Client Alert

Last month, the Securities and Exchange Commission issued a Section 21(a) Report of Investigation (the "Report") concerning the importance of policies and procedures to ensure compliance with the federal securities laws, including insider trading prohibitions.¹ Although the Report addressed the responsibilities of investment managers specifically, it is a shrill warning for all public companies to make sure they have in place effective and well-understood insider trading policies.

Background
The Report involved insider trading by The Retirement Systems of Alabama ("RSA"), a state agency that administers 20 retirement funds with aggregate assets in excess of $30 billion. In July 2005, RSA entered into negotiations to finance the acquisition of The Liberty Corporation ("Liberty") by Raycom Media, Inc., a company founded by RSA. In August 2005, prior to the public announcement of the proposed acquisition, RSA's CEO instructed his investment staff to purchase Liberty stock. Shortly after the announcement of the merger, the price of Liberty stock rose approximately $10 per share, resulting in a $700,000 increase in the value of the Liberty shares purchased by RSA. At the time of the events described in the Report, RSA had no program, policy, practice or training to ensure that its investment staff understood and complied with the federal securities laws in general or insider trading laws in particular. RSA also did not have a compliance officer, and the general counsel's responsibilities did not include oversight of RSA's investment activities.

Discussion
State pension funds such as RSA are exempt from the requirements of the Investment Company Act of 1940 and the Investment Advisers Act of 1940, two federal statutes that regulate money managers. However, public pension funds and their employees, as well as all public companies, are subject to the anti-fraud provisions of the federal securities laws and the rules thereunder. Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 prohibit the purchase and sale of securities on the basis of material, nonpublic information in breach of a duty of trust or confidence. That prohibition covers "insiders," those who acquire the information in the context of a relationship of trust or confidence, and persons who are "tippees" of either insiders or persons who have misappropriated the information. In addition, controlling persons who fail to prevent insider trading may be subject to civil penalties under Section 21A of the Exchange Act.

In issuing its Report, the SEC noted that RSA's trading could have been prevented if RSA had implemented adequate policies and procedures to assure compliance with the federal securities laws. Most of the RSA investment personnel involved in the matter, including its CEO, did not have a clear understanding of the securities law duties and risks implicated when they came into possession of material, nonpublic information. RSA's general counsel was not responsible for securities law compliance and was not consulted before the trades. Furthermore, there was no practice or procedure for RSA's investment staff to seek advice from outside counsel regarding such issues. The SEC believes that had there been a reasonable compliance program in place at RSA at the time of the events described in the Report, RSA likely would not have purchased Liberty stock prior to the public announcement of the transaction.

The SEC often utilizes a Section 21(a) report to communicate broad policy statements and to draw attention to areas of current concern for the SEC staff. In the case of RSA, the SEC decided not to impose penalties because of RSA's cooperation with the investigation and other mitigating factors. However, for public companies generally, the Report should be considered to be a warning shot. It is unlikely the SEC will deal as leniently with the next company whose failure to have in place an effective program to prevent insider trading leads to a violation of the insider trading laws. In particular, companies should consider the following:

• Do we maintain sufficient insider trading policies and procedures?
• Are our policies clear and understandable to non-lawyers?
• Do we communicate the policies periodically to our insiders?
• Are the policies followed and enforced?

Note
¹ Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The Retirement Systems of Alabama, Release No. 57446 (March 6, 2008) (available at http://www.sec.gov/litigation/investreport/34-57446.htm).

Contact Information
If you have any questions regarding your company's insider trading policies and procedures or any other matters addressed in the Report, please contact Meredith Burbank, the principal drafter of this client alert, or you may contact the Womble Carlyle attorney with whom you usually work or one of our Corporate and Securities attorneys.