June 24, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
RE: Exchange Act Release No. 34-45742; File No. S7-09-02
Dear Mr. Katz:
This letter comments on the revision to the Securities and Exchange Commission Form 8-K filing requirements proposed in Release No. 34-45742, dated April 12, 2002 (the "Proposal"). This letter, submitted on behalf of a firm client, focuses, in particular, on the two-day reporting cycle proposed for certain securities transactions.
The Proposal is intended to accelerate disclosure of transactions in an issuer's securities by certain insiders. Among other things, the Proposal seeks to add three new types of transactions to the current list of events that an issuer must disclose on a Form 8-K: (a) transactions by directors and executive officers in an issuer's equity securities (including derivative transactions and transactions with the company); (b) any contract or written plan entered into by directors or executive officers in order to comply with the affirmative defense provisions of Exchange Act Rule 10b5-1(c); and (c) money loans to directors and executive officers made or guaranteed by the company or an affiliate.
Insider transactions in an issuer's securities can be an important component in the mix of information about a public company. Information about these transactions provides a window into the actions of the individuals most familiar with a company. While sales may be executed for reasons unrelated to the company's performance (such as portfolio diversification), director and executive officer open market purchases are perceived as particularly significant.1 For example, increased purchases by executive officers after U.S. equity markets reopened on September 17, 2001 represented a tangible signal that the equity securities of their companies were undervalued after a dramatic market correction.2 More generally, empirical studies consistently have found that trading by insiders outperforms broad market indices.3
The current structure for reporting transactions by directors and executive officers is antiquated. Reports of transactions under Section 16(a) of the Securities Exchange Act are due no sooner than ten days after the month in which they occur. Since insiders are not required to file reports on the SEC's EDGAR system, investors typically must rely on intermediaries to compile data from hard copies. Inevitably, valuable information is slow to reach the marketplace. For example, the length of the current period for disclosing insider transactions likely delayed investor access to this information when U.S. markets reopened in September, 2001. The Dow Jones Industrial Average had increased 12 percent from its post September 11, 2001 lows before director and executive officer reports reflecting September, 2001 purchases were due to be filed on October 10, 2001.4
While the Proposal has great merit, we urge the Commission to revisit the proposed requirement that issuers file Form 8-K reports within two days if the value of the transaction equals or exceeds $100,000. We believe that a two-day reporting requirement is destined to produce a spate of inaccurate and untimely reports. Such a requirement would be particularly burdensome for large transactions executed by an issuer's non-management directors. Our letter addresses these concerns and proposes a slight modification that would allow the Commission to achieve its policy objective.
I. A Reporting Deadline Two Days From the Trade Date Is Impractical
In the era of the Internet, it is natural to expect that information about a fixed event - e.g., an individual's market transactions in a company's securities - should be available virtually instantly. Indeed, some legislative proposals would require disclosure of information of insider transactions on the same day of the transaction.5 The Commission's proposing release stressed that the "reportable event" that triggers the two-day reporting requirement "would be the trade date." We believe that the truncated two-day reporting cycle would be unduly burdensome for issuers.
Information about director and executive officer transactions in an issuer's securities is not the company's information nor, typically, is this information generated by the company's internal systems. Instead, trade information is created by individuals who, in turn, would need to transfer this information to the issuer to facilitate the disclosures contemplated by the Proposal. It would be burdensome, at best, to effect that transfer within the two days contemplated by the Proposal.
Information about securities trades is processed over two dates. The first is the trade date, or the date on which a party commits, typically through a transaction on a securities market, to purchase or sell the security. The second is the "settlement date," or the date of the actual exchange of the payment and security, which Exchange Act Rule 15c6-1 mandates occur no later than three business days after the trade date.
Requiring issuers to report director and executive officer trades before they settle will create a high risk of tardy and/or inaccurate filings. Requiring disclosure in this "interim" period will subject this reporting to errors that occur prior to settlement.6 Timely filings may be possible if the individual has consented to electronic confirmation of transactions and has transmitted the information immediately to the issuer. Under the best of circumstances, the issuer will be required to receive the information, prepare the form and arrange for filing - all within a 48-hour period. A delay at any step could produce a late filing. In the absence of timely electronic notification, this reporting may be based on anecdotal accounts - e.g., reports will be based on an individual's report regarding their broker-dealer's oral representation that the trade was executed in a particular way. Such reporting is possible. In practice, however, we believe that the two-day reporting requirement will impose a significant administrative burden on the issuer, and even that effort may not be enough to produce accurate reports before the proposed deadline.
If the Proposal is adopted, the adverse impact of tardy Form 8-K filings will not be limited to the prospect of SEC enforcement actions. The proposing release specifically notes that the revised Form 8-K instructions would include an instruction that the Commission does not find it in the public interest to sanction violations that are corrected promptly and occurred despite the adoption of reasonable procedures. While that reflects a balanced approach to the use of the Commission's enforcement remedies, it cannot ameliorate completely the impact of a late filing relating to a substantial transaction by a company's director or executive officer. In many instances, these filings will be monitored closely by the financial press and market participants. A late filing could result in considerable public embarrassment and reputational harm even in the absence of an SEC enforcement action.
By contrast, if the settlement of the trade was the reportable event, then the reporting process would be significantly simpler and more accurate. At the same time, the marketplace would have the information within five business days of the transaction on the relevant exchange. This represents a substantial improvement over current reporting requirements while minimizing the burdens and inaccuracies associated with such filings.
II. Transactions by Non-Management Directors Should Be Exempt From a Two-Day Reporting Requirement
The difficulties with two-day reporting are particularly pronounced for transactions by an issuer's non-management directors. Requiring the issuer to report, on an accelerated basis, personal transactions of individuals independent of the company would only compound the logistical hurdles. The burdens associated with compliance with these rules will far outweigh the benefits associated with accelerated reporting.
Independent directors are central to the modern U.S. corporate governance model.7 Recent reform initiatives have reinforced that independence. In 1999, the "Blue Ribbon Committee" charged with assessing audit committee effectiveness stressed that "independence is critical to ensuring that the board fulfills its objective oversight role and holds management accountable to shareholders."8 In the wake of that report, the independence requirement excludes, in most instances, former employees for a three-year period and individuals who have a direct business relationship with the company from audit committee membership.9 Earlier this month, a New York Stock Exchange committee recommended that listing standards be amended to require that independent directors comprise a majority of each company's board and that board audit, nominating and compensation committees be made up solely of independent directors.10
The independence of most non-management directors poses significant logistical problems for issuers attempting to comply with a requirement to report personal securities transactions within a two-day period. The two-day deadline would require virtually instantaneous coordination with these directors regarding their personal finances. Unlike executive officers (who, at a minimum, are integrated into the company systems and subject to the company's direction), non-management directors are often geographically dispersed and consumed in day-to-day responsibilities unrelated to the issuer. Meeting the two-day reporting cycle with non-management directors would pose a significant administrative challenge for issuers.
As just one example, the complexities surrounding the reporting of transactions executed by trusts pose a logistical burden for issuers. The Proposal would require an issuer to report transactions related to trusts that an insider would be required to report under Rule 16a-8. That requirement is not always clear. For example, under Rule 16a-8(b)(2), an insider who served as a trustee and had a pecuniary interest in a trust could be required to report trust transactions over which the insider did not exercise investment control. In effect, the Proposal would involve issuers in coordinating their filings with the activities of often complex trust structures that involve insiders. Requiring that disclosure two days after a trade will place a marked strain on that coordination.
Again, we believe that having the settlement date of the transactions trigger the reporting requirements would ameliorate some of these difficulties. To the extent that the Commission makes a determination that a two-day reporting cycle tied to the trade date is necessary, we believe that this abbreviated schedule should be limited to executive officers. It is important to recognize that the difficulties associated with reporting for non-management directors should cause them to be placed in a separate category.
We appreciate your consideration of our comments. Please call Karl Groskaufmanis at 202-639-7314 if you have any questions about or require clarification of our comments.
Karl A. Groskaufmanis
|1||See Josef Lakonishok and Immoo Lee, Are Insider Trades Informative? 14 Rev. Fin. Stud. 79, 109 (2001) ("Insiders have many reasons to sell shares but the main reason to buy shares is to make money. Our results support this view.").|
|2||See, e.g., John Friedman, Insiders Sell Less, Buy More, Sending Bullish Stock Signals, L.A. Times, Oct. 23, 2001, at 1 (noting marked decrease in insider sales and increase in insider purchases from September 2001 data).|
|3||See, e.g., Carr Bettis, Don Vickrey and Donn W. Vickrey, Mimickers of Corporate Insiders Who Make Large-Volume Trades, Fin. Analysts J., Sept.-Oct. 1997, 57, 60 ("[O]utsiders who mimicked insiders still had opportunities to earn significant abnormal returns during the sample period."); H. Nejat Seyhun, The Information Content of Aggregate Insider Trading, 61 J. Bus. 1, 22 (1988) ("[N]et aggregate insider trading activity in a given month is significantly positively correlated with the return to the market portfolio during the subsequent two months.").|
|4||On September 25, 2001, the DJIA closed at 8235.81. By October 10, 2001, the DJIA had recovered to 9240.86. See also Jonathan Moreland, Two Modest Proposals For Fixing Insider Trading Rules, TheStreet.com, Feb. 11, 2002, at http://www.thestreet.com.|
|5||See, e.g, Fully Informed Investor Act of 2002, S. 1897, 107th Cong. (2002); Insider Trading Full Disclosure Act of 2002, H.R. 3769, 107th Cong. (2002).|
|6||See Joseph T. Gramlich and Sam Sparhawk IV, Straight Through Processing and T+1: A Call to Action, Am. Bank. Assoc. Trust and Investments, Nov.-Dec. 2001, 33 ("The average daily volume of trades not affirmed prior to settlement grew from 12,000 to 41,000 between 1995 and 1999, and 10 percent of domestic trades . . . currently experience errors, most frequently mismatched trade data.").|
|7||See, e.g., Jill E. Fisch, Taking Boards Seriously, 19 Cardozo L. Rev. 265, 265 (1997) (noting "the dramatic evolution of the corporate board - from a homogenous insider-dominated club to a diverse and independent body.").|
|8||Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees 22 (1999), http://www.nyse.com/pdfs/blueribb.pdf.|
|9||See, e.g., Exchange Act Release No. 34-42233 (Dec. 14, 1999), available at http://www.sec.gov/rules/sro/ny9939o.htm (approving the adoption of amendments to Section 303 of the New York Stock Exchange Listed Company Manual).|
|10||See Report of the New York Stock Exchange Corporate Accountability and Listing Standards Committee (June 6, 2002), http://www.nyse.com/pdfs/corp_govreport.pdf.|