Disclosure Requirements

Almost every publicly traded company is required to disclose information to the Securities Exchange Commission (SEC). These disclosures come in the form of Annual, Quarterly, and Current Reports.

Annual Reports

Also known as Form 10-K or 10-K reports. This report includes a description of the business, risks, financial statements for the year, management analysis, and information about the compensation of executives. Depending on the status of the company, the latest these annual reports are due is 90 days after the end of the year.

Quarterly Reports

Reports need to file annual quarterly reports for quarters 1, 2, and 3. Also known as 10-Q.

Current Reports

After a triggering event listed in Form 8-K, the company is required to file a current report. Some triggering events include: bankruptcy, appointing new officers, changing the bylaws, etc.

Section 10(b) and Rule 10 b-5

According to these Rules, the company is subject to liability for providing inaccurate reports (including public statements). Violation of the rule could result in private action if the following elements are satisfied.

Materiality

A fact is material if it has a substantial likelihood that a reasonable investor would use the information to make an investment decision.

Scienter

Scienter is “a mental state embracing intent to deceive, manipulate, or defraud.” Recklessness in the report can meet this definition. The pleading standard must also be done with particularity (have to describe in detail why scienter exists).

Connection with the Purchase or Sale of a Security

The statements were designed to influence the investing public.

Reliance

The plaintiff needs to show that the misstatements or omissions were in part a reason why the plaintiff made the investing decision. This reliance is presumed under the “fraud-on-the-market” theory.

Economic Loss

Plaintiff must actually show that they suffered an economic loss due to the fraud. “Shares were 25, but are now 20 after correcting the information.”

Loss Causation

The plaintiff must show that the harm/loss was caused by the misrepresentation.

Proxy Voting Regulations

The vast majority of shareholders in private companies vote by proxy (in person attendance is just not that feasible).

Proxy Statement and Card

To prevent a corporation from soliciting proxies by fraud, corporations are required to provide all the information necessary for the shareholder to make an informed decision regarding the proxy. This information is included in the proxy statement and includes: information relating to the decisions to be made, biographies, and the like. The proxy card is the voting mechanism utilized in determining how many votes go where. Additionally, corporations typically need to provide the shareholders with the financial status of the corporation and will distribute a 10-K for the shareholders to review before the decision is made.

Shareholder Proposals

Because shareholders rarely meet in person, proposals often need to be submitted at least 4 months in advance. According to the SEC, shareholders must meet certain financial obligations within the corporation to submit a proposal. Once the proposal is submitted, the corporation can then filter out which proposals will be presented based on whether the proposal is not the responsibility of the shareholders or an improper request of the shareholders. This filtering is then approved or denied by the SEC before being presented for a vote.

Public Company Director Elections

Director elections are not meaningful, despite it being one of the few things shareholders actually have a right to vote on. This is because most shareholders vote by proxy and can only vote for those listed on the proxy card… provided by the management (board) of the corporation. As such, whoever the board picks will win. This is because even if the shareholders disapprove and “withdraw authority” or “reject” the nominee, their vote does not count against (no minus votes). Therefore, as long as there is one vote in favor of the nominee, the nominee will be selected.

The only way for disgruntled shareholders to compete is by creating their own proxy cards and solicit those proxies in competition to the board’s proposal. This is usually an expensive and time consuming process and thus rarely occurs.

Other ways to increase shareholder say is by implementing majority voting (instead of plurality), or to have proxy access bylaws (saying that shareholders have a right to submit contested names up for the proxy vote).

Takeaway: The board’s nominees will usually always be elected.

Corporate Governance Listing Standards

For a corporation to be listed in the NYSE or the NASDAQ, they have to meet certain governance requirements in addition to the financial requirements. These requirements include:

  1. Majority of directors must be independent
  2. Hold executive sessions comprised of non-management and independent directors
  3. Have a corporate governance committee comprised entirely of independent directors (purpose is to nominate directors)
  4. Have a compensation committee comprised entirely of independent directors.
  5. Constitute an audit committee comprised entirely of independent directors.
  6. Maintain and disclose corporate governance guidelines.
  7. Maintain a code of business conduct and ethics.

Insider Trading

Parties cannot either buy or sell securities on the basis of material, nonpublic information about the security. In other words, you can’t buy or sell if you have “inside knowledge” not privy to any other party.

Classical Theory

If a party has a relationship with the corporation and as a result of that relationship is able to obtain confidential information that is material in making an investment decision, then trading on that security is prohibited. This relationship can arise from being an actual or constructive (temporary) insider.

Misappropriation Theory

Even if a party is not an insider, if that party has a duty or trust or confidence related to material facts (like a third-party law firm, or spouse of a director), then the party cannot use the information to their advantage in trades.

Rule 14e-3

If a party obtains nonpublic information as a result of facilitating a tender (pending) offer to buyout shareholders, then the party is not allowed to trade based on that information. A breach here does not have to come as the result of a breach of a fiduciary duty, but the rule does require the the transaction involves a “tender offer.”

Tipper/Tippee Liability

A tipper is somebody who discloses nonpublic information (a “tip”). A tippee is the individual who uses that information to make a trade. Under all the theories above, both the tipper and the tippee could be liable for insider trading (depending on the facts).

Disclaimer

The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.

Will Laursen

Show Your Support

$5/month

Share
Table of Contents