Stronger Insider-Disclosure Rules Put Compliance Pressure on Banks

New rules now apply when insiders of a publicly held bank report on their purchase or sale of its stock to the Securities and Exchange Commission or the Office of Thrift Supervision.

The rules provide for public disclosure of noncompliance. Therefore, a strict compliance program is required to protect the bank and its insiders.

Banks must no longer view compliance as solely the responsibility of the insider.

Sweeping Changes

In January, following congressional action, the SEC adopted sweeping changes to Section 16 rules under the Securities and Exchange Act of 1934.

The changes affect all officers, directors, and major shareholders of publicly held banks who file at the Office of Thrift Supervision. V. Gerard Comizio, senior associate chief counsel at the OTS, said that "banks filing with the OTS will be subject to the new Section 16 rules."

Also, according to Gerald Gervino, senior attorney at the Federal Deposit Insurance Corp., FDIC rules "quite similar to the new Section 16 rules adopted by the Securities and Exchange Commission" will be implemented as soon as possible.

|Exempt' Transactions

The rules provide for stiff fines and make significant changes in the way transactions are to be reported.

A new Form 5 must be filed 45 days after the end of a company's fiscal year. Insiders will use it to report "exempt" transactions - gifts, plan activity, and so on - not reported during the year. The form will also be used to disclose previously unreported nonexempt transactions.

The new Form 5 will make enforcement easier for the SEC, the FDIC, and the OTS. Section 16 filers will be required to point a finger at themselves by disclosing previously unreported "non-exempt" transactions. Enforcement agencies will be able to total all the transactions for each filer during the year and compare with the total given on the Form 5 or last Form 4. A discrepancy will indicate missing or late filings.

Derivative Securities

According to Peter Romeo, coauthor of "The Section 16 Reporting Guide," "the most innovative change proposed by the commission relates to stock options and other so-called derivative securities."

Under the previous rules the grant or acquisition of a derivative security was viewed as a nonevent for reporting purposes.

The new rules state that the acquisition will be viewed as a purchase but the exercise, exchange, or conversion will be treated as a nonevent. This means that once an option has been held for at least six months, an insider will be able to exercise the option and sell the underlying stock immediately, without worry about having the exercise matched against the sale and being a short-swing violation.


Grants of options will have to be reported on Form 4 by the 10th of the month following the event. Options granted prior to the effective date of the new rules must be reported on the first Form 4 or 5 filed. The bank should consider reporting these options for all its filers now, rather than waiting until a non-exempt transaction occurs.

Another significant change was in the definition of "officer." Duties rather than title will now determine who must file. The FDIC has said it will not adopt this narrower definition; the OTS will.

Section 16 filers must conform to the new rules or face stiff penalties. In the first year, banks will have to review the last two years of filings to decide if there were late or missing filings. Filings that were not reported by May 1 must be listed in the bank's next proxy and 10K reports.

Until now, some banks have taken the position that Section 16 compliance was the responsibility of the officer or director, and not the bank. As a result, over 20% of all transactions are filed late, and a significant number are missing.

The Disclosure Issue

The regulatory agencies hope that the prospect of embarrassing public disclosure will prompt banks to implement effective compliance programs for assisting their Section 16 filers.

The tough penalties came about because Congress on Oct. 15 gave the SEC new legal and financial remedies with the passage of the Security Enforcement and Penny Stock Reform Act of 1990. This legislation authorizes the commission to:

* Institute administrative proceedings for violations of any provision of the 1934 Securities and Exchange Act, and to seek cease-and-desist orders.

* Seek monetary penalties in the event a cease-and-desist order is violated.

This legislation will free the SEC from the costly and time-consuming injunctive process formerly used for enforcement. Cease-and-desist orders will be relatively easy to obtain, and insiders can expect enforcement to increase significantly.

Money Penalties

The Security Enforcement Act has three tiers of monetary penalties for insider violations of a cease-and-desist order:

* The first tier, used for first-time 16(a) violations, is up to $5,000 per violation.

* The second tier, for "deliberate or reckless disregard of a regulatory requirement," is up to $50,000 per violation.

* The third tier, for a violation that results in or creates a significant risk of substantial losses to others, is up to $100,000 per violation.

The response to the new rules and legislation has been overwhelming. Executive Press of San Francisco, the publisher of Mr. Romeo's book, is among the organizations that have held seminars held around the country that have been extremely well attended by corporate secretaries and corporate counsel.

Be Prepared

Experts suggest that the bank itself should prepare all Section 16 filings.

According to Mr. Romeo, who is with the Washington law firm of Hogan & Hartson, banks that "fail to disclose delinquent and missing filings filed after May 1 could face the prospect of having their proxies for the annual meeting invalidated and could face monetary and other penalties for violations of the securities laws."

The full implications of having insiders names in proxies with "late filer" and "failed to file" next to their names is still unknown. But in this era of greater corporate scrutiny, it is certain that shareholders, the investment community, and the press will take notice.

Mr. Robert Gabele is president of Invest/Net Group Inc., a Fort Lauderdale, Fla., firm that produces a data base of Section 16 filings for the Securities and Exchange Commission, the Federal Deposit Insurance Corp., and the investing public.

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