Corporate Practice Series Portfolio No. 15-4th, Inside Information: Prevention of Abuse, addresses the obligations of a U.S. public company and its insiders arising from the possession of material nonpublic information concerning the company or its securities. After initially discussing what information is deemed to be material and nonpublic, the portfolio then analyzes the prohibitions against insider trading, the scope of the company’s obligation to disclose material information, and the formulation of corporate procedures that promote compliance with the insider trading prohibitions and disclosure requirements. The portfolio also discusses potential liabilities and statutory defenses for insider trading, as well as the liability for short-swing profits under Section 16 of the Securities Exchange Act of 1934.

 

Portfolio 15-4th: Inside Information: Prevention of Abuse

I. Introduction and Overview

II. Prohibitions Against Trading in Securities While in Possession of Material Nonpublic Information 
    A. Overview 
    B. Traditional or Classic Insider Trading—The `Disclose or Abstain' Obligation of Corporate Insiders 
        1. The duty to disclose or abstain from trading 
        2. Who is an insider? 
            a. Traditional insiders 
            b. Temporary insiders 
    C. The Misappropriation Theory—Abuse of Information Obtained by an Outsider of the Corporation 
        1. Source of the misappropriation theory 
        2. Fiduciary duties or similar relationships of trust and confidence

III. Use of Material Nonpublic Information 
    A. Overview 
    B. Nonpublic Information 
        1. Dissemination and price impact 
        2. Public dissemination of information and the Internet 
    C. Material Information 
        1. The reasonable investor test 
        2. Future events—the probability/magnitude test 
        3. Financial statement materiality 
        4. Soft information: opinions and beliefs 
        5. Vague or nonspecific information 
    D. Possession Versus Use

IV. Tippers and Tippees: Prohibitions Against Disclosing Material Nonpublic Information to Traders 
    A. What Is Tipping? 
    B. Tipper Liability 
        1. Duty 
        2. Personal benefit 
        3. Special circumstances in misappropriation cases 
    C. Tippee Liability

V. Trading on Information Concerning a Tender Offer—Rule 14e-3 
    A. Overview 
    B. General Prohibition 
    C. The ‘Chinese Wall' Exception Concerning Transactions by Financial Institutions 
    D. Transactions by the Bidder 
    E. Tipping Prohibition

VI. Special Problems in the Law of Insider Trading 
    A. Trading in Nonequity Securities 
        1. Options 
        2. Debt 
        3. Credit default swaps 
    B. Stock Substitutes

VII. The Consequences of Insider Trading 
    A. Overview 
    B. Securities and Exchange Commission Enforcement Proceedings 
        1. SEC enforcement remedies 
        2. Special sanctions for insider trading 
    C. Criminal Prosecution 
    D. Private Liability 
    E. Defenses to Insider Trading Charges Under Rule 10b5-1

VIII. Public Company Obligations to Disclose Material Nonpublic Information 
    A. Overview 
    B. SEC Reporting Requirements 
        1. Description of business 
        2. Material pending legal proceeding 
        3. Management's Discussion and Analysis 
        4. Additional material information 
    C. Rule 10b-5 and ‘Informal' Disclosure 
        1. Delaying disclosure of material information: the right to remain silent 
        2. Disclosure duties 
            a. Duty to speak truthfully and completely 
            b. Duty to correct 
            c. Duty to update under certain circumstances 
            d. Duty to respond to rumors or to correct third-party statements 
            e. Duty of issuers engaged in purchases or sales 
        3. The problem of selective disclosure 
            a. Regulation FD 
            b. Selective disclosure and communication with analysts 
            c. Selective disclosure and stock exchange rules 
    D. Disclosure Obligations Under Exchange Listing Standards 
        1. Duty to make prompt disclosure 
            a. New York Stock Exchange (“NYSE”) 
            b. American Stock Exchange (“Amex”) 
            c. National Association of Securities Dealers Automated Quotations (“NASDAQ”) 
        2. Duty to respond to rumors and unusual market activity 
        3. Consequences of failure to comply

IX. Structuring a Corporate Compliance Program for Nonpublic Information 
    A. Overview 
    B. Legal Risks of Failing to Implement Insider Trading Compliance Programs 
        1. Financial services firms 
        2. Public companies 
    C. Protecting Against Insider Trading 
        1. Design of specific policies and procedures 
        2. Trading restrictions 
        3. Procedures to protect confidentiality 
        4. Implementation 
        5. Enforcement of the policy 
    D. Making Informal Disclosure 
        1. Organizational framework 
            a. Centralize control over corporate communications 
            b. Form a knowledgeable team 
            c. Give the disclosure team complete access to the corporate communications process 
            d. Define the role and authority of outside public relations advisers 
            e. Establish a policy and procedures to prevent abuse of information 
        2. Content of disclosure 
            a. Continuously consider the need for disclosure 
            b. Use care to ensure the accuracy and completeness of disclosure 
            c. Make forward-looking statements sparingly 
            d. Avoid ‘puffing' and ‘hype' 
            e. Monitor the need to correct or update prior public statements 
        3. Disclosure methodology 
            a. Prepare formal press releases 
            b. Consider filing a Form 8-K 
            c. Develop a disclosure routine 
        4. Dealing with the analyst community 
            a. Develop a regular schedule of analyst meetings 
            b. Carefully monitor meetings with individual analysts 
            c. Avoid reviewing analyst reports 
            d. Avoid responding to analyst earnings estimates 
        5. Dealing with the press 
            a. Be open and forthright 
            b. Develop a `no comment' policy 
            c. Use caution in responding to inquiries concerning rumors 
            d. Use caution in responding to unusual stock market activity 
    E. Reporting Obligations for Attorneys

X. Insider Trading Under §16 of the Securities Exchange Act of 1934 and Liability for Short-Swing Profits 
    A. Introduction 
    B. Section 16 Insiders 
        1. Officers 
        2. Directors 
        3. Ten percent beneficial owners 
        4. Consultants and nonemployees 
    C. Equity Securities and Beneficial Ownership for §16 Liability and Reporting Purposes 
        1. Equity securities 
        2. Beneficial ownership 
    D. Purchases and Sales 
        1. Subject transactions 
        2. Derivative securities 
        3. Unorthodox transactions 
    E. Exemptions 
        1. Transactions between a public company and its officers and directors 
            a. Stock awards and option grants 
                i. Approval by a committee of two or more non-employee directors 
                ii. Approval by the board of directors 
            b. Discretionary transactions 
            c. Tax-conditioned plans 
        2. Mergers, reclassifications, and consolidations 
        3. Derivative securities 
        4. Dividend reinvestment plans 
        5. Domestic relations orders 
        6. Splits 
        7. Change in form of beneficial ownership 
        8. Bona fide gifts 
        9. Market making activity 
    F. Reporting Requirements 
        1. Form 3 
        2. Form 4 
        3. Form 5 
        4. Filing mechanics 
        5. Company disclosure of §16 compliance 
    G. Liability 
        1. Determining the measuring period of less than six months 
        2. Calculation of realized profits 
        3. Avoiding §16 forfeiture

Portfolio 15-4th: Inside Information: Prevention of Abuse

Wks. 1 Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. §78j(b))

Wks. 2 Rule 10b-5 (17 C.F.R. §240.10b-5)

Wks. 3 Insider Trading and Securities Fraud Enforcement Act of 1988 (Pub. L. No. 100-704)

Wks. 4 Legislative History of the Insider Trading and Securities Fraud Enforcement Act of 1988 (House Report 100-910)

Wks. 5 Letter of the Securities and Exchange Commission Proposing New Insider Trading Legislation

Wks. 6 Sarbanes-Oxley Act of 2002 (Pub. L. No. 107-204), Section 409, Real Time Issuer Disclosures

Wks. 7 Section 16 of the Securities Exchange Act of 1934 (15 U.S.C. §78p)

Wks. 8 Regulations Under Section 16 (17 C.F.R. §240.16)

Wks. 9 Form 3: Initial Statement of Beneficial Ownership of Securities

Wks. 10 Form 4: Statement of Changes of Beneficial Ownership of Securities

Wks. 11 Form 5: Annual Statement of Beneficial Ownership of Securities

Wks. 12 Exchange Act Release No. 17,120, Tender Offers (Sept. 4, 1980)

Wks. 13 Rule 14e-3, Transactions in Securities on the Basis of Material, Nonpublic Information in the Context of Tender Offers

Wks. 14 Exchange Act Release No. 43,154, Selective Disclosure and Insider Trading (Aug. 15, 2000)

Wks. 15 Regulation FD

Wks. 16 Division of Corporation Finance: Manual of Publicly Available Telephone Interpretations, Fourth Supplement (June 8, 2001)

Wks. 17 Exchange Act Release No. 57,446, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The Retirement Systems of Alabama (Mar. 6, 2008)

Wks. 18 Exchange Act Release No. 58,288, Commission Guidance on the Use of Company Web Sites (Aug. 1, 2008)

Wks. 19 New York Stock Exchange Listed Company Manual Section 2: Disclosure and Reporting Material Information

Wks. 20 NYSE Amex Company Guide: Part 4: Disclosure Policies (§§401–404)

Wks. 21 Excerpts From NASDAQ Marketplace Rules, Section 5000: NASDAQ Listing Rules*

Wks. 22 Sample Insider Trading Policy

Wks. 23 “Corporate Compliance Programs to Prevent Insider Trading Should Be Reevaluated in Light of Recent Developments,” Corporate Counsel Weekly (Apr. 24, 2002)

Wks. 24 Memorandum to Directors and Officers Regarding Section 16

Wks. 25 Vincent F. Chiarella v. United States, 445 U.S. 222 (1980)

Wks. 26 Raymond L. Dirks v. Securities and Exchange Commission, 463 U.S. 646 (1983)

Wks. 27 Basic, Inc. v. Levinson, 485 U.S. 224 (1988)

Wks. 28 United States v. O’Hagan, 521 U.S. 642 (1997)

Wks. 29 Staff Accounting Bulletin No. 99, 64 Fed. Reg. 45,150 (Aug. 19, 1999)

Wks. 30 U.S. Securities and Exchange Commission Definition of Insider Trading

Wks. 31 Speech by SEC Staff: “Opening Remarks to the Securities Industry and Financial Markets Association Regulatory Symposium on Insider Trading”

Wks. 32 Speech by SEC Staff: “Insider Trading – A U.S. Perspective” (Sept. 19, 1998)

Larry P. Ellsworth
Jenner & Block LLP
Washington, D.C.

Michael K. Lowman
Jenner & Block LLP
Washington, D.C.