If the Office of Fraud Detection and Market Surveillance of the Financial Industry Regulatory Agency (FINRA) has never conducted a review of trading activity in your company’s publicly-traded securities, then you might be living in ignorant bliss about the adequacy of your insider trading program. At least, know this – just having a board-approved insider trading policy won’t cut it. Every publicly-traded company needs an insider trading program.
When FINRA identifies unusual trading activity, it causes them to first look at what event involving the company inspired the activity, which means they look at the timing of the trading activity in correlation to the company’s announcement of something material to investors’ decisions to trade in the company’s securities. Once they identify the event, such as an announcement of a merger or the announcement of financial results, the next step is for FINRA to ask the company for information not only about who knew what and when they knew it, but also about what processes and controls the company had in place to prevent the leaking of material non-public information (MNI).
Like all policies, the processes and controls supporting the company’s insider trading policy are what give the policy teeth. Without them, all you have is a piece of paper with words on it. Following are the components of a sound insider trading program:
1) A policy that is relevant to the company’s business. If your company is in the business of keeping other companies’ MNI secret then your insider trading policy should extend beyond your own company’s securities. If your company is newly public, chances are your outside law firm provided you with their stock policy, which typically pertains only to the company’s own securities. It is important to read through the policy with the realities of the company’s business in mind.
2) A training and certification program for all officers, employees, directors and independent contractors. It is critical to ensure that all employees, officers, directors and independent contractors understand what illegal insider trading and MNI are and the mechanics of the company’s insider trading policy. This is especially critical for newly public companies whose employees must understand that it is no longer “business as usual” after the company goes public. Many employees will be tempted to monitor the company’s stock price after the IPO and buy and sell the company’s stock through their own brokerage accounts. Thorough training and a certificate for everyone to sign acknowledging that they have received the training and understand the mechanics of the policy are very important.
3) Identification of criteria for insider designations. Every company is different in the way it shares MNI among employees of differing ranks and functional responsibilities. Therefore, the criteria for designating an employee an insider subject to heightened trading restrictions will vary. Rank and functional responsibility are two good starting points. For example, if the company routinely holds meetings for all employees with the rank of “Senior Vice President” and MNI is discussed at these meetings, then all SVPs should be designated as insiders. Since lower level employees in finance and accounting are in possession of financial data on a daily basis, perhaps all employees in F&A should be designated as insiders. If the employee basis is small enough and there are not many “Chinese Walls,” then it might be best for all employees to be designated insiders.
4) A process for identifying individuals to be flagged as “insiders” and notifying insiders of their designations. This is where the human resources department must be engaged as a partner and cooperate with the legal or compliance department to share information about new-hires and terminations in a timely fashion. Once a daily or weekly list of insiders is identified, Legal or Compliance should send a notification to each individual explaining what the designation means, providing a link to the policy and putting in plain terms what the individual’s responsibilities are as an insider. In addition, lists of participants in working groups involved in special projects that are themselves MNI, e.g., merger or acquisition, are especially important to maintain with due care.
5) Coordination with stock plan administrator. The brokerage firm that administers the company’s employee stock purchase plan (ESPP) and equity incentive plans will likely provide an online capability for the sale of stock purchased by, or awarded to, employees, officers and directors under these plans. The brokerage firm typically designates codes to each participant based on their status as employee, named executive officer or director and will prevent the individual from submitting sell orders during blackout periods or, if an officer or director, at all times absent Compliance Officer approval. As such, it is critical to work out a file-sharing process between HR, Compliance/Legal and the equity plan administrator so that employees are properly flagged, trading windows are known and new-hires and terminations are accounted for.
6) A process for the submission and approval of insider’s trading requests. Many policies include a form for the submission of insider trading requests. These forms typically require the individual to provide details about their intended transaction (e.g., buy/sell, quantity and price). These forms should also include a certification for the employee to sign, acknowledging that they understand the policy and what constitutes MNI and certifying that they are not in possession of MNI.
7) A process for the identification of transactions under 10b5-1 plans. Trades in the company’s stock that are set to take place automatically when the company’s stock trades at a certain price most often come to the Compliance Officer’s attention after they take place. They are typically communicated in a simple e-mail notification from the brokerage company that administers the plan. That can put the company on its heels when investors call up the company’s investor relations officer to ask why the company’s CEO just unloaded a large amount of the company’s stock. Therefore, it is very important to set up a dashboard of the schedules of all 10b5-1 plan transactions and monitor planned trades in correlation to the company’s stock price so that the company’s IR and PR teams can get ahead it.
8) A process for notifying all employees of the opening and closing of the inside trading window. Trading windows typically open two days after the announcement of earning and close two weeks ahead of the end of the quarter. Employees should be adequately notified of the opening and closing of trading windows, and insiders subject to heightened trading restrictions should be reminded of their obligation to seek approval form the Compliance Officer.
9) Reference to the policy in the company’s Code of Conduct and Business Ethics. Since insider trading is an ethical matter, reference to the policy should be made in the company’s code of Code of Conduct in order to reinforce the seriousness of the topic.
10) A process for documenting and filing all of the above. When FINRA or the SEC does come knocking, it will request that the company produce a ton of information pertaining to the controls the company has in place to prevent illegal insider trading in the company’s securities. It will also request information pertaining to specific transaction that’s took place within their window of inquiry. As such, every piece of documentation described above including all certifications, insider trading requests, trading window notifications, insider designations, insider lists, 10b5-1 plan approvals, etc. should be stored both electronically and in hard copy ina safe and accessible location.
Even though it is not within FINRA’s jurisdiction to prosecute an issuer for trading abuses, FINRA does refer cases to the SEC for further investigation, and the SEC does have the jurisdiction to investigate issuers and hold the issuer’s directors, officers and employees accountable under the U.S. securities laws and regulations. In the event of any such investigation, a solid insider trading program will, at least, demonstrate to the SEC that the company takes illegal insider trading seriously.