The nation’s leading regulatory and financial institutionshave recently shown increased scrutiny concerning insider trading. Thisscrutiny has been coupled with a surge of regulatory investigations spanningall sectors of the economy.
Even without an allegation of improper trading, misuse ofconfidential information imposes costs on companies, including significant harmto reputation, reduced share price and investor confidence, interference withcorporate transactions, and the expense of executive time required to deal withattendant civil and regulatory litigation. For example, the recent firings of two senior executives of DowChemical—one of whom was also a board member—highlight the challenges directorsface with respect to confidential information. The two executives allegedly discussed and encouraged the potential saleof the company with an investment firm without the board’s approval. Reciprocalsuits and an informal Securities and Exchange Commission inquiry followedpublic disclosure of the incident.
These cases underscore how difficult it is for companies tokeep secrets secret. Many recent insidertrading cases involved employees providing confidential information to familymembers. Some involved seniorexecutives. Worse yet, compliance officersthemselves have been perpetrators ofinsider trading schemes.
When an employee acts illegally or improperly, the actionsof the firm will often be subject to regulatory scrutiny. To determine whethera company bears culpability, federal regulators will consider the adequacy ofthe corporation’s pre-existing compliance program, as well as any remedialactions it has taken, including implementation of an effective complianceprogram or the improvement of an existing one. Regulators will evaluate whethera compliance program is adequately designed and whether management is enforcingthe program or tacitly encouraging misconduct. Failure to take basicprecautions against the misuse of confidential information may be deemedevidence of reckless disregard and could result in corporate liability. At theextreme, the Federal Sentencing Guidelines give credit for the existence of aneffective compliance and ethics program if it was in place at the time of theoffense.
An effective compliance program can play a significant rolein minimizing corporate liability. Some important principles apply:
- Compliancerules and procedures should be in writing and disseminated widely.
- Tomaximize comprehension of compliance rules, employees should attend periodictraining programs and submit written acknowledgements of receipt andunderstanding.
- Complianceprograms should require the dissemination of confidential information on aneed-to-know basis and the use of code names for important matters.
- Employeeswith access to confidential information should be subject to formal tradingrestrictions. These could include, forexample, closed or blackout periods during which employees cannot trade thecompany’s securities, preclearance of all trades by a compliance officer, andestablishment of Rule 10b5-1 plans.
- Periodiccompliance audits should be conducted.
In addition, an effective compliance program depends inlarge part on enforcement by competent and ethical compliance officers. Directors and senior officers should closelyscrutinize candidates for these positions and conduct background checks priorto their appointment. Effective compliance begins with the “tone at the top.”
In today’s regulatory environment, a strong complianceprogram serves many purposes. While aboard cannot always protect against bad actors, it can take steps to reducefinancial and reputational harm to the company when misdeeds inevitablyoccur. This limits the potential costsof an employee’s greed, which are very real for the company, its directors, andits shareholders.