Fannie Mae, the $53.8 billion home mortgage giant, recently told all of its 5,000 employees they cannot trade its stock until the embattled mortgage giant finally files its delayed and restated results.

“The company felt it was prudent to avoid the appearance of inappropriate activity,” confirms Janis Smith, a spokeswoman for the mortgage giant. She would not say how long the blackout will remain in effect, stressing that many Fannie Mae employees have access to material non-public information, or are working on something sensitive as the company prepares its financial filings.

Annex

According to experts, this is not exactly a common occurrence. “It’s very unusual to extend a freeze to employees who are not involved on a senior level,” says Alan Annex, head of the corporate group for Greenberg Traurig in New York City. That said, Annex adds, “companies are free to impose any restrictions in terms of trading securities.”

Indeed, as a matter of course, companies typically prohibit executives and employees from buying or selling their shares just prior to and after they report quarterly financial results. That’s why many executives adopt individual trading plans under Securities and Exchange Commission rule 10b5-1, which enables insiders to spread stock trades over a certain period of time regardless of any material, non-public information they may receive after adopting their plans (see related coverage on 10b5-1 plans above, right).

Although Annex would not discuss Fannie Mae specifically, he asserts that it’s a “prudent course” to freeze trading while a company is in a state of flux in terms of their SEC filings and they know they are going to restate their results.

And although they are free to maintain this lockdown indefinitely, Annex adds, “I would think a company not in compliance with the 1934 Act [The Securities Exchange Act of 1934] would work to get back in compliance,” very quickly.

A Critical Factor

But the Fannie Mae global blackout raises some interesting questions about insider trades. Specifically: Employees at public companies are regularly in possession of material non-public information, even when their company is meeting its filing deadlines—so why is Fannie Mae’s situation so different and urgent?

Fannie Mae’s Smith explains that during normal times, the company not only would be releasing timely quarterly financials, but issuing press releases from time to time to announce other critical and not-so-critical developments. But until the company finally files its restatements and delayed reports, it has essentially stopped making any kinds of public announcements. The upshot: More employees are potentially in possession of key, important information than is generally the case.

“This is a critical factor,” Smith stresses. “There is information not being made public that would be reported regularly under normal circumstances,” she adds.

For many, the report of a trading blackout still evokes anxious memories of Enron, whose 401(k) plan was "locked down" for a period of time as the stock crumbled, ostensibly because the company was transferring plan records from one record-keeping third-party administrator to a new one. However, Enron’s lockdown was for a relatively short period, and the stock did not fall that much during that period; it had already crashed before the lockout period began.

Experts note that an Enron-like situation has no chance of repeating itself at Fannie Mae for one critical reason—employees were never allowed to purchase company stock in their 401(k) plans.

SOX 306

Below is an excerpt from Section 306 of The Sarbanes-Oxley Act of 2002.

(a) PROHIBITION OF INSIDER TRADING DURING PENSION FUND BLACKOUT PERIODS—

(1) IN GENERAL—Except to the extent otherwise provided by

rule of the Commission pursuant to paragraph (3), it shall be

unlawful for any director or executive officer of an issuer of any

equity security (other than an exempted security), directly or indirectly,

to purchase, sell, or otherwise acquire or transfer any

equity security of the issuer (other than an exempted security)

during any blackout period with respect to such equity security

if such director or officer acquires such equity security in connection

with his or her service or employment as a director or

executive officer.

(2) REMEDY—

(A) IN GENERAL—Any profit realized by a director or

executive officer referred to in paragraph (1) from any purchase,

sale, or other acquisition or transfer in violation of

this subsection shall inure to and be recoverable by the

issuer, irrespective of any intention on the part of such director

or executive officer in entering into the transaction.

(B) ACTIONS TO RECOVER PROFITS—An action to recover

profits in accordance with this subsection may be instituted

at law or in equity in any court of competent jurisdiction

by the issuer, or by the owner of any security of the

issuer in the name and in behalf of the issuer if the issuer

fails or refuses to bring such action within 60 days after

the date of request, or fails diligently to prosecute the action

thereafter, except that no such suit shall be brought more

than 2 years after the date on which such profit was realized.

See Related SEC Rulemaking Regarding Insider Trades During Pension Fund Blackout Periods

The 306 Impact

Since Enron’s collapse, insiders who do own company stock through their 401(k) enjoy a lot more protection, thanks to Section 306 of the Sarbanes-Oxley Act. The provision expressly prohibits officers and directors from selling stock during blackout periods when the rank and file can’t execute transactions. It also requires companies to provide at least 30 days advance notice to all plan participants about an upcoming blackout period.

A “blackout period” has been defined as any period of more than three consecutive business days during which the ability of not fewer than 50 percent of the participants or beneficiaries under all individual account plans to trade the shares is temporarily suspended.

Richman

According to industry experts, the process of instituting such blackout periods is not complicated. If the blackout is related to a company’s 401(k) plan, the company must enter an amendment in writing, explains Ronald Richman, who specializes in Employment and Employee Benefits at Schulte Roth & Zabel. “They don’t have to ask for permission, but they must amend the 401 (k) plan,” he explains.

Richman notes that it’s not an elaborate amendment process, and doesn’t take long to implement.

Sensitivity To Employees

Fannie Mae, however, is not the first company to institute a temporary trading ban on its stock for employees. $36.8 billion Freddie Mac, the shareholder-owned government-sponsored sister to Fannie Mae, has one in place for about 800 individuals. However, Freddie Mac spokesperson Shawn Flaherty asserts that the firm does not have blackout periods, but rather has “restrictive periods after earnings are released,” according to spokesperson Shawn Flaherty.

She explains that as a matter of course, the company has always had a relatively restrictive window policy, which would open for just six weeks after quarterly earnings are announced. However, when the company announced in 2003 that it would not be able to report its earnings on time, the restrictions remained in place.

It opened the window after it announced what it called business results updates in April 2003, but later in the year it stopped issuing these business results updates and subsequently kept the restrictions in place. When the company reported its 2004 earnings back in March, it did reopen the window for six weeks, but has since closed it; the restrictions will remain in place until late August, when the company plans to report results for the first two quarters of this year, Flaherty explains. “We wanted our employees to be beyond reproach,” she says.

Accounting problems have plagued both Freddie Mac and Fannie Mae; an investigation at the latter is ongoing, with reports of potential restatements topping $10 billion. Congress is considering tightening the oversight of both entities.

Interestingly, Freddie Mac took a much more liberal approach to stock owned in 401(k) plans. Beginning 2004, it lifted the window permanently, so that participants can reallocate their accounts at all times.

Of course, a trading freeze could create a hardship for individuals who need funds for high-cost items, like a new house. Freddie Mac’s Flaherty says employees can discuss their special needs with the company’s attorneys to “make it work.” However, she stresses the policy has been well communicated from executives and via the company’s internal Web site. “It was a big time of change for the company,” she emphasizes. “The employees understood.”

Fannie Mae’s Smith says the company is sensitive to this issue, also; the company’s lawyers will review requests for waivers on a case-by-case basis. How long will these restrictions remain in place? Says Smith: “Just as long as it is prudent to remain in place.”