By Bill Flook
The House of Representatives, by a wide margin, on January 13, 2020, passed a measure to bar corporate insiders from trading on material nonpublic information in the days before making a Form 8-K current report filing.
H.R. 4335, the 8-K Trading Gap Act of 2019, is sponsored by Rep. Carolyn Maloney, a New York Democrat. The bill passed on a 384-7 vote.
The 8-K Trading Gap Act would amend the Securities Exchange Act of 1934 to mandate the SEC issue rules requiring reporting companies to “maintain policies, controls, and procedures that are reasonably designed to prohibit executive officers and directors of the issuer from purchasing, selling, or otherwise transferring any equity security of the issuer, directly or indirectly,” during the period between coming into possession of material nonpublic information and the company publicly disclosing it.
“Corporate executives shouldn’t be allowed to trade on significant information ahead of the public and investors, but that’s exactly what’s happening because of this legal loophole,” said Maloney in a statement. “My bill has a very simple solution to this problem; prohibit executives from trading during the four-day gap between when an event happens and when the company publicly files a Form 8-K to alert the public and shareholders of the event.”
She urged the Senate to quickly pass the bill, citing the broad bipartisan support for the measure. Sen. Chris Van Hollen, a Maryland Democrat, in September 2019 introduced the Senate version of the 8-K Trading Gap Act.
“When a corporation faces a big change — like a data breach, merger, or acquisition — public transparency is crucial to prevent insider trading and protect retail investors,” Van Hollen said in a statement following passage of the House bill. “But under the current system, corporate insiders have a head start on the public, allowing them to sell off stock or cash in on private information. This is a total abuse of the public trust.”
Proponents of the legislation argue it would more explicitly close the so-called “trading gap” in the window before an 8-K is filed, preventing insiders from gaining an edge over retail investors. A 2015 Columbia Law School paper that reviewed thousands of 8-K filings found insiders “are more likely to engage in open market purchases of their own company’s stock when the firm is about to reveal new agreements with customers and suppliers.” The paper’s authors, who include now SEC Commissioner Robert Jackson, urged Congress to reconsider “the effects of information-forcing rules such as those governing Form 8-K on the incidence and profitability of trading by insiders.”
Opponents of the bill say it is redundant to existing insider trading prohibitions under Rule 10b-5. In written testimony for an April 2019 Financial Services subcommittee hearing, Thomas Quaadman, executive vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, expressed skepticism that the bill would prevent future insider trading.
“A bad actor who has determined to violate the federal securities laws by engaging in conduct as serious as insider trading is not likely to be deterred by a second, redundant prohibition against the same misconduct that is found in an employer’s internal policies, procedures, and controls,” Quaadman testified.
Quaadman added that the bill assumes that all events triggering a Form 8-K filing are certain on the first day of a four-business-day reporting cycle. Those decisions, he wrote, can take several days of consultation with counsel, and in many cases a company doesn’t resolve to file an 8-K until closer to the reporting deadline.
Today, a company has a deadline of four business days following an 8-K triggering event to make the filing. The SEC set that deadline in 2004 in Release No. 33-8400, Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date, which also expanded the number of reportable events under Form 8-K. The SEC had originally proposed to create a two-business-day deadline, but ultimately doubled that filing period after an industry outcry.
Prior to those reforms, public companies had five business days, or 15 calendar days, to file an 8-K, depending on the circumstances, and had a shorter list of reportable events.
The SEC issued the rule as part of its “real time issuer disclosures” mandate under Section 409 of the Sarbanes-Oxley Act of 2002, which called on reporting companies to release information on certain material changes “on a rapid and current basis” to protect investors.
This article originally appeared in the January 15, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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