Earlier this year, the U.S. Securities and Exchange Commission proposed two sets of rule changes that may significantly affect public companies and their shareholders.
Specifically, the proposals seek to eliminate the selective disclosure of material information and to clarify insider trading rules. If the SEC stays true to its past enforcement strategy, it is likely that such proposals will be accompanied by heightened enforcement efforts in those areas.
Last year, the SEC’s enforcement division focused heavily on accounting, Internet and insider trading issues. In fact, 1999 became known as “The Year of the Accountant” in SEC circles, with particular attention being paid to the common practice of “managing” earnings through the misuse of reserves, restructuring charges and other write-offs.
The public’s captivation with soaring Internet stocks also made it susceptible to falling prey to Internet scams. Consequently, nearly any type of investment vehicle circulated on the Internet will get the SEC’s attention, as well as that of various state securities bureaus.
The SEC, which formed a “cyberforce” of 250 lawyers and accountants to uncover and prosecute Internet-related securities fraud, primarily has focused on issues related to online brokerages, “free” stock giveaways, and message board manipulation of stock prices.
As can be expected in a booming and acquisition-minded stock market, illegal insider trading has remained an SEC priority, although the types of cases being brought have changed. It is no longer common to see such actions brought against Wall Street titans. Instead, the SEC’s focus has shifted to younger Wall Street types, particularly to analysts, who are not old enough to have learned lessons from the publicized Boesky, Levine and Milken cases in the 1980s.
It has also been said that the SEC’s focus has shifted “away from Wall Street and to Main Street” because the proliferation of online trading has broadened dramatically the profile of both the typical investor and illegal trader.
– New SEC Rules And
The SEC’s two tools for governing the federal securities laws , rulemaking and enforcement , usually work hand in hand. When the SEC identifies a particular topic as being ripe for rule changes, future enforcement efforts in that area should be expected. Addressing selective disclosure and insider trading concerns likely will be prime examples of this two-pronged approach.
o Selective Disclosure , Selective disclosure typically involves a public company’s preferential dissemination of important information to favored analysts or institutional investors ahead of the rest of the market.
If the “tippee,” recipient of the material information trades before public disclosure, both the tippee and the “tipper” may be subject to insider trader liability. Such liability may extend beyond the individual tipper to the company itself.
In December 1999, the SEC proposed new rules specifically designed to address selective disclosure.
To combat the practice, the SEC proposed Regulation FD (Fair Disclosure), which would require that (1) when an issuer intentionally discloses material information, it must do so through public, not selective, disclosure; and (2) when an issuer learns that it has made a non-intentional material selective disclosure, it makes prompt public disclosure of that information.
According to the proposal, an issuer could make the required public disclosure by (1) filing the information with the SEC; (2) issuing a press release; or (3) providing public access to a conference call or meeting.
– Concern For Chilling
The Information Flow
Critics of Regulation FD, which was open to public comment through mid-March, argue it could backfire by chilling the flow of information because uncertainty regarding its meaning might cause some companies to err on the side of nondisclosure, which ultimately would defeat the SEC’s paramount goal of full and complete disclosure to the marketplace.
o Insider Trading , Proposed SEC Rules 10b5-1 and 10b5-2 address two unsettled issues in insider trading law. The “use versus possession” issue; and the application of the “misappropriation theory” where the nonpublic information traded upon was obtained based upon family or personal relationships.
The SEC has been hurt by recent decisions in some circuits, including the Ninth Circuit Court governing California, which require that the insider trading defendant actually used the nonpublic material information when he or she made the decision to trade, rather than the more lenient standard requiring mere possession of the information.
Rule 10b5-1 is intended to validate the SEC’s long-held position that insider trading liability arises when a person trades while “aware” of material nonpublic information. The new rule, however, does provide for some affirmative defenses, such as when the trade resulted from a preexisting plan, contract, or instruction that was made in good faith.
With Rule 10b5-2, the SEC seeks to clarify and strengthen the existing law regarding the “misappropriation” theory of insider trading liability. While the Supreme Court has upheld the theory in the context of trading on misappropriated confidential information gained in breach of a confidential business relationship, such as that involving an attorney and client, the law is less settled where the misappropriation involves nonpublic information gained in the context of a personal or familial relationship.
– Quicker SEC Action
Expected During 2000
As nearly every subject of an SEC investigation will attest, the probes usually are slow, methodical and expensive affairs that slowly grind away at the target’s resources. The SEC has responded to such criticism by stating publicly that it intends to bring enforcement actions more swiftly.
In fact, the SEC has suggested that it may undertake more tandem prosecutions by it (civil powers) and the U.S. Attorney’s Office (criminal powers). This is consistent with other statements by SEC officials that they expect the SEC to make more criminal referrals for non-securities offenses, such as perjury and obstruction of justice.
In short, the SEC shows no sign of slowing down in the year 2000.
Prosser, a former SEC enforcement attorney, is a member of the Securities Litigation Group in the San Diego office of Brobeck, Phleger & Harrison LLP.