EMPLOYEE BENEFIT IMPLICATIONS OF NEW SEC RULES FOR SECTION 16 INSIDER REPORTS At its open meeting on August 27, 2002, the SEC adopted final rules implementing provisions of the Sarbanes-Oxley Act of 2002 that amend the Section 16 reporting requirements. A general description of the SEC final rules (“Rules”) and other SEC initiatives was included in a previous LawFlash from our Securities Practice (available at http://www.morganlewis.com/seclawflash10.htm). The Rules are also described in detail in a White Paper from our Securities Practice, which is available at http://www.morganlewis.com/wp0249.pdf. The purpose of this LawFlash is briefly to highlight several aspects of the Rules that will be of particular interest to clients of our Employee Benefits and Executive Compensation Practice. The Rules are effective for transactions that occur on or after August 29, 2002. Background Section 16(a) of the Securities Exchange Act of 1934 (“Act”) requires reporting of transactions involving company equity securities by “insiders” (officers, directors and 10% shareholders) of most domestic public companies. Under Section 16(a), insiders are required to report, among other things, any changes in ownership of company equity securities. Prior to Sarbanes-Oxley, most of the transactions that were not exempt from “short-swing profits” liability, as well as exercises or conversions of derivative securities such as stock options, were required to be reported on Form 4 within 10 days following the close of the calendar month in which they occurred. Sarbanes-Oxley amended Section 16(a) to require that change in ownership reports be filed within two business days following the day on which the transaction is executed, unless the SEC determines that such two-day reporting is not “feasible.” Discretionary Employee Benefit Plan Transactions Under Rule 16b-3(c), most transactions by insiders involving company stock under “tax conditioned plans,” such as qualified profit-sharing/401(k) plans and employee stock purchase plans, are exempt from the Form 4 reporting requirements. Neither SarbanesOxley nor the new rules change this exemption. However, certain “discretionary transactions” under such employee benefit plans – namely, voluntary intraplan transfers involving a company equity securities fund, or cash withdrawals funded by voluntary dispositions of company securities – are not exempt under Rule 16b-3(c). Those discretionary transactions are, therefore, subject to the new accelerated reporting rules.
In promulgating the Rules, the SEC determined that standard two-business-day reporting of discretionary transactions was generally not “feasible.” The Rules thus provide a slight relaxation of the two-day requirement for such transactions. Specifically, for a discretionary transaction where the reporting person does not select the date of execution, the date on which the plan administrator notifies the reporting person that the transaction has been executed is deemed the date of execution, so the Form 4 may be filed within two business days following the date of such notification. However, if the date of notification is later than the third business day following the trade date, then the third business day following the trade date is deemed the date of execution. This means that, at most, a discretionary transaction may be timely reported within five business days following the trade date (assuming the notification is given on or after the third business day following the transaction). Moreover, if the reporting person selects the date of execution, the extended reporting deadline will not be available. For example, assume an insider elects, on Monday, October 7, 2002, to transfer a portion of his 401(k) plan account balance from the company stock fund into a money market fund, and the transfer is not actually effected, under plan procedures, until Thursday, October 10. If the plan administrator notifies the insider on or after Monday, October 14, the insider’s Form 4 must be filed no later than the close of business on Wednesday, October 16. If the notification occurs on an earlier date, the Form 4 must be filed within two business days after the date the insider was actually notified by the plan administrator. Reporting companies with participant-directed 401(k) plans that include company stock funds will immediately need to review, and, if necessary, revise their existing arrangements with their plan recordkeepers/service providers to ensure prompt reporting of covered discretionary transactions, so that their insiders can comply with the applicable reporting requirement. Dramatically Accelerated Reporting of Transactions Involving Stock Options and Other Derivative Securities, or Restricted Stock Grants to insiders of certain derivative securities, such as stock options, which may be exempt from the “short-swing profits” provisions of Section 16(b) pursuant to the exemption provided by Rule 16b-3(d), were, prior to the promulgation of the Rules, permitted to be reported annually on Form 5, as were certain other transactions related to such securities, such as cancellations and expirations where no value was received for any such cancellation or expiration. Other transactions involving derivative securities, such as exercises or nonexempt dispositions, were reportable monthly on Form 4. Grants of restricted stock exempt under Rule 16b-3(d) were also permitted to be reported annually on Form 5. The Rules eliminate the ability to report any transactions related to such derivative securities, or to restricted stock, on Form 5, and provide that all such transactions are now subject to Form 4 reporting. Moreover, the Rules make clear that all such transactions are now subject to the new two-business-day reporting requirement.
This new reporting rule will require affected companies immediately to review and revise their procedures for granting, documenting and communicating awards to insiders of stock options and other derivative securities, such as stock appreciation rights or phantom shares, as well as restricted stock grants. In particular, companies should immediately review their practices and procedures concerning the approval of grants by their compensation committees to ensure that information regarding the grants is immediately communicated to the insiders, so that they (presumably with the assistance of the company) can meet the two-business-day reporting requirement. The Rules are available online at www.sec.gov/rules/final/34-46421.htm. For further information, please contact: Contact John G. Ferreira Joseph E. Ronan, Jr. Mims Maynard Zabriskie Phone 412.560.3350 215.963.5793 215.963.5036 E-mail jferreira@morganlewis.com jronan@morganlewis.com mzabriskie@morganlewis.com