Company Secrets - Best Practices for Reducing Litigation and Liability Prospects

The nation’s leading regulatory and financial institutions have recently shown increased scrutiny concerning insider trading. This scrutiny has been coupled with a surge of regulatory investigations spanning all sectors of the economy. 

Even without an allegation of improper trading, misuse of confidential information imposes costs on companies, including significant harm to reputation, reduced share price and investor confidence, interference with corporate transactions, and the expense of executive time required to deal with attendant civil and regulatory litigation.  For example, the recent firings of two senior executives of Dow Chemical—one of whom was also a board member—highlight the challenges directors face with respect to confidential information.  The two executives allegedly discussed and encouraged the potential sale of the company with an investment firm without the board’s approval. Reciprocal suits and an informal Securities and Exchange Commission inquiry followed public disclosure of the incident. 

These cases underscore how difficult it is for companies to keep secrets secret.  Many recent insider trading cases involved employees providing confidential information to family members.  Some involved senior executives.  Worse yet, compliance officers themselves have been  perpetrators of insider trading schemes. 

When an employee acts illegally or improperly, the actions of the firm will often be subject to regulatory scrutiny. To determine whether a company bears culpability, federal regulators will consider the adequacy of the corporation’s pre-existing compliance program, as well as any remedial actions it has taken, including implementation of an effective compliance program or the improvement of an existing one. Regulators will evaluate whether a compliance program is adequately designed and whether management is enforcing the program or tacitly encouraging misconduct. Failure to take basic precautions against the misuse of confidential information may be deemed evidence of reckless disregard and could result in corporate liability. At the extreme, the Federal Sentencing Guidelines give credit for the existence of an effective compliance and ethics program if it was in place at the time of the offense.

An effective compliance program can play a significant role in minimizing corporate liability. Some important principles apply:

• Compliance rules and procedures should be in writing and disseminated widely.

• To maximize comprehension of compliance rules, employees should attend periodic training programs and submit written acknowledgements of receipt and understanding.

• Compliance programs should require the dissemination of confidential information on a need-to-know basis and the use of code names for important matters.

• Employees with access to confidential information should be subject to formal trading restrictions.  These could include, for example, closed or blackout periods during which employees cannot trade the company’s securities, preclearance of all trades by a compliance officer, and establishment of Rule 10b5-1 plans.

• Periodic compliance audits should be conducted. 
  

In addition, an effective compliance program depends in large part on enforcement by competent and ethical compliance officers.  Directors and senior officers should closely scrutinize candidates for these positions and conduct background checks prior to their appointment. Effective compliance begins with the “tone at the top.”

In today’s regulatory environment, a strong compliance program serves many purposes.  While a board cannot always protect against bad actors, it can take steps to reduce financial and reputational harm to the company when misdeeds inevitably occur.  This limits the potential costs of an employee’s greed, which are very real for the company, its directors, and its shareholders.