Companies that allow directors, officers, and other company insiders to engage in personal margin loan and share pledge arrangements should take precautions to avoid legal violations. Inadequate disclosures of such arrangements can result in fines and other consequences under U.S. securities laws.

A recent illustration of personal margin loans and stock pledges leading to adverse company consequences involved Carl Icahn and his publicly listed company Icahn Enterprises L.P. (IEP). As a result of insufficient disclosures of these arrangements, Carl Icahn was forced to pay a substantial fine to the Securities and Exchange Commission (SEC).

Icahn’s margin loan issue was brought to light by an article released by Hinderburg Research, an activist short-selling research firm. According to the Hinderburg Research article, Carl Icahn was using margin borrowing and then pledging units of IEP in order to secure the personal margin loans.

The SEC subsequently launched an investigation into Icahn’s activities. They found that Icahn   had pledged over 50% of IEP’s outstanding units as collateral to secure his personal margin loans. Additionally, certain of Icahn’s wholly-owned entities had also pledged IEP units to guarantee these obligations. Despite these margin loans and unit pledges being worth billions of dollars, the public disclosure by Carl Icahn as an individual as well as by his publicly listed company IEP was limited.

A Schedule 13D is a required SEC filing by anyone that acquires at least 5% of any class of a company’s securities. The Schedule 13D reports the specific beneficial ownership percentage held by the reporting party as well as disclosure about the relevant transaction. Amendments to the Schedule 13D must be filed whenever there is a material change in the facts disclosed in the previous Schedule 13D filing or if the beneficial ownership percentage increases or decreases by at least 1%.

Schedule 13D filings in the 1990s, 2003 and 2005 had only provided general disclosure about the existence of pledged IEP units being used as collateral for personal margin loans. However, these filing failed to disclose the specific number of units or dollar amount of these pledges. Pursuant to Item 6 of the Schedule 13D requirements, the reporting party is required to describe any contracts or other arrangements between the Schedule 13D filer and any other party regarding securities of the issuer, including pledged securities.

Furthermore, pursuant to Item 7 of the Schedule 13D requirements, copies of material written agreements relating to the contracts described in Item 6 must be filed as exhibits to the Schedule 13D filing. Icahn failed to file a copy of the margin loan agreement until prompted by the SEC investigation.

In addition to Mr. Icahn’s Schedule 13D disclosure failures, the SEC found that the lack of disclosure about Icahn’s margin loans and related unit pledges in IEP’s Form 10-K annual report was a violation of U.S. securities laws. Pursuant to Item 403(b) of Regulation S-K, a company’s Form 10-K annual report must describe the security ownership of directors and executive officers. Such disclosure must include the amount of any pledged securities.

As a result of these disclosure failures under U.S. securities laws, Icahn had to pay a civil monetary penalty to the SEC. In penalizing Mr. Icahn, the SEC emphasized that there is responsibility for compliance with disclosure obligations at both the individual and company levels.

Most companies have an insider trading policy that outlines the prohibited trading activities for company insiders. The insider trading policy will prohibit buying or selling the company’s securities while the insider is in possession of material non-public information (MNPI). Many insider trading policies also prohibit company insiders from taking personal margin loans because such loans are deemed to create a potential conflict of interest.

The SEC findings against Icahn and IEP underscore the importance of properly disclosing margin loan and share pledge arrangements in public filings. A company’s legal counsel should have robust processes in place to make sure the company is made aware of the existence of such arrangements and that SEC disclosure requirements are followed.