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As proxy season kicks off, companies should be mindful of their disclosure obligations regarding related-person transactions, especially those involving immediate family members of executive officers and directors. On January 15, 2025, the Securities and Exchange Commission ("SEC") announced the settlement of an enforcement action against a publicly traded software and payment processing company (the "Company"), for failing to disclose $4.7 million in payments over three years that were made to siblings and children of executive officers and directors as compensation for services as non-executive employees and commissions as independent sales agents. The company also paid a civil money penalty.
What are related-person transactions and why are they important? Under Regulation S-K, Item 404(a), companies must disclose transactions since the beginning of the last fiscal year in excess of $120,000 in which the company was a participant and any "related person had or will have a direct or indirect material interest." A related person includes any director, director nominee, or executive officer of the company as well as any immediate family member. The definition of "immediate family member" is quite broad and is defined as any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, sister-in-law, and anyone sharing the household of the director, executive officer or nominee. Similar rules apply regarding greater than 5% shareholders of the company.
The purpose of this disclosure is to inform investors of any potential conflicts of interest, favoritism, or undue influence that may arise from transactions between the company and its insiders or their relatives. The disclosure must include the name of the related person, the basis of the relationship, the related person's interest in the transaction and the approximate dollar amount of the transaction, and any other information that would be material to investors.
What did the Company do wrong? According to the SEC's order, it filed Forms 10-K for 2020, 2021 and 2022 that incorporated by reference related-person transaction information from the immediately forthcoming proxy statements. However, each proxy statement failed to disclose that:
- A sibling of an executive officer and director (as well as a child of a different director) received, in each of 2020, 2021 and 2022, approximately $1.1 million in compensation while serving as a non-executive employee of the company.
- A sibling of another executive officer received $167,947 in compensation while serving as a non-executive employee of the company in 2022.
- A sibling of an executive officer and director (as well as a stepchild of a different director) received payments from the company of residual commissions while acting as an independent sales agent not employed by the company, in the respective amounts of $281,609, $492,096 and $463,565 in 2020, 2021 and 2022.
The SEC alleged that, in each case, these immediate family members were related persons who had a direct or indirect material interest in the transactions, and that the transactions and related information should have been disclosed in the Forms 10-K and proxy statements. Therefore, the SEC charged that the company violated Section 13(a) and Section 14(a) of the Exchange Act and related rules. The SEC took into account the company's cooperation and remedial acts, such as disclosures and improvements to related-person policies and procedures.
What are the key takeaways? This enforcement action serves as a reminder that companies should carefully review their related-person transactions and ensure that they comply with the disclosure requirements under Item 404(a) of Regulation S-K. Companies should also have effective policies and procedures to identify, evaluate, and report on related-person transactions, and to provide adequate training and oversight to the personnel involved. Companies should also be aware that the SEC may scrutinize related-person transactions involving the employment of immediate family members, and that the amount involved in the transaction includes all compensation, not just the salary of the employee. Failure to properly disclose related-person transactions with family members may expose companies to SEC enforcement actions and penalties, as well as reputational damage and shareholder litigation.
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