A review of Section 16 filing responsibilities

With all the attention on High Frequency Trading and some pundit viewpoints that they are insider trading, here is a review of insider trading from an issuer perspective.

There are three types of corporate insiders for purposes of Section 16: officers, directors and greater than 10% shareholders. We refer to these three types of corporate insiders collectively as Section 16 insiders.

The company officers subject to Section 16 are:

  • The president
  • The principal financial officer
  • The principal accounting officer (or, if there is no such accounting officer, the controller)
  • Any vice president in charge of a principal business unit, division or function (such as sales, administration or finance)
  • Any other officer who performs a significant policy-making function
  • Any other person who performs similar policy-making functions for the company

Section 16 insiders must file reports with the SEC disclosing their beneficial ownership of and transactions in a public company’s equity securities. The three forms on which Section 16 insiders must make these reports – Forms 3, 4 and 5.

insiderForm 3: Initial Statement of Beneficial Ownership of Securities.

Section 16 insiders must file an initial report on Form 3 with the SEC within 10 days of becoming subject to Section 16. For a person who is elected an officer or director of a company that already has a class of equity securities registered under Section 12, the 10-day period begins when the person becomes an officer or director. Section 929R of the Dodd-Frank Act amended Section 16 of the Exchange Act to authorize the SEC to establish by rule a shorter time period within which a new Section 16 insider would be required to file a Form 3. As this handbook goes to publication, the SEC has not proposed any rule change that would shorten the current 10-day reporting window.

Persons who are officers, directors or greater than 10% shareholders of a company that registers a class of equity securities (and did not previously have a class of registered equity securities) are required to file a Form 3 on the effective date of the company’s registration statement. In any case, the Form 3 must disclose all equity securities of the company that the Section 16 insider beneficially owned on the date the person became subject to Section 16. Even if a director or officer owns no securities on the date he or she becomes a Section 16 insider, he or she is still required to file a Form 3.

In certain circumstances, the Section 16 insider should file an initial Form 3 earlier than is required. As discussed below, a Section 16 insider generally must report changes in his or her beneficial ownership of the company’s equity securities on Form 4 within two business days. If the Section 16 insider’s beneficial ownership of the company’s equity securities changes during the 10-day period before he or she must file a Form 3 (e.g., where a new director is granted restricted stock upon his or her appointment), the SEC recommends that the Section 16 insider file an initial Form 3 concurrently with a Form 4 reporting the change, notwithstanding that the rules permit the Form 3 to be filed at a later date.

Form 4: Statement of Changes in Beneficial Ownership.

After filing a Form 3, a Section 16 insider must report any subsequent change in beneficial ownership of the company’s equity securities by filing a Form 4 within two business days, unless the transaction is exempt from reporting or is eligible for deferred reporting.

Transactions that must be reported on Form 4 include, but are not limited to:

  • Non-exempt purchases and sales of equity securities held in the Section 16 insider’s name
  • Transactions involving equity securities held by others but that the Section 16 insider is deemed to beneficially own (i.e., equity securities in which the Section 16 insider has a “pecuniary interest,” as discussed above)
  • Exercises or conversions of derivative securities
  • Acquisitions and grants of any of the company’s equity awards (including options), even if not presently exercisable
  • Entry into various other derivative transactions, including equity swaps and similar hedges
  • Awards to non-employee directors made pursuant to equity incentive plans
  • Equity securities received from a non-exempt dividend reinvestment
  • Dispositions of equity securities to the company (e.g., the company’s retention of shares to pay the Section 16 insider’s tax withholding obligation upon the exercise of stock options)
Click the image to request our free Corporate Governance Handbook.

Click the image to request our free Corporate Governance Handbook.

Following an IPO, the directors and officers of the company before it became public may be required to report certain pre-IPO transactions in the company’s equity securities. Such a filing obligation may arise if the director or officer engages in a reportable transaction less than six months after the date that the company’s registration statement becomes effective. In such event, the director or officer is required to “look back” for a period of six months from the date of the reportable transaction and report on its first required Form 4 any transactions in the company’s equity securities that occurred during that period. Persons who are Section 16 insiders by virtue of being greater than 10% shareholders are not subject to six-month look-back periods. Likewise, a covered officer or director may be required to report transactions that occur after the company ceases to be a public company (i.e., because of termination of its Section 12 registration and reporting obligations). An otherwise reportable transaction occurring after the company is no longer public will be reportable on Form 4 if (and only if) the transaction is not exempt from Section 16(b) and occurs within six months of an “opposite way” transaction that was also subject to Section 16(b) and occurred while the company was public. For purposes of this rule, an acquisition and subsequent disposition (or vice versa) are considered “opposite way” transactions.

A covered officer or director may also be required to report transactions that occur after the termination of that person’s officer or director status. An otherwise reportable transaction occurring after the cessation of a person’s officer or director status will be reportable on Form 4 in the same circumstance as a transaction that occurs after a company ceases to be public (i.e., if (and only if) the transaction is not exempt from Section 16(b) and occurs within six months of an “opposite way” transaction that was also subject to Section 16(b) and occurred while the person was still a director or officer). A person who is a Section 16 insider solely by virtue of being a greater than 10% shareholder ceases to be subject to Section 16 reporting requirements once the person ceases to be a greater than 10% shareholder.

The SEC has adopted a variety of exemptions from the reporting requirements of Section 16(a) based upon the nature of the transaction. These exemptions apply to the following types of transactions:

  • Any increase or decrease in the number of equity securities held as a result of a stock split or a stock dividend applying equally to all securities of a class
  • The acquisition of rights, such as shareholder or preemptive rights, pursuant to a pro rata grant to all holders of the same class of registered equity securities
  • Transactions that effect only a change in the form of beneficial ownership without changing the person’s pecuniary interest in the subject equity securities (note, however, that this exemption does not cover the exercise and conversion of derivative securities or deposits to and withdrawals from voting trusts)
  • Certain transactions pursuant to tax-conditioned employee benefit plans
  • Acquisitions made pursuant to a dividend reinvestment plan, provided that the plan meets certain requirements specified in Rule 16a-11 under the Exchange Act
  • Acquisitions or dispositions of an equity security pursuant to a domestic relations order
  • The disposition or closing of a long derivative security position as a result of cancellation or expiration, provided that the Section 16 insider receives no value in exchange for the expiration or cancellation

In addition to the above exemptions, the SEC has adopted a number of exemptions based upon the status of the Section 16 insider. Depending on the circumstances, certain of these exemptions may be available to executors and other fiduciaries, odd-lot dealers, market makers, arbitrageurs, underwriters and other persons who participate in a distribution of the company’s equity securities.

Form 5: Annual Statement of Changes in Beneficial Ownership

A Section 16 insider must report certain transactions on a year-end report on Form 5 within 45 days after the end of the company’s fiscal year. Some transactions, most notably gifts, are not required to be reported on Form 4, but must be reported on Form 5. A Section 16 insider is required to file a year-end Form 5 to report any transaction that the person should have reported during the fiscal year on Form 3 or Form 4, but did not. Transactions reportable on Form 5 are limited to the following:

  • Certain transactions occurring during the most recent fiscal year that are exempt from short-swing profit liability under Section 16(b), such as bona fide gifts of the company’s equity securities, but excluding exempt transactions which involve the company
  • Qualifying de minimis acquisitions of the company’s equity securities
  • Transactions that the Section 16 insider should have reported on Form 3 or Form 4 during the most recent fiscal year, but did not

Disclosure of Reporting Delinquencies; Compliance Programs. Item 405 of Regulation S-K requires a company to disclose in its annual proxy statement and annual report on Form 10-K certain information regarding the failure of any Section 16 insider to timely file a Section 16 report during the previous fiscal year or prior fiscal years. For each such delinquent Section 16 insider, the company is required to set forth the number of late reports, the number of transactions that were not reported on a timely basis, and any known failure to file a required Form 3, 4 or 5. Although there is no official sanction placed upon the company as a result of the filing delinquencies of its insiders, such disclosures are potentially embarrassing.

Accordingly, every public company should develop and implement a strong compliance program to ensure that its directors and officers timely file all required reports. In addition to minimizing the potential for embarrassing disclosures of the type described above, a strong compliance program will assist the company’s directors and officers in avoiding both short-swing liability under Section 16(b) and SEC enforcement actions to enforce Section 16(a)’s reporting requirements.

Filing Procedures and Website Posting.

All Section 16(a) reports must be filed with the SEC electronically using the SEC’s EDGAR filing system, and all reports become publicly available immediately upon filing.

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One response to “A review of Section 16 filing responsibilities

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