SEC Comment Letters–A New Twist on Insider Trading?

A few days ago the New York Times reported a recent study by three professors at the Haas School of Business at the University of California at Berkley that notes increased insider sales just prior to the EDGAR filing of certain SEC comment letters. Although I would not presume to pass on the validity of this study or the conclusions it draws about insider trading, it does raise an interesting point that all companies should consider.

A summary of the study…

As the New York Times article highlights, the study focuses on comment letters that question a company’s revenue recognition practices under the theory that such issues are substantial enough to get the attention of management and are potentially material to investors. In fact, about 20% of all comment letters from 2006 through 2012 addressed revenue recognition in some fashion, which generated a study sample group of approximately 1,300.

Within this sample group, the professors’ research showed that insider sales within the five-day period before the comments letters were published on EDGAR were about 70% higher than normal selling patterns. The study also notes that:

  • pursuant to SEC policy, comment letters are not posted to EDGAR until 20 business days following completion of the SEC staff’s review; and
  • market reaction to negative information in comment letters is much more delayed than is typical for other types of company disclosures (for example 10-K, 10-Q or 8-K), presumably because the market does not closely track comment letter content.

The study then concludes that “corporate insiders take advantage of this opportunity and unload shares prior to the public disclosure of SEC comment letter correspondence pertaining to material financial disclosure and reporting issues.”

Patricia Dechow, one of the study’s authors, is quoted in the New York Times article as saying:

“It seems that the insiders are using information that’s not available to other market participants. But because most companies don’t seem to have a written policy against it, I guess there’s no reason they can’t do it.”

Is Professor Dechow correct?

I think most of us would disagree with Professor Dechow’s assessment of what is permitted by typical corporate policies. Virtually all insider trading policies (not to mention the securities laws themselves) prohibit any insider from trading in the company’s securities while in possession of material nonpublic information. The existence of a serious SEC comment on any substantive issue, including revenue recognition, would be considered material in many cases, particularly if the comment is ultimately resolved against the company. Furthermore, most executives would have actual knowledge, or would be deemed to have implicit knowledge, of the material content of an SEC comment letter, as well as its final disposition. Therefore, if posed this specific question, a securities lawyer likely would advise against an insider trading prior to appropriate public disclosure of either a potentially material SEC comment or its actual resolution (for example, an earnings restatement or other accounting adjustment).

What should you do?

This brings me to my point: many insiders and their advisors may not think about pending, undisclosed SEC comments when evaluating the existence of material nonpublic information. Fortunately, many companies limit executive trading to properly adopted Rule 10b5-1 plans or to the window following the filing of a periodic report, which may address material open or undisclosed SEC comments in its MD&A. These safeguards should prevent most unintentional trading slip-ups.

Even so, there is a lot of subjectivity around these decisions, and the hindsight applied to insiders’ transactions can be glaring. The challenge is to be sure not to overlook an undisclosed comment letter when assessing an insider’s ability to trade.


  • Take a few minutes to be sure your insider trading policy is worded in a way that would prohibit such trades, and consider whether to add language specific to this situation.
  • Remember to determine whether a material comment letter is outstanding (including not yet filed on EDGAR or otherwise disclosed) before clearing an insider’s trade.