Prohibitions on insider trades during pension fund blackout periods

October 16, 2014

5273The senior officers of a corporation, notably the president, chief executive officer (“CEO”) and chief financial officer (“CFO”), are typically vested with all power and authority required for the day-to-day operation of the business, subject to oversight by the board of directors. See Corporate Directors and Officers (§§ 9:1 et seq.). While this general concept has survived the wave of corporate governance reforms, a number of new rules and regulations were adopted to curb the incentives for senior managers of public companies to engage in activities that might be harmful to investors. Examples include the following:

  • Officers are prohibited from exerting, or attempting to exert, improper influence on the conduct of an audit, including any attempt to fraudulently influence, coerce, manipulate or mislead any public or certified accountant engaged in the audit.
  • The CEO and CFO will be required to forfeit certain bonuses and profits in the event their company is required to restate its accounting results due to material noncompliance by the company, as a result of misconduct, with any financial reporting requirement imposed under the securities laws.
  • Any officer who violates Section 10(b) of the Exchange Act or Section 17(a)(1) of the Securities Act, including the rules and regulations promulgated thereunder, can be barred from acting as a director or officer of a reporting company if a court determines that the person’s conduct demonstrates “substantial unfitness” to serve in such capacities.
  • Executive officers of reporting companies are prohibited from engaging in certain trading activities in securities of such companies during pension fund blackout periods.
  • Personal loans to officers of reporting companies have essentially been prohibited.

Each of the prohibitions listed above applies with equal force to directors of public companies, including outside directors that are not employed as managers of the company.

As noted above, directors and officers are prohibited from trading in equity securities they received as compensation for services to the company during any “blackout period” of an “individual account plan.” (Sarbanes-Oxley Act § 306(a)(1), 15 U.S.C.A. § 7244(a)(1). See also SEC Release No. 34-47225, Insider Trades During Pension Fund Blackout Periods (Jan. 22, 2003).) The term “individual account plan” is defined by reference to ERISA and would include a company’s 401(k) plan or other profit-sharing or retirement plan. (Sarbanes-Oxley Act § 306(a)(5), 15 U.S.C.A. § 7244(a)(5)) A blackout period generally exists in those situations where the issuer or plan fiduciary suspends the ability of at least 50% of the plan participants to buy or sell the issuer’s securities. (Sarbanes-Oxley Act § 306(a)(4), 15 U.S.C.A. § 7244(a)(4))  Any profit from trades that are made in violation of this restriction may, regardless of the intent of the seller, be recovered by the company through a civil action brought by the company or through a shareholder derivative suit. (Sarbanes-Oxley Act § 306(a)(2), 15 U.S.C.A. § 7244(a)(2)) Such blackout periods must be disclosed to officers, directors, the SEC, and plan participants. (Sarbanes-Oxley Act § 306(a)(6),(b); 15 U.S.C.A. § 7244(a)(6), (b))  For a form of notice to be distributed internally regarding prohibitions on trading during pension blackout periods, see Specialty Form at § 91:232.50.  The Form is based on a model released by the US Department of Labor (DOL) and while use of the model is not mandatory, it is recommended as a means for ensuring the minimum level of compliance.  Regardless of the form of notice used, plan administrators must be sure that the notice describes participants’ and beneficiaries’ rights otherwise available under the plan during the blackout period and its projected duration, including the expected start and end dates, and that the notice provides the name, address and phone number of the plan administrator or other person responsible for answering participants’ questions about the blackout.