441 ALI-ABA Course of Study Fundamentals of Securities Law May 31 - June 1, 2012 San Francisco, California Developments under Section 16 By Peter J. Romeo Alan L. Dye Hogan Lovells US LLP Washington, D.C.
442 TABLE OF CONTENTS Page I. THE STATUTORY PROVISION...1 II. III. IV. STATUTORY INSIDERS...2 A. Officers...2 B. Directors...4 C. Ten Percent Owners...4 D. Trusts...10 BENEFICIAL OWNERSHIP...10 A. Family Holdings...11 B. Corporate Holdings...12 C. Partnership Holdings...12 D. Trust Holdings...13 THE REPORTING SYSTEM...14 A. The Sarbanes-Oxley Act...15 B. Reporting Forms...16 C. Reportable Transactions...18 D. Filing Mechanics...19 E. Issuer Disclosure...20 F. Remedies For Noncompliance...21 G. Compliance Methods...23 V. DERIVATIVE SECURITIES...24 A. Securities Covered...25 B. Excluded Securities...27 VI. VII. PURCHASE AND SALE.. 30 TRANSACTIONS WITH THE ISSUER UNDER RULE 16b-3...31 A. Summary of Rule 16b-3...33 B. The Four Categories of Exemption...34 C. Tax-Conditioned Plans...34 D. Discretionary Transactions...35 E. Acquisitions From the Issuer...38 F. Dispositions to the Issuer...39 G. The Advance Approval Exemptions...41 H. Compliance Chart...50
443 DEVELOPMENTS UNDER SECTION 16 By Peter J. Romeo and Alan L. Dye* I. THE STATUTORY PROVISION Section 16 is a charter provision of the Securities Exchange Act of 1934 ( 1934 Act ) designed primarily to deter officers, directors and ten percent owners of public companies from misusing inside information about their companies for personal trading gain. 1 These statutory insiders must file with the Securities and Exchange Commission ( SEC or Commission ) public reports under Section 16(a) disclosing their holdings of and transactions in the equity securities of their company (also referred to as the issuer ), disgorge under Section 16(b) to the issuer any profits resulting from "short-swing" transactions in the issuer's equity securities, 2 and refrain under Section 16(c) from short sales of the issuer's equity securities. 3 Liability under Section 16(b) for profitable shortswing transactions is strictly imposed, without regard to the insider s intent or whether inside information actually was misused. 4 * Peter J. Romeo and Alan L. Dye are partners of Hogan Lovells in Washington, D.C. 1 The text of Section 16 is set forth in 15 U.S.C. 78(p). The rules under Section 16 can be found in 17 C.F.R. 240.16a-1 et. seq., and the Section 16 reporting forms are located in 17 CFR 249.103-105. 2 A short-swing transaction is any purchase and sale, or sale and purchase, of the issuer's equity securities within less than six months. The courts have held that the period of less than six months encompasses a transaction only if the transaction occurs at least two days before the corresponding date six months after a matching opposite way transaction. See, e.g., Pfeiffer v. Price, Fed. Sec. L. Rep. (CCH) 93,080, at 95,347 n. 5 (D. Del. 2004) (sale on April 24 could not be matched with purchase on October 23). The number of days in a month is irrelevant when calculating the period. Thus, a purchase on March 1 would be matchable with a sale 182 days later on August 30, but a purchase on February 1 would not be matchable with a sale 180 days later on July 31. 3 In addition to applying to transactions involving an issuer s equity securities, Section 16 also encompasses transactions involving security-based swap agreements and security futures products that relate to such securities. See 303(g) and (h) of the Commodity Futures Modernization Act of 2000, Pub. L. No. 106-554, (2000)( CFMA ), and 762(b)(5) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (2010) ( Dodd-Frank ). The CFMA made clear that Section 16 applies to swap agreement and futures products, while Dodd-Frank clarified the application of Section 16 to swap agreements. The Commission issued an interpretive release in 2002 which addresses the application of Section 16 to security futures products. See Rel. No. 34-46101 (2002). 4 The prevailing belief of Congress was that anything other than an arbitrary approach under Section 16(b) would enable insiders to continue all but the most blatant of practices and take refuge behind an artificial wall of good Faith. Petteys v. Butler, 367 F. 2d 528, 532 (8 th Cir. 1966), cert. denied, 385 U.S. 1006 (1967).
444 2 This article provides an overview of Section 16, 5 with citations to rule changes and published staff interpretive positions where appropriate. 6 The discussion below addresses six major areas under Section 16: (1) statutory insiders, (2) beneficial ownership, (3) the reporting system, (4) derivative securities, (5) purchases and sales, and (6) transactions with the issuer. II. STATUTORY INSIDERS Determining who is an officer, director or ten percent owner for purposes of Section 16 often presented difficulties prior to the SEC s overhaul of the Section 16 rules and forms in 1991. 7 Under the former rules, for example, there was uncertainty whether a person holding the title of vice president who did not have high-level executive responsibilities nevertheless should be deemed an officer. In addition, there were doubts as to the calculation of ten percent beneficial ownership in certain situations. The Commission addressed most of these difficulties in 1991, and produced guidelines that are clear-cut, although not free of controversy. A. Officers In 1991, the SEC adopted a new definition of the term "officer" which applies solely for purposes of Section 16. 8 Unlike its predecessor, 9 the definition focuses on a person's duties rather than the person's title. Specifically, the definition identifies as Section 16 officers the issuer's president, principal financial officer, principal accounting officer (or, if the issuer has no principal 5 For more complete information about Section 16, see the following publications by the authors: Section 16 Treatise and Reporting Guide (3d ed. 2008), Section 16 Deskbook (Spring 2011 edition), Section 16 Forms and Filings Handbook (7 th ed. 2009), and quarterly SEC Updates, all of which are published by Executive Press, Inc., P.O. Box 21639, Concord, CA 94521-0639 (tel. no. (925) 685-5111). See also Section 16.net, the authors Section 16 website. 6 Relevant interpretive and no-action letters issued by the SEC staff are cited herein by providing the name of the person or entity who is the subject of the letter and the date the letter became publicly available. Interpretations of the Section 16 rules and forms set forth in Compliance and Disclosure Interpretations issued by the SEC staff are cited by reference to either the Q number from the Questions and Answers of General Applicability or the Interp number from the Interpretive Responses Regarding Particular Situations. 7 See Rel. Nos. 34-28869 (1991), 34-28869B (1991), and 34-29131 (1991). The overhaul, which is referred to generally in this article as the 1991 changes, revised every rule and form adopted by the SEC under Section 16. 8 See Rule 16a-1(f). 9 See the definition of "officer" in Rule 3b-2 under the 1934 Act, which applied to Section 16 prior to the adoption of Rule 16a-1(f) in 1991.
445 3 accounting officer, its controller), any vice-president in charge of a principal business unit, division, or function (such as sales, administration, or finance), and any other person, including officers of the issuer's parent or subsidiaries, who performs significant policy-making functions for the issuer. The definition allows persons (typically vice presidents) who are officers in name only and do not perform in a high-level executive capacity to avoid the responsibilities and burdens of Section 16. Because the current definition is modeled after the definition of "executive officer" 10 (with the exception that the principal financial officer and the principal accounting officer always are Section 16 officers, regardless of whether they are executive officers), an issuer's Section 16 officers will in most cases be the same persons who are considered executive officers for purposes of the issuer's Form 10-K and annual proxy statement. 11 Where they are not the same, the issuer should be prepared to explain why there is a difference, since the SEC may inquire about the variance. A note to the definition of "officer" states that persons identified as executive officers (together with the issuer's principal financial officer and principal accounting officer) will be presumed to have been designated by the issuer's board of directors as the issuer's officers for purposes of Section 16. 12 As a consequence of this note, many companies find it advisable to have the board of directors pass a resolution annually (usually in connection with the approval of the Form 10-K) designating those persons within the company who will be deemed Section 16 insiders. Such a resolution not only enhances continued compliance with Section 16, but also should protect from liability those persons excluded from the list. As under the pre-1991 rules, issuers and their counsel are responsible for determining whether, in light of the particular facts and circumstances, an individual employee is an officer for purposes of Section 16. Because of the fact-intensive nature of the analysis, the SEC staff will not express a view whether a particular person is a Section 16 officer. 13 10 See Rule 3b-7 under the 1934 Act for the definition of "executive officer." 11 Item 401(b) of Regulation S-K, which is invoked by Item 7 of Schedule 14A and Item 10 of Form 10-K, requires issuers to identify their executive officers. 12 Rule 16a-1(f) also should be used to determine which officers of a registered closed-end investment company and its investment advisor are subject to Section 30(h) of the Investment Company Act of 1940, a counterpart of Section 16. Investment Company Institute (June 12, 1991). 13 American Bar Association, Q.1 (July 3, 1991).