Insider Trading and COVID-19: Navigating Regulatory Scrutiny During the Pandemic

The Securities and Exchange Commission (SEC or Commission) has recently made several public pronouncements related to the COVID-19 pandemic, indicating that it intends to focus enforcement efforts on insider trading. Acknowledging that many companies have faced financial challenges because of COVID-19, the SEC has warned that the current environment may create more opportunities for insider trading: a greater number of individuals are becoming privy to potentially market-moving information; that information is arguably even more valuable than under normal circumstances, and necessary reporting delays will increase the time in which insiders possess that information before disclosure. The SEC has advised companies to exercise vigilance under these circumstances, including through regular disclosures of critical information, particularly regarding the impact of COVID-19 on corporate operations, and through other best practices that proactively limit opportunities for employees to engage in suspicious trading.

This alert details (1) recent statements and actions by the SEC concerning insider trading during the pandemic and related regulatory issues, followed by (2) topics to consider to help minimize and address the potential risks created by these issues.

Recent SEC Statements and Actions Concerning Insider Trading and COVID-19

On May 12, 2020, at the annual Securities Enforcement West conference, SEC Enforcement Division Co-Director Steve Peikin and Associate Regional Director of Enforcement Katharine Zoladz reported on the SEC’s response to the pandemic and its outlook on future enforcement actions. As detailed in Mr. Peikin’s keynote address,¹ the Commission has formed a Coronavirus Steering Committee to proactively identify and investigate potential misconduct arising out of current market conditions, including through monitoring trading activity that suspiciously tracks announcements by companies in industries affected by COVID-19. In addition, Mr. Peikin and Ms. Zoladz affirmed the SEC’s commitment to identifying and investigating insider trading arising out of the pandemic, and referenced a series of public statements issued by the SEC and its chairman concerning insider trading and good “corporate hygiene” practices as the economy responds to the current crisis.

The SEC has repeatedly emphasized its expectation that the current economic climate will create more opportunities for individuals to trade while in possession of material nonpublic information.² That increased risk is largely due to the broadened scope of information that may become material in light of COVID-19: As companies work to respond in real time to the challenges posed by the pandemic, any information about that response has the potential to move markets. The SEC has advised market participants to take particular notice of information that might not have been considered material prior to the pandemic but could be of great significance now, including information on “the effects COVID-19 has had on a company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties.”³

The SEC further warned that the value of such information might become even more significant when there are delays in disclosing that information to the marketplace. Although delayed filings, earnings reports and other forms of disclosure have become an increasingly expected consequence of the pandemic, the SEC cautioned that these delays can result in a greater number of people, including, for example, “directors, officers, employees, and consultants and other outside professionals” having access to material information for longer periods of time.⁴ In a March 30 appearance on the CNBC program “Squawk Box,” SEC Chairman Jim Clayton highlighted the proliferation of “a great deal of asymmetric information, and what people would call material non-public information” leaking into the marketplace. While declining to comment on any ongoing investigations, including the recent investigation of Sen. Richard Burr who allegedly traded stocks when in possession of classified information about COVID-19, Chairman Clayton further advised that “anyone who is privy to private information about a company or about markets needs to be cautious about how they use that private information. That’s sort of fundamental to our security laws and that applies to government employees, public officials, et cetera.”⁵

With these issues in mind, the SEC recently advised companies to take certain steps to reduce the risk that corporate insiders will trade while in possession of material nonpublic information. Primarily, the SEC encouraged companies to make regular, timely and full disclosures of information related to the effects of COVID-19 on operations. As advised by the SEC Division of Corporate Finance, companies should “be mindful of their established disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD and selective disclosure prohibitions to ensure to the greatest extent possible that they protect against the improper dissemination and use of material nonpublic information.”⁶ During a May 4 Special Meeting of the Investor Advisory Committee, Chairman Clayton provided three questions which he encouraged companies to consider during the pandemic in identifying the type of information warranting disclosure:⁷

1. How long can the business sustain its current operating posture in the absence of additional funding?
2. Have supply and distribution chains been temporarily or permanently disrupted?
3. How [does the company] plan to manage the health and safety of [its] employees and customers as [it] and other market participants seek to increase activity?

In addition, the SEC recently reminded employers to encourage their employees to follow best practices regarding the protection and distribution of material nonpublic information, including by practicing “good hygiene,”⁸ and refraining from trading until material information is fully disseminated to the marketplace.⁹

The SEC has already begun to bring enforcement actions in response to the pandemic. In March, it imposed trading suspensions on securities of Praxyn Corp. in response to Praxyn’s suspicious press releases concerning an inventory of N-95 masks. The SEC subsequently pursued an investigation and brought fraud charges against the company. In addition, in mid-May, the SEC announced that it was conducting inquiries of public companies that received Paycheck Protection Program funding to verify the companies’ disclosures concerning the effects of COVID-19 on their business. As the economic effects of COVID-19 continue to unfold, companies can expect the SEC to continue its enforcement efforts, and to focus on insider trading schemes relating to the pandemic.

Practice Points Following the SEC’s Recent Guidance

In light of the SEC’s stated focus on insider trading relating to the pandemic, below are some considerations for companies seeking to curtail the risks of insider trading and related regulatory issues of which companies should be aware:

• Remain mindful of the SEC’s expanded view of what might constitute material information during the course of the pandemic. The SEC’s recent guidance indicates that information related to a company’s status in light of the current economic climate and the COVID-19 pandemic may now have a material impact on a company’s share price. Companies should consider Chairman Clayton’s May 4 remarks to identify markers of potentially material information that may not have previously been considered material, including:
  
  
  • Information related to a company’s plans to apply for federal bailout funding, to request share buybacks or to enact other capital preservation efforts.
  • Consideration of plans to downsize, furlough or hire employees.
  • Plans to issue pay cuts or suspend operations.
  • The health of employees or key executives.
  • The risks and challenges of remote operations.
  • Information regarding the performance and operations of participants within the customer and the supply chain.
    
    
• Ensure timely disclosure of material information, including information concerning COVID-19. To reduce the window in which potentially market-moving information is nonpublic, companies should issue timely disclosures whenever possible. When questions arise as to whether disclosure is necessary or appropriate, it may be advisable to err on the side of disclosure. In these situations, it may be preferable to consult with disclosure counsel.
  
  
• Provide tailored guidance on information security and compliance to employees working remotely. Encourage employees working from home to engage in good “cyber hygiene” practices to ensure that any nonpublic information learned during the course of their remote employment remains confidential. Remind them to avoid disclosing any information about the company to family members, friends or others in the home. Companies may encourage employees to (i) designate an area in their home that affords privacy and protects confidential information from others, (ii) use privacy screens on their computers, (iii) lock their computers when they are away from their work area, (iv) use a company-issued computer, and (v) avoid saving data to a personal device. In addition, some financial services providers are subject to regulations requiring the recording of business-related communications. Those providers should implement updated practices for maintaining compliance with these regulations while employees work from home. For example, companies should encourage traders to (i) use mobile trading apps instead of phone calls when conducting trades to create digital records and (ii) log detailed handwritten notes of calls.
  
  
• Exercise increased vigilance over selective disclosures to brokers, analysts and company investors. Regulation FD prohibits the disclosure of information to brokers, analysts or company investors unless that information was previously publicly disclosed or is simultaneously disclosed to the public. As the effects of COVID-19 continue to unfold, companies may field an influx of questions from investors and other financial professionals. It is critical to issue regular reminders to all corporate spokespersons, who may possess market-moving information, of their selective disclosure requirements to protect against inadvertent or inconsistent disclosures.
  
  
• Consider expanding the list of employees who receive guidance concerning trading. Because more employees than usual may have access to material nonpublic information during this turbulent time, companies should consider disseminating updated policies and regular reminders to all employees.
  
  
• Update internal trading policies and remind employees of the risks of trading while in possession of potentially market-moving information. Through both updating internal trading policies and issuing regular companywide reminders, companies should inform all employees of their obligations to consider whether they possess potentially market-moving information, including information related to the company’s response to the COVID-19 pandemic, before trading in company securities. Companies may also wish to remind employees to be particularly wary of trading before significant announcements, especially if the company plans to report bad news. Companies should also remind employees that material nonpublic information can come from other companies or even from the government, including through lobbyists or political intelligence firms; given the increase in government relief programs during the pandemic, employees may have expanded communications with the government concerning confidential information. Companies should encourage employees to consult counsel or compliance personnel before trading if they are unsure whether they are in possession of material nonpublic information.
  
  
• Train employees on the unique threats posed in the current environment. Along with updating internal policies, companies should consider training, including by videoconference, to ensure that employees are aware of the specific risks to the company raised by the COVID-19 pandemic. Trainings should address the company’s updated guidance on the criteria for material nonpublic information in the context of COVID-19, and they should encourage employees to follow best practices for working remotely, as described above.
  
  
• Reevaluate trading restrictions, including blackout periods and 10b5-1 trading plans. Because more employees may become privy to an expanded scope of market-moving information during the pandemic, companies may wish to consider lengthening blackout periods and expanding their application to accommodate additional employees. Similarly, companies may also wish to consider the pros and cons of amending 10b5-1 plans to accommodate additional employees. Because SEC staff have historically been suspicious of revisions to 10b5-1 plans, and the utility of such plans may diminish with increased amendments to the plan, companies should exercise caution and consult with counsel before finalizing any plan modifications.
  
  
• Proactively investigate suspicious trading activity. Companies may actively review employee trades on an ongoing basis to identify any activity that may warrant an investigation. Should screening reveal suspicious trading activity, companies must fulfill any document preservation obligations. Companies should also consider retaining experienced outside counsel to conduct an internal investigation and cooperate with any investigating regulators. In light of the logistical challenges presented by the pandemic in interviewing potential witnesses remotely and in collecting relevant documents, companies should also consider the advantages of providing counsel to employees and executives to help manage and address these challenges.

^{1 Keynote Address: Securities Enforcement Forum West 2020, Steven Peikin, Co-Director, SEC Division of Enforcement, May 12, 2020, Transcript of remarks available here. Note that before they spoke, each representative of the SEC who addressed the Securities Enforcement Forum West conference provided a disclaimer that the views they expressed were their own and not representative of the views of the Commission.}

^{2 See, e.g., SEC Public Statement, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity (March 23, 2020), available here; SEC, Coronavirus (COVID-19) SEC Division of Corporation Finance CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available here; SEC Public Statement, The Importance of Disclosure – For Investors, Markets and Our Fight Against COVID-19 (April 8, 2020), available here.}

^{3 SEC, Coronavirus (COVID-19) SEC Division of Corporation Finance CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available here.}

^{4 SEC Public Statement, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity (March 23, 2020).}

^{5 CNBC Transcript: SEC Chairman Jay Clayton Speaks with CNBC’s Andrew Ross Sorkin on “Squawk Box” Today (March 30, 2020), available here.}

^{6 SEC, Coronavirus (COVID-19) SEC Division of Corporation Finance CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available here.}

^{7 SEC Public Statement, Statement from Chairman Jay Clayton, Remarks at Special Meeting of the Investor Advisory Committee (May 4, 2020), available here.}

^{8 CNBC Transcript: SEC Chairman Jay Clayton Speaks with CNBC’s Andrew Ross Sorkin on “Squawk Box” Today (March 30, 2020), available here; CNBC Transcript: SEC Chairman Jay Clayton Speaks with CNBC’s Andrew Ross Sorkin on “Squawk Box” Today (April 7, 2020), available here.}

^{9 SEC Public Statement, Statement from Chairman Jay Clayton and William Hinman, Director, Division of Corporation Finance, The Importance of Disclosure – For Investors, Markets and Our Fight Against COVID-19 (April 8, 2020), available here.}