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The V&E Report
Insights in Government Enforcement and Investigations

Proposed Law Seeks to Seal “8-K Trading Gap”

The recently proposed 8-K Trading Gap Act of 2019 seeks to address a perceived loophole in current insider trading laws, creating additional regulation and potential source of insider trading liability for directors and executives. In September 2017, Equifax announced a data breach that exposed the personal information of some 147 million people. It was not just this data breach that drew the ire of regulators and the general public, however. It turned out that a number of senior Equifax executives, including the company’s chief financial officer, sold shares worth $1.8 million in the days after Equifax began investigating the breach, a date that was more than a month prior to public announcement of the matter.1 Thus far, two Equifax employees have been convicted and sentenced for insider trading.2

Senator Chris Van Hollen (D-Md) had this incident in mind when he, along with Representative Carolyn Maloney (D-NY), proposed The 8-K Trading Gap Act of 2019 (the “Act”).3 In a press release regarding the Act, Sen. Van Hollen stated “As we saw in the Equifax consumer data breach, big corporate executives and insiders have a clear advantage over the public when it comes to the 8-K filing.” The Act seeks to limit opportunities that officers and directors have to commit insider trading by prohibiting them from trading in company equity securities during the period between when a Form 8-K reporting or disclosure obligation arises and the date the company files with, or furnishes to, the SEC a Form 8-K disclosing the event.

Under current law, companies must file or furnish a Form 8-K within four business days of a reportable event. This time lag has created a so-called “8-K trading gap”, during which market-moving information may be known by those inside the company but not public-company investors.4 The Act seeks to prevent insider trading from occurring during this period by amending the Securities Act of 1934. This Amendment would instruct the SEC to issue a set of rules that require companies to have policies, controls, and procedures reasonably designed to prohibit insider trading during this four-day period. The Act permits the SEC to make exceptions for transactions that occur automatically or are made pursuant to an advanced election.

Proponents of the legislation say that the specific circumstances of the trading in Equifax were not unique. One study cited in support of the Act found that, when insiders engage in open-market purchases during the four days preceding 8-K filings, they are correct about the directional impact of the 8-K filing more often than not, and that the chance of this outcome being the product of random chance is close to zero.5 The North American Securities Administrators Association has also voiced support for the law, and stated that closing the 8-K trading gap “is a basic issue of fairness for retail investors.”6 Opponents of the proposal argue, however, that the start date for the trading blackout period may be very difficult to determine. They also argue that Rule 10b-5 already prohibits trading on material nonpublic information, as demonstrated by the two convictions related to the Equifax insider trading.7

The fate of the draft Act, and how its final iteration will look should it become law, remains uncertain. Corporate directors, officers, and in-house counsel should stay abreast of developments concerning this proposed legislation as it could provide an additional source of insider trading liability, and signals a focus by at least some legislators on addressing perceived opportunities for insider trading by tightening the period in which corporate insiders may make trades.

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1 Stacy Cowley, Ex-Equifax Executive Charged with Insider Trading Tied to ’17 Breach, New York Times (March 14, 2018)

2 Kate Brumback, A Former Equifax Manager Just Got Sentenced For Insider Trading After Making $75,000 Off of its Massive Data Breach, Business Insider (October 18, 2018)

3 H.R. 4335; S. 2488

4 Alma Cohen, Robert J. Jackson, Jr. and Joshua Mitts, The 8-K Trading Gap, Columbia Law and Economics Working Paper No. 524 (September 7, 2015)

5 Liz Hoffman, Insiders Beat Market Before Event Disclosure: Study, Wall Street Journal (September 14, 2015)

6 Dave Kovaleski, Securities Group Supports Legislative Proposals at Hearing, Financial Regulation News (April 5, 2019)

7 John C. Coffe, Jr., Testimony Before the House Financial Services Subcommittee on Investor Protection (April 2, 2019)

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Authors

Michael L. Charlson

Michael L. Charlson Partner

Clifford Thau

Clifford Thau Partner

Marisa Antos-Fallon

Marisa Antos-Fallon Counsel

Laurel S. Fensterstock

Laurel S. Fensterstock Senior Associate

Bryan Hogg

Bryan Hogg Associate