United States: More "Broken Windows": SEC Charges Schedule 13D Filers With Disclosure Violations For Failing To Update Ownership Reports

Last Updated: March 25 2015
Article by Chip Phinney and Megan N. Gates

When a significant stockholder in a publicly-held company is considering plans to take the company private, how soon must the stockholder disclose those plans in a Schedule 13D filing?

The SEC recently announced settlements of charges against eight officers, directors, and/or major shareholders in cases involving three different public companies for failing to file timely amendments to Schedule 13D stock ownership disclosure forms to report plans to take those companies private. Like the SEC's actions last September against late Section 16 form filers, these new actions appear to be intended to remind officers, directors, and shareholders at public companies of the importance of making timely disclosures mandated by SEC rules, following the "broken windows" approach to enforcement outlined by SEC Chair Mary Jo White.

In the orders relating to these cases, the SEC took the position that a Schedule 13D disclosure "must be amended when a plan ... has been formulated" with respect to a disclosable matter, such as a going-private transaction, even where the filer's previous Schedule 13D generally reserved the right to engage in the kinds of transactions subject to disclosure. In commenting on these cases, SEC Enforcement Director Andrew Ceresney emphasized that broad boilerplate statements are not sufficient: "Stale, generic disclosures that simply reserve the right to engage in certain corporate transactions do not suffice when there are material changes to those plans, including actions to take a company private." The SEC has also cautioned that an amendment may also be required even before a plan has been definitively formulated if there is a material change in the facts set forth in a previous Schedule 13D.

Section 13(d)(1) of the Securities Exchange Act and SEC Rule 13d-1 together require any person who acquires beneficial ownership, directly or indirectly, of more than five percent of certain classes of equity securities, including voting stock in any publicly registered company, to file a Schedule 13D (or in some cases Schedule 13G) within 10 days of the acquisition. Item 4 of Schedule 13D requires the filer to "[s]tate the purpose or purposes of the acquisition of securities of the issuer" and "[d]escribe any plans or proposals which the reporting persons may have which relate to or would result" in certain specified changes in the company's corporate or capital structure, including any extraordinary corporate transaction, such as a merger, reorganization or liquidation, or delisting the company's securities. If there is any material change in the facts stated in a previously filed Schedule 13D, the filer must submit updated information under Section 13(d)(2) of the Exchange Act and SEC Rule 13d-2(a).

In the settled administrative proceedings announced recently, the SEC found that the respondent beneficial stockholders had violated Section 13(d) of the Exchange Act by failing to file timely Schedule 13D amendments disclosing plans to take the respective public companies with which they were associated private. The SEC noted that proof of scienter (a.k.a. "intent") is not a prerequisite to establishing a violation of Section 13(d), and in none of these cases did the SEC find that that the violations were deliberate. The civil penalties assessed by the SEC ranged from $15,000 to $75,000.

Six of the eight cases concerned a going-private transaction involving a hospital management services company. In these cases, the company's proxy statement for the transaction, filed in September 2014, revealed that the company and the respondent stockholders had begun considering privatizing the company in early 2011. By January 2014, according to the SEC, the respondents had taken specific steps indicating that they intended to take the company private. These steps included informing management that they would support a going-private transaction and securing waivers from preferred stockholders. Over the next several months, the respondents allegedly discussed the specific structure of the transaction and related valuation issues. But the respondents did not file amended Schedule 13Ds disclosing that they were evaluating a potential going-private transaction until April 2014 or, in most cases, June 2014. The SEC also found that the respondents had violated Section 16 of the Exchange Act by failing to file timely Form 4s and Form 5s reporting previous acquisitions of stock in the company. In another case, the majority owner of a publicly held company did not update its Schedule 13D until eight months after it had informed management that it intended to privatize the company. And in the remaining case, the chairman and CEO of a publicly traded footwear company began to consider going private in October 2012 and then initiated discussions with other shareholders about privatization, according to the company's proxy statement, but he did not file an amended Schedule 13D until August 2013.

These actions by the SEC present a potential conundrum for Schedule 13D filers. An insider who intends to effectuate a going-private transaction will frequently want to keep its intentions guarded until disclosure is absolutely necessary. At the same time, the insider must be mindful of not materially altering the "plans and proposals" with respect to the issuer (which are required to be described in Item 4 of the Schedule 13D) without updating its disclosure. The lesson here seems to be that, while insiders will initially want to file Schedule 13D disclosures that are sufficiently broad to encompass a wide range of possible actions concerning the subject company, these disclosures must be amended promptly following a material change or development in those plans. Securities and disclosure counsel can assist in determining when the materiality line has been crossed, and also when it appears on the horizon.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Chip Phinney
Megan N. Gates
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