The U.S. Securities and Exchange Commission (SEC) has ramped up its enforcement of related party transaction disclosures in recent years, sending a clear message to companies about the importance of transparency. High-profile cases, including proceedings against Lyft, underscore how serious the SEC is about ensuring companies fully disclose these transactions. With that in mind, let’s dive into why related party transactions are so significant and what companies should keep in mind when navigating this regulatory landscape.

What Are Related Party Transactions?

At its core, a related party transaction involves a deal or arrangement between a company and individuals or entities with a pre-existing relationship, often family members, executives, or major shareholders. The SEC’s Item 404(a) of Regulation S-K requires disclosure of any such transactions since the beginning of the last fiscal year, provided the transaction amount exceeds $120,000 and the related party has or will have a direct or indirect material interest.

This rule ensures that investors have full visibility into potential conflicts of interest, especially when a company’s internal dealings could materially impact its financial health or governance.

Why Do These Transactions Matter?

Investors rely on transparent reporting to make informed decisions. Without detailed disclosures, shareholders may be unaware of how personal relationships within a company could influence decision-making. The SEC’s rules prevent executives and directors from engaging in transactions that might not be in the best interest of the company or its shareholders. Failure to disclose such deals, as seen in recent enforcement actions, could lead to significant penalties.

Lyft: A Cautionary Tale

The SEC’s enforcement action against Lyft is a notable example. Although Lyft was not a direct party to a particular transaction, the company played a crucial role in negotiating contract terms, which the SEC argued made it a "participant." This case highlighted how the SEC broadly interprets the term “participant” under Item 404(a), even if the company itself isn’t a contractual party.

The action serves as a reminder that companies must carefully assess all relevant transactions, even those where they may not appear to be directly involved.

What Must Be Disclosed?

To comply with Item 404, companies must disclose:

• The name of the related person and their relationship to the company.
• The value and nature of the related party’s interest in the transaction.
• Any details about the transaction that are material to investors.

This includes financial arrangements such as loans, leases, or contracts where an executive’s family member or another related party stands to gain from the deal. Companies must be diligent in identifying any indirect material interests, such as a relative’s business benefiting from corporate contracts.

Best Practices for Compliance

Given the SEC’s broad interpretation of “participant” and the increased scrutiny of related party transactions, companies should:

1. Maintain Thorough Internal Review Processes: Ensure all transactions are reviewed by independent board members or audit committees to avoid conflicts of interest.
2. Disclose Early and Often: When in doubt, disclose any and all relevant transactions to mitigate risk.
3. Consult Legal Counsel: Seek guidance on whether specific transactions meet the SEC’s disclosure thresholds.

Conclusion

As SEC enforcement actions increase, related party transactions remain a key area of focus for public companies. By ensuring robust internal procedures and transparent disclosures, companies can maintain investor trust and avoid costly legal pitfalls.

You can find the blog on related party transactions for domestic companies published on September 24, 2024, on the Securities Law Blog at the following link:

Related Party Transactions – Domestic Companies