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Second Circuit Case Shows How Confidentiality Pact May Support Insider Trading Charges

A recent decision by the U.S. Court of Appeals for the Second Circuit shows how an investor’s entering into a confidentiality agreement with an issuer of securities may support insider trading charges against the investor.

The decision, United States v. Kosinski, No. 18-3065 (2d Cir., Sept. 22, 2020), did not create new law in the Second Circuit.  But the court did reaffirm its earlier holding that by agreeing to keep confidential  information provided by an issuer, a trader had taken on a fiduciary-like duty to the issuer sufficient to support insider trading charges under section 10(b) of the Securities Exchange Act of 1934.  And it rejected the argument that to create the requisite duty, the agreement needed to have a no-trading provision as well as a confidentiality provision.

What creates a sufficient duty has been a hotly disputed issue in insider trading law in recent years.  It elicited heightened attention during the SEC’s case against billionaire Dallas Mavericks owner Mark Cuban, where the SEC’s charges were based in part on an alleged promise by Cuban to maintain confidentiality as to information provided by issuer Mamma.com.

But Cuban’s case did not resolve that issue as a legal matter.  Rather, the U.S. Court of Appeals for the Fifth Circuit, without addressing all of the legal questions posed,  held that the SEC had alleged enough to support a finding that Cuban had agreed both to maintain confidentiality and not to trade, so that the case could go to a jury.  It did,

SEC Announces Charges Against Fulton Financial Corporation and Interface, Inc., in Bellwether of Increased Earnings Management Enforcement Activity

On September 28, the SEC announced charges against two public companies, Interface, Inc. (“Interface”) and Fulton Financial Corporation (“Fulton”), for violations related to the reporting of improperly calculated earnings per share (“EPS”) that enabled the companies to meet or exceed consensus analyst estimates.  In the case of Interface, charges were also levied against the company’s former Chief Financial Officer (“CFO”) and Chief Accounting Officer (“CAO”) for directing subordinates to book unsupported, manual accounting entries that did not comply with generally accepted accounting principles (“GAAP”). These enforcement actions are a result of the implementation of an “EPS Initiative” by the Division of Enforcement that seeks to leverage risk-based data analytics to identify potential instances of accounting and disclosure violations, including those resulting from earnings management practices.

The SEC focused on accounting entries recorded on Interface’s books during the period from the second quarter of 2015 through the second quarter of 2016. The SEC alleged that Interface reported financial results that did not accurately reflect the company’s actual performance, and, instead, inflated income and EPS figures to show consistent earnings growth.  The alleged misstatements were found to be materially misleading because the earnings reported in two quarters enabled the company to meet consensus analyst EPS estimates when, had the unsupported accounting entries not been made, the company would have delivered results below analyst estimates. The SEC alleged that a lack of adequate internal controls over financial reporting created an environment in which the CFO and CAO (then-Corporate Controller) were able to direct

When What Goes Down Comes Up – Reporting NEO Compensation Restoration

As the COVID-19 pandemic unfolded, public companies took action in response to the impact and potential impact of the pandemic on their businesses and the economy.  The actions often included temporary compensation reductions (voluntary and otherwise) for a company’s principal executive officer, principal financial officer and/or named executive officers (collectively, “NEOs”).

As would be expected, many companies reported these changes under Item 5.02(e) of Form 8-K, which is triggered when a company enters into, adopts or materially amends a material compensatory plan or arrangement with NEOs or in which they participate.  Some companies, however, reported the reductions under Item 7.01 or 8.01 of Form 8-K or, sometimes, in a stand-alone press release or not at all.  As we previously noted in March, companies that did not report the reductions under Item 5.02(e) likely were comfortable that, based on their specific facts and circumstances, the decreases were not material to the executives’ compensation arrangements or, in the case of voluntary compensation reductions where employment agreements were in place, perhaps by analogy to SEC C&DI 117.13, that Item 5.02(e) was not triggered.

As we move into the final quarter of 2020, and in view of developments following the initial compensation reductions relative to the continuing effects of the pandemic, a number of industries and companies have had relatively positive financial performance in the face of the pandemic, and may have a more favorable business outlook or simply better visibility into the effects of the pandemic.  As a result, some companies have

SEC Amends Whistleblower Award Program Rules to Add Clarity, Efficiency and Transparency

On September 23, 2020, the SEC voted 3-2 to adopt long-awaited amendments to rules governing its Whistleblower Program. The amendments’ stated purpose is to provide greater clarity to whistleblowers, and increase the whistleblower program’s efficiency and transparency.  In addition, according to SEC Chairman Jay Clayton, the “rule amendments will help us get more money into the hands of whistleblowers, and at a faster pace.” Click here to read the Alert in full.

Divided SEC increases Rule 14a-8 shareholder proposal requirements

On September 23, 2020, a divided SEC adopted amendments to the Rule 14a-8 shareholder proposal rule by a 3-2 vote. The changes, among other things:

  • increased the stock ownership requirement for eligibility to submit a proposal,
  • strengthened certain procedural requirements, and
  • raised the thresholds to resubmit a proposal that was previously voted on by shareholders.

Click here for a client alert describing the amendments in more detail.

SEC Issues New COVID-19 Guidance: Health-Related or Personal Transportation Benefits May Be Perqs

The SEC Division of Corporate Finance yesterday issued new Regulation S-K guidance, CD&I 219.05, to help public companies determine whether benefits provided to executive officers because of COVID-19 should be disclosed as perquisites or personal benefits for purposes of executive compensation proxy disclosures.  Consistent with Release 33-8732A, the guidance confirms that an item provided because of the COVID-19 pandemic is not a perquisite or personal benefit if it is “integrally and directly related to the performance of the executive’s duties,” which depends on the particular facts.

The CD&I states:  “In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees.”

Perqs have been, and will continue to be, an area of SEC focus.  We urge companies to carefully give thought

Kodak Releases Special Committee Report – Details Failures in Corporate Governance Practices

We previously blogged about the myriad issues arising in connection with the botched announcement by Kodak of a potential $765 million loan from the federal government as part of its coronavirus response measures, as well as insider stock transactions preceding and immediately following the announcement.  Kodak’s board formed a special committee to conduct an internal investigation.  Akin Gump, retained by the special committee to conduct the investigation, last week delivered its report of over 70 pages of factual findings and legal analysis, concluding that there were no violations of law or company policy, but identifying corporate governance issues requiring attention and remediation.  The company has posted the report on its website.

As we previously blogged, on July 27 the internal public relations team at Kodak released an alert to local media that Kodak would be making a big announcement the following day concerning a major initiative between Kodak and the federal government.  Stories immediately started circulating on social media and the websites of local network affiliates. Kodak then contacted the recipients of the advisory to tell them it was meant only as background and was not intended for publication.  The formal announcement followed before the market open on July 28 when Kodak and the U.S. International Development Finance Corp (DFC) jointly announced a ”letter of interest” contemplating a $765 million loan to Kodak to launch a new pharmaceutical business. Although the press release made clear that this was only a letter of interest and the loan was subject

CFTC Report: Climate Change Poses Major Risks to U.S. Financial System

Includes recommendations for action by SEC and other financial regulators

Last week, a subcommittee of the Commodity Futures Trading Commission issued a sweeping report addressing climate change risks, concluding that they pose both major systemic and sector/regional-level risks to the stability of the U.S. financial system and its ability to sustain the American economy.  Further, it concludes that such risks are increasing rapidly, economic incentives are misdirected and immediate action across the global financial system is required.

The report is wide-ranging with a number of specific, detailed recommendations.  Its length and complexity make it impractical to summarize for this blog, but fortunately, the report does include a well-organized executive summary (beginning on page i).

Some of the report’s key points include:

  • The United States should establish a price on carbon. A fair, economy-wide carbon pricing regime is necessary to fix a fundamental market flaw in the economic system to ensure that appropriate incentives are in place for the efficient allocation of capital
  • U.S. regulators should use their broad, flexible authority to start addressing the risks now
  • Research arms of federal financial regulators should study the financial implications of climate-related risks, including the potential for and implications of climate-related “sub-systemic” shocks to financial markets and institutions in particular sectors and regions of the United States (e.g., agricultural and community banks and financial institutions serving low-to-moderate income or marginalized communities)
  • Financial regulators, in coordination with the private sector, should work together to rapidly improve the quality of data, analytics

SEC Staff Provides Roadmap for Extending Confidential Treatment Orders

The SEC staff amended CF Disclosure Guidance: Topic No. 7 on September 9, 2020 to address the options for companies with confidential treatment orders that are about to expire.  The guidance explains that companies have three choices:

  • Refile the unredacted exhibit. If the contract is still material and none of the redacted information still needs to be protected, the company should refile it in complete, unredacted form.
  • Extend the confidential period pursuant to Rules 406 or 24b-2. If the contract continues to be material, and the previously redacted information continues to be confidential, the company may request to extend the period of confidential treatment by filing an application under Rule 406 of the Securities Act of 1933 or Rule 24b-2 of the Securities Exchange Act of 1934.
    • Short-form application for orders about to expire and initially issued less than three years ago.  If the order is about to expire and was initially issued less than three years ago, companies may use the short-form application, which provides a streamlined process to file an application to extend the time for which confidential treatment has been granted. If the company reduces the extent of omitted information, it must file the revised redacted version of the exhibit on Edgar when submitting the application.

Short-form applications should be submitted to CTExtensions@sec.gov. That email address should not be used for any other confidential treatment request.

    • New application for orders about to

SEC Staff Announces Temporary Procedures for Supplemental Materials and Rule 83 Confidential Treatment Requests

In light of health and safety concerns related to the pandemic, the SEC staff recently announced the availability of a temporary secure file transfer process for the submission of supplemental materials pursuant to Rule 418 under the Securities Act of 1933 or Rule 12b-4 under the Securities Exchange Act of 1934 and information subject to Rule 83 confidential treatment requests (“CTRs”).

From time to time companies provide supplemental materials to the SEC staff, typically when responding to SEC comments.  Rule 418 provides broad authority to the SEC and its staff to request information concerning a company, its registration statement, the distribution of its securities and market or underwriter activities. Rule 12b-4 provides similar authority with respect to registration statements and periodic or other reports. Both rules require the SEC to return supplemental materials upon request, provided the request is made at the time they are furnished to the staff and return of the materials is consistent with the protection of investors and FOIA.  Rule 418 also requires that the materials not have been filed in electronic format.

SEC Rule 83 provides a procedure by which persons submitting information may include a CTR for portions of that information where no other confidential treatment process applies. Typically, this is utilized when companies provide responses to SEC staff comments.  Rule 83 generally requires the submission of the information covered by the CTR separately from that for which confidential treatment is not requested, appropriately marked as confidential, and accompanied by

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