 disclosure, that the late filings were “due to administrative errors and due to the fact that the Company’s headquarters in Israel work Sundays through Thursdays.” Investors might be sympathetic to this rationale, but the SEC is not.  

Just as with the penalties for incorrect item 405 disclosures, the penalties for late filings involved a large amount of filings in each case, often hundreds of filings or transactions valued at over $1 million in aggregate.

Best Practices

I’ve noticed some recurring themes in each of the enforcement actions. Based on this, I have the following suggestions for refining your Section 16 compliance procedures:

1. Develop effective notification and reporting procedures. If your company agrees to take responsibility for submitting Section 16 filings for your insiders, you must develop procedures to ensure you are notified of insider transactions and you submit the filings on time. This protects both the company and the insiders.
2. Update procedures to address recurring errors. A few late filings here or there aren’t likely to result in an enforcement action in the absence of other securities law violations. But if you notice a pattern of repeated late filings, review your procedures to identify and remediate the cause.
3. Disclose delinquencies. When insider filings are delinquent, comply with the item 405 disclosure requirement. In all cases where companies had disclosure failures, the fines were higher than for companies that had delinquent filings but had properly disclosed them. Implement an audit process at year-end to identify all reportable insider transactions and verify timely reporting.
4. Don’t allow reporting failures to go uncorrected. When you discover that insiders have unreported transactions at the end of the year, make sure the transactions are reported on either a Form 4 or 5. In several cases, reporting failures extended beyond the end of the company’s fiscal year. This resulted in a failure to submit a Form 5 filing for the year and a late filing once the Form 4 was eventually submitted. It’s not clear that this affected the penalties levied against the company or insider, but it certainly didn’t help matters.