April 24, 2008

Second Circuit Agrees Rule 16b-3 Available to Directors by Deputization

From Alan Dye’s “ Blog“: The U.S. Court of Appeals for the Second Circuit has affirmed the holding of a judge in the Southern District of New York that a director by deputization, including one that also is a ten percent owner, may rely on Rule 16b-3 to exempt its transactions with the issuer in Roth v. Perseus. Here is the opinion (the facts of the Roth case are described in this blog.) The Ninth Circuit had previously held that Rule 16b-3 applies to a director by deputization in Dreiling v. American Express Co..

The SEC filed an amicus curiae brief with the court, just as it did in Dreiling, arguing that Rule 16b-3 is available to directors by deputization. The court agreed, holding that the Commission’s view is neither inconsistent with Section 16(b) nor plainly erroneous and therefore is entitled to deference under Chevron U.S.A Inc. v. Natural Resources Defense Council. The court also upheld the validity of Rule 16b-3, holding that the rule is not arbitrary, capricious, or manifestly contrary to the statute.

The court was persuaded that the SEC had a legitimate rationale for the rule: a director’s or officer’s transactions with the issuer are subject to the fiduciary duties of the insider and the gatekeeping function served by the board or committee of non-employee directors. The plaintiff-appellant had argued that a director by deputization doesn’t owe the same fiduciary duties to the corporation that an elected director does and therefore should not be protected by Rule 16b-3. The court declined to address the extent of the fiduciary duties of a director by deputization, holding instead that the SEC could reasonably have concluded that the fiduciary duties of the director(s) appointed by the director by deputization were sufficient to justify the SEC’s position.

Alan’s blog has a new functionality: you can now input your email address (it’s the second box on the left side of the blog) so that you will be notified as soon as Alan has posted something new. Members of should sign up for this nifty service.

And yes, this notification service is available for this blog too. We’ve had this functionality for quite some time and thousands get this blog pushed out to them every day. Simply input your email address in the box to the left of this very text…

Time to Tune-up Your Insider Trading Policy: The RSA 21(a) Report

Last month, the SEC issued an Exchange Act Section 21(a) Report regarding Enforcement’s investigation of the Retirement Systems of Alabama (RSA). The “message” of the Report is one that likely seems obvious to all of us: have the policies, procedures, training and personnel in place to ensure compliance with the federal securities laws, including insider trading prohibitions. This is apparently a message that the SEC thinks warrants repeating through the unusual venue of a Section 21(a) report, which is probably enough to prompt most responsible companies to take a hard at their insider trading policies and procedures – and more importantly the actual understanding of those policies and procedures by employees, directors, etc. – in order to make sure that everything is operating effectively.

The situation described in the 21(a) Report is somewhat astonishing. The RSA, with more than $30 billion in assets under management, had no policies, procedures, training or compliance officer in place to make sure that it was complying with the federal securities laws in general or insider trading prohibitions in particular. The activities of the RSA’s employees, including its CEO (who has held that position for 30 years), showed a profound lack of knowledge – or judgment for that matter – when purchasing the shares of an acquisition target of one of their portfolio companies while confidential negotiations regarding the acquisition were ongoing. These trades were unusual in that the CEO directed them even though he was rarely involved in equity trading decisions and the target’s market capitalization was well below the RSA’s investment guidelines.

I think this Report points out something that it is often easy to forget for securities law practitioners – issues that seem completely obvious to us like the potential for insider trading violations may never even occur to others, including experienced business people. This is why policies and procedures are important, but perhaps more important is the process of educating employees about the law, the policies and procedures – and the serious implications arising from insider trading and other securities law violations.

This Report should give everyone responsible for compliance – no matter how big or small a company – an excuse to dust off that insider trading policy manual (or create on if you don’t have one) and figure out a way to refresh everyone’s memory about insider trading issues. An annual training exercise and reminder memoranda are always a good baseline, but you may need to do more to really reach people within the organization and leave a lasting impression.

For more information, check out our “Insider Trading Policies” Practice Area.

Why a Section 21(a) Report?

Section 21(a) Reports like the RSA report are a funny thing. It seems odd for the SEC to use a specific fact pattern – particularly where it did not feel it was appropriate to impose penalties – to communicate some broad policy statements, but that is usually what these reports are all about. In some instances, the purpose of the 21(a) Report is to put everyone on notice that the SEC is interested in pursuing Enforcement actions in a particular area in the future. There have only been a handful of 21(a) Reports over the past few years – you can see them all on this page at

In the RSA case, the SEC decided to not impose penalties because (1) RSA essentially sought to rescind the transactions with the sellers who sold RSA the stock while it was in possession of material nonpublic information; (2) any penalty would be paid out of the retirement system assets to the detriment of state and local employees; (3) a compliance program was established; (4) RSA and the CEO cooperated in the investigation; and (5) no individual profited from the conduct.

Instead, the 21(a) Report says that it seeks to “remind investment managers, public and private, of their obligation to comply with the federal securities laws and the risks they undertake by operating without an adequate compliance program.” But the lessons of the report should not be limited to investment managers, because just like RSA (which is not subject to SEC regulation as a broker-dealer or investment advisor), all public companies face the same risks – and potential liability under Exchange Act Section 21A – as a controlling person who fails to prevent insider trading. For this reason, I think that it is best to read the report broadly and use it as a catalyst for revisiting the effectiveness of insider trading compliance programs.

– Dave Lynn