The Latest Section 16 Developments with Alan Dye

Answers to Questions Submitted in Advance

Wednesday, January 24, 2024

Audio Archive

Alan:  Thank you, Barbara.

I will start, as we usually do, by covering developments over the last year that affect Section 16 compliance.  After that, we will respond to the questions submitted by members in advance of the program.  A couple of the questions we’ll cover came in through the Q&A forum on Section 16.net, and we usually receive a few questions by email during the program.  If we do, I will try to answer those questions during the program.  If we can’t get to them, I’ll respond to them by adding them to the transcript of today’s session.

Amendments to Reporting Requirements

Amendments to Form 4 and Form 5

As we discussed last year, the SEC adopted its proposed amendments to Form 4 and Form 5 which added a checkbox to the top of each form.  The box is to be checked if a reported transaction occurred pursuant to a trading plan intended to comply with Rule 10b5-1.  At the same time, the SEC added an instruction to the forms requiring that if a reported transaction occurred pursuant to a Rule 10b5-1 plan, a footnote be included disclosing the date the plan was adopted. The addition of the Rule 10b5-1 checkbox and the new instruction became effective on April 1, 2023.  At that time, it wasn’t clear whether the box should be checked only if the trading plan was adopted under the newly amended Rule 10b5-1, which became effective on the same date, or should also be checked when reporting a transaction that occurred under a 10b5-1 plan adopted under the prior version of the rule.  The staff cleared up the uncertainty by providing oral advice that the box should be checked only if the plan was intended to comply with the new version of the rule.  In August, the staff formalized that advice in a Compliance and Disclosure Interpretation.  If a filer wants to disclose that a reported transaction occurred under the old rule, the filer can do that by including a footnote in the report. The filer just shouldn’t check the 10b5-1 checkbox.

Amendments to Rule 16a-3

I also mentioned last year that the SEC had adopted amendments to Rule 16a-3 to require that an insider’s disposition of securities by gift be reported on Form 4 within two business days, rather than on Form 5 within 45 days after the end of the fiscal year. Those amendments became effective on February 27 of last year. Even though dispositions by gift are reportable on Form 4, they remain exempt from Section 16(b) under Rule 16b-5.       

Amendments to Section 13(d)/(g) Rules

In October, the SEC adopted most of the amendments to its rules under Sections 13(d) and 13(g) proposed in February 2022. Most of the amendments accelerated the deadlines for filing Schedules 13D and 13D and amendments to the schedules.  Those changes shouldn’t have much effect on Section 16 compliance. Fortunately, the SEC did not adopt proposed amendments which would have impacted Section 16 compliance by expanding the circumstances under which investors might be deemed ten percent owners. The proposals would have done that by (i) attributing to holders of cash-settled swaps and other derivative securities, if the securities are held with the purpose or effect of changing or influencing control of the issuer, beneficial ownership of a portion of the “reference” securities and (ii) expanding the circumstances under which two or more investors may be deemed a “group.” In lieu of adopting the proposed amendments, the SEC included in the adopting release guidance intended to clarify its views regarding the application of the existing 13(d)/(g) rules to cash-settled derivatives and groups.

Cash-Settled Derivative Securities. The SEC’s guidance regarding cash-settled derivative securities essentially repeated the guidance the SEC provided in 2011 regarding the applicability of existing Rule 13d-3 to security-based swaps. The SEC said that the facts and circumstances of a particular transaction may lead to attribution of beneficial ownership of securities underlying a swap under any of the three existing provisions of Rule 13d-3 that address attribution.

First, if a cash-settled derivative security provides its holder with sole or shared voting or investment power over the reference security, through a contractual term of the derivative security or otherwise, the holder of the derivative security may beneficially own the reference security under Rule 13d-3(a). Second, if the derivative security has the purpose or effect of divesting the holder of beneficial ownership or preventing the vesting of beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(g), the holder may be deemed to beneficially own the reference security under Rule 13d-3(b). Third, if a cash-settled derivative security gives the holder a right, which may be based on an “understanding,” to acquire the reference security within 60 days, or at any time if the holder has a purpose or effect of changing or influencing control of the issuer, the holder may beneficially own the reference security under Rule 13d-3(d)(1).

Group Formation in Absence of an Agreement. The SEC had proposed to amend Rule 13d‑5, which provides that a “group” is formed when two or more persons “agree” to act together, to eliminate the requirement that investors “agree” with one another and provide instead that a group is formed when investors “act as a group under Section 13(d)(3),” which parallels the language of the statute. The proposal drew a lot of negative commentary, mainly for expanding the common understanding of what gives rise to a group and for making the determination of group status more difficult and uncertain.  Uncertainty would make it easier for the Section 16(b) plaintiffs’ bar to establish the existence of a group and impose Section 16(b) liability on unwitting investors. The SEC said the proposed amendment was not intended to expand the circumstances that give rise to a group, but was intended merely to codify the SEC’s view that the existence of a group does not depend “solely” on the presence of an express agreement. The SEC’s new guidance provides that, depending on the particular facts and circumstances, “concerted actions” by two or more persons may be sufficient to constitute “acting together” as a group if the actions are “in furtherance of” the acquisition, disposition, holding or voting of securities.

Helpfully, the SEC seemed to dispel the notion that parallel investment activity alone is sufficient to make investors a group: “[T]he Commission recognizes that for a finder of fact, including the Commission itself, to determine that a group has been formed under Section 13(d)(3) or 13(g)(3), the evidence must show, at a minimum, indicia, such as an informal arrangement or coordination in furtherance of a common purpose to acquire, hold, or dispose of securities of an issuer. If two or more persons took similar actions, that fact is not conclusive in and of itself that a group has been formed.”

Group Formation Through Tipping. The SEC had also proposed to amend Rule 13d-5 to deem a group to be formed when a person who plans to file a Schedule 13D discloses the upcoming filing to another investor for the purpose of causing that investor to acquire securities of the same class, and the other investor in fact acquires securities of the same class based on that information. Instead, the SEC provided guidance describing the circumstances under which, applying existing rules, the SEC would consider a tipper and a tippee to be a group.

Section 16(a) Enforcement Sweep

Now let me turn to the SEC’s Section 16(a) enforcement program.  I’ve been mentioning for the last couple of years rumors of a possible enforcement sweep, similar to the sweep the SEC undertook in 2014, when it initiated and simultaneously settled 34 enforcement actions alleging violations of Section 16(a) and, in some cases, Sections 13(d) and (g). The SEC said in its press release announcing the 2014 sweep that it expected to bring more Section 16(a) enforcement actions in the future, but for the next nine years the SEC brought only a handful of 16(a) claims, and then only where the insider was also being charged with other, more serious violations of the securities laws.  Then, this past September, the SEC announced another sweep, initiating and simultaneously settling 11 cease-and-desist proceedings based on violations of Sections 16(a).  Six of the respondents were Section 16 insiders, and five were issuers who were charged with causing their insiders’ Section 16(a) violations. Three of the insiders were also charged with violating Section 13(d), and three of the issuers were charged with violating Section 13(a) by failing to disclose insiders’ reporting delinquencies under Item 405 of Regulation S-K.

A look at the nature of the violations may indicate what kind of behavior the SEC considers bad enough to warrant an enforcement action.  Bear in mind that, every year, over 40% of companies disclose at least one late or unfiled report under Item 405, but still enforcement actions are rare. So, we know that ordinary, isolated violations aren’t likely to catch the SEC’s eye.

Issuer as “Cause” of Section 16(a) Violations.  All of the five issuers were charged with causing insiders’ Section 16(a) violations by undertaking to assist insiders with their reporting obligations and then negligently failing to file reports on time.  In most cases, the transactions reported late occurred pursuant to equity plans and therefore were known to the issuer at the time they occurred.  The enforcement orders do not disclose the precise number of reports filed late, but the detail provided indicates that the number of late reports ranged from as few as 60 to more than 150.

Insiders’ Section 16(a) Violations.  Two of the individual respondents were officers of the issuer, two were directors, and three (including one of the directors) were ten percent owners.  The number of late reports ranged from approximately 20 to 60 or more, and reports were filed from days to months late.  In some cases, the SEC appeared to be influenced by the dollar amount of the transactions (e.g., the SEC noted that half of one director’s late reports involved over $26 million in transactions). 

Item 405 Disclosure Failures.  Each of the three issuers charged with failure to comply with Item 405 failed to comply in multiple years. In some instances the issuer failed to address Item 405 at all, in some the issuer made an affirmative statement that all required reports had been filed on time, and in some the issuer identified delinquent insiders and the nature of the transactions reported late but failed to disclose either the number of late reports or the number of transactions reported late.

Civil Money Penalties.  In addition to consenting to an order prohibiting future violations, each respondent agreed to pay a civil money penalty.  The penalties imposed on issuers ranged from $115,000 to $200,000.  The penalties imposed on individuals ranged from $66,000 to $150,000. 

These enforcement actions demonstrate that the SEC remains committed to enforcing the Section 16(a) reporting requirements, even in the absence of violations of other provisions of the federal securities laws.  There may be more to come—the press release announcing the sweep said the consent orders are part of “the SEC’s ongoing investigation of potential beneficial ownership violations.”

Section 16 Exemption for Foreign Private Issuers

Last year I became aware of a legislative effort to amend Section 16(a) to extend its coverage to insiders of foreign private issuers.  An SEC rule (3a12-3) exempts insiders of foreign private issuers from Section 16, but the proposed amendment would have nullified that rule. The proposal was first introduced in the Senate in 2022, as the Holding Foreign Insiders Accountable Act.  It was introduced by Senators John Kennedy and Chris Van Hollen and was intended to address trading abuses by insiders of certain foreign private issuers, mainly in China and Russia, who avoided trading losses by selling issuer stock shortly before a significant decline in its price. Subjecting foreign insiders to Section 16 would, the Senate sponsors said, alert investors to insider sell-offs and give American law enforcement agencies better ability to identify insider trading. The proposed amendment went nowhere in 2022 but was reintroduced in 2023 and became part of Senate version of the National Defense Authorization Act for 2024, which passed the Senate in July.  The House bill, though, didn’t contain a similar provision, and the Senate provision was dropped in conference.  So, the amendment will not be enacted this year.  Those who advise foreign private issuers might want to keep an eye out for a similar bill this year. 

Section 16(b) Litigation

 Attribution of Issuer Repurchases to Insider. A noteworthy new development occurred this year in Section 16(b) litigation.  Glenn Ostrager, a longtime member of the plaintiffs’ bar, submitted demand letters to at least three companies asking them to recover short-swing profits from their controlling shareholders.  The trades Mr. Ostrager sought to match were open-market sales by the controlling shareholder and stock repurchases by the issuer.  His theory is that a controlling shareholder has a pecuniary interest in any shares repurchased by the issuer, so the issuer’s repurchases can be matched with the controlling shareholder’s sales to the extent of the controlling shareholder’s proportionate interest in those shares.

No issuer chose to pursue the claim, so Mr. Ostrager filed an action against one insider in the District Court for the Middle District of Florida. The judge in that case granted the insider’s motion to dismiss the complaint, holding that an issuer’s repurchase of its own securities is not an indirect purchase of issuer securities by the issuer’s controlling shareholder.  The plaintiff in that case has filed a motion to reconsider, and in the meantime Ostrager has filed actions against controlling shareholders of two other companies, one in the Southern District of New York and the other in the Eastern District of New York.  If a court were to agree with the plaintiff, all insiders, not just controlling shareholders, would be at risk of 16(b) liability if they sold stock within six months of an issuer repurchase.  

QUESTIONS AND ANSWERS

Ok, Barbara, that’s all I wanted to say about recent developments.  Should we start addressing the questions? 

Receipt of Gift of Indirectly Owned Shares

Barbara: We have an executive officer whose three minor children were gifted shares by their grandparents in 2021, and the gifts were reported on Form 4 as the acquisition of indirect ownership of shares by gift, using transaction code “G” and a “V” for voluntary reporting. We have just learned that the children recently received another gift of shares. We are tracking down the date of the gifts, but if the gifts occurred after the effective date of the 2023 rule change relating to gifts, how do you suggest we handle the reporting?

Alan: As I mentioned at the beginning of the program, the amendments to Rule 16a-3 became effective February 27, 2023. The amendments changed the reporting deadline for dispositions by gift, by requiring that they be reported on Form 4 within two business days, but not the deadline for acquisitions by gift, which remain reportable on Form 5. Since the insider, through the insider’s children, acquired securities by gift, the acquisition can be reported on Form 5 after the end of the fiscal year. As the insider did in 2021, however, the insider can choose to report the acquisition on Form 4, voluntarily, in which case the Form 4 can be filed any time before the Form 5 would be due.

Reporting Rule 10b5-1 Plan Sale and Non-Plan Sale on Same Form 4

Barbara: A Section 16 officer consummates two transactions over two days. First, the officer sells common stock on the open market. Then, the next day, the officer sells common stock on the open market upon the vesting of restricted stock units, pursuant to a “sell to cover” Rule 10b5-1 plan adopted under the new 10b5-1 rules. The officer would like to file a single Form 4 to report both sales. If the Form 4 reported only the sell-to-cover transaction, the new Rule 10b5-1 box would have to be checked. Can both transactions be reported on a single Form 4, and if so, would it be appropriate to check the 10b5-1 box?

Alan: Yes, both sales may be reported on the same Form 4, and the Rule 10b5-1 box should be checked. The box should be checked if any transaction reported in the Form 4 occurred pursuant to a Rule 10b5-1 plan adopted under the amended rule. To indicate which transaction occurred pursuant to a trading plan, a footnote should be attached to the line reporting that transaction, and the footnote should disclose the date the plan was adopted.

Year-End Form 5 Compliance

Barbara: If during out annual year-end Section 16 compliance check we discover that a reporting person had an open market sale which should have been reported but wasn’t, I assume we could report the sale on Form 5.  Am I correct that we would report the sale the same way we would have reported the sale if it had been timely reported on Form 4 (for example, using a weighted average price and disclosing the range of prices in a footnote)?  Do you recommend that we drop an additional footnote to explain that the Form 5 is reporting a sale that should have been reported earlier on Form 4, or will that be self-evident?

Alan: Yes, you can report the sale late, on Form 5, without having to file a Form 4.  You should report the sale in the same way you would have reported it if you had reported it on Form 4, including the weighted average price and the footnote disclosing the range of prices.  The total holdings in Column 5 of Table I should be based on the insider’s ownership as of the last day of the fiscal year, not the date of the sale.  I don’t think there is any need to add a footnote to disclose that the transaction is being reported late.  The Form 5 will include a checkmark in the delinquency box to show that a transaction is being reported late, and the transaction code for the sale will have to be accompanies by a “4” in the transaction code column, so it will be very clear to any reader that the sale should have been reported on Form 4 and is being reported late.  

Chief Operating Officer as Non-Section 16 Insider

Question:  If a company’s board determines that the designated chief operating officer is not an executive officer because he is not in charge of a principal business unit, division or function and does not perform a significant policy-making function, is it ok not to consider the person a Section 16 officer?

Answer:  Yes, if the board has made that determination, then it’s appropriate not to consider the chief operating officer to be a Section 16 officer.  The definition of "officer" in Rule 16a-1(f) includes certain officers by title, including the president, PFO and PAO, but it doesn’t specifically include a chief operating officer.  The definition does, though, include any person who is in charge of a principal business unit, division or function or who performs a significant policy-making function at the corporate level.  The definition of “executive officer” in Rule 3b-7 is nearly identical.  At most companies, a chief operating officer performs a significant policy-making function and is considered by the company to be an executive officer and a Section 16 officer.  The determination is based on the facts and circumstances of the individual’s role within the company, however.  If the board has determined that the chief operating officer is not an executive officer, it logically follows that he would not be considered a Section 16 officer either.

Filing Form 4 Using Issuer’s EDGAR Codes

Barbara: The board appointed a new director on short notice, and we are concerned that the SEC will not process the Form ID in time to allow us to file a Form 4 to report the director’s receipt of an award of restricted stock units on the effective date of his appointment.  If we don’t receive the director’s EDGAR codes on time, could we file the Form 4 using the issuer’s EDGAR codes, and avoid having to disclose a filing delinquency under Item 405?

Alan: The EDGAR system will accept the Form 4 using the issuer’s EDGAR codes, and the Form 4 will show up on the issuer’s EDGAR filing page, but not as a filing by the director.  I have my doubts, though, whether the SEC would consider that a timely filing for Item 405 purposes, but it might not be unreasonable to take that position. When Section 16 reports first had to be filed electronically (in 2003), a lot of filers were slow getting up to speed, and sometimes filers used the issuer’s EDGAR codes, usually by accident.  The staff at that time suggested that the filing didn’t have to be deemed late but should be refiled under the insider’s codes.  The staff was being accommodating, I think, as filers learned the EDGAR system.  I doubt the staff would treat the filing as timely today, but at least filing might offer a basis for filing again when the insider has EDGAR codes, and perhaps requesting a filing date adjustment.  I don’t know if the staff would be receptive, but it could be a possibility.  

Reporting Performance Share Awards

Barbara:  I would appreciate a review of the proper reporting of performance shares granted to Section 16 officers.  In our case, the award will vest at the end of three years, and the number of shares earned will be determined by the achievement of performance criteria relative to the performance of a peer group of companies.  During the three-year period, dividends will accrue on the target number of performance shares and will be reinvested in additional performance shares.

Alan:  In almost all cases, performance shares are not reportable on Form 4 at the time of the initial grant.  The reason is that the staff takes the position that an award of shares that is subject to a material condition that is beyond the insider’s control does not represent a pecuniary interest in the underlying securities until the condition has been satisfied.  Here, it sounds like the performance metrics are material conditions.  In addition, vesting is based not only on the issuer’s performance, but also on the performance of a group of peer companies.  So, for two reasons, vesting of the performance shares is subject to a material condition beyond the insiders’ control, and therefore the awards were not reportable on Form 4 at the time of initial grant.  Instead, the acquisition of any shares earned will be reportable on Form 4 at the time they are earned.  Generally that date is the date on which the compensation committee determines the extent to which the performance metrics were met and certifies the number of shares to be issued to each grantee.  At that time, the shares will be reportable in Table I if they pay out in stock, or possibly in Table II if they pay out in the form of time-vesting restricted stock units that settle in cash.  The accrual of additional performance shares during the three-year earn-out period as reinvested dividends will not be reportable, for the same reason that the initial award is not reportable.  Any dividend shares earned at the end of the performance period will be reportable on Form 4 in the same way the underlying performance shares are reported.

Performance Shares Partially Earned

Barbara:  We are hoping you can provide guidance for reporting our performance-based awards.  The company granted PSUs that will vest and settle in three years based on the achievement of several financial goals.  The performance will be measured each year and also at the end of the three-year period using the applicable weighting for each year in the performance cycle.  As such, although the aggregate number of shares to be issued will not be determined until the end of year three, we will know at the end of each of the first two years the minimum number of shares earned for that year based on the annual performance criteria.  The question is:  are we required to report the “earned” shares each year, or can we report everything upon completion of the full three-year performance period?

Alan:   Others may not agree with my response, but my view is that, once an officer becomes entitled to a minimum number of shares at the end of a year, subject only to the passage of time and continued employment through the end of the performance cycle, the rights and obligations of the officer and the company with respect to those shares become fixed and irrevocable, such that the officer has acquired beneficial ownership of the shares and should report the acquisition on Form 4.  I’m aware that some companies wait until the end of the three-year performance period to report the acquisition of shares, on the theory that the award doesn’t become fixed until then, when the total number of shares issuable is known.  I’m not suggesting that those companies are not reporting their performance awards in an acceptable way, that’s just not the way I recommend reporting.

Form 3 Reporting of Shares Held in Revocable Trust

Barbara:  We have a new director who holds shares of company stock in a revocable living trust.  On her Form 3, should we report the shares as owned directly or indirectly?

Alan: You can report the shares either way, as directly owned and combined in Column 5 of Table I with any other shares the director owns directly, or you can report the shares on a separate line, as indirectly owned by the trust.  Historically, the SEC staff viewed living trusts as having no economic effect on the insider’s ownership, since the insider could spend the trust assets any way he or she chose, and could withdraw the shares from the trust at any time.  That position allowed insiders to disregard the trust and report the trust’s holdings as directly owned.  The shares are held in a trust, though, so it’s entirely appropriate and acceptable to report the trust’s holdings as indirectly owned.  Both ways of reporting are common.  If you report the shares as directly owned, there is no need to include a footnote disclosing that the shares are held in a trust.

Including Current Transaction in Form 4/A Correcting Previously Reported Transaction

Barbara:  We recently discovered that a reporting person’s 2022 option grant was understated when reported on Form 4.  The same reporting person plans to execute an open market sale this week, unrelated to the under-reported option, and we will need to report that sale on Form 4.  Can we report the sale in a Form 4/A filed to correct the error in the Form 4 filed to report the option grant?  If the answer is yes, would we do that by updating the holding in Table I and reporting the sale in Table I?    

Alan:  I don’t think the current sale can be included in a Form 4/A filed to correct the option grant, because the Form 4/A needs to speak as of the date of the option grant.  Instead, the sale needs to be reported in its own Form 4, showing the date of the sale in Box 3 of the Form 4.  The option information can be corrected in a Form 4/A, either re-reporting the grant or listing the option as a holding, with a corrected number in Columns 7 and 9 and a footnote explaining the correction.  If the error in reporting the option grant was de minimis or immaterial, you might consider re-reporting the option in the Form 4 filed to report the insider’s sale, as a holding, and explaining in a footnote that the reporting person is correcting an error that appeared in the original Form 4. 

Form 4 Exit Box

Barbara:  A Section 16 officer engages in a reportable transaction one day before they lose their Section 16 status.  Because the transaction took place while the individual was subject to the Section 16 requirements, I believe a Form 4 has to be filed to report the transaction, even though the due date for the Form 4 is after the person is no longer subject to Section 16.  Do you agree, and if so do I need to check the exit box on the form?

Alan:   Yes, I agree that the transaction has to be reported on Form 4.  All that matters is that the person was a Section 16 insider on the date of the transaction.  The person’s status on the due date for the Form 4 isn’t relevant to whether the transaction has to be reported.  Whether the Form is filed on the reporting person’s last day as an insider or the day after, the exit box should be checked to show that the filer is no longer subject to Section 16.   

Form 144 Filings

Barbara:  Does a Form 144 have to be filed any time a Section 16 insider sells stock in the open market and reports the sale on a Form 4, assuming the sale exceeds 5,000 shares or $50,000 in proceeds?  Since the SEC started requiring Forms 144 to be filed electronically, our Section 16 officers’ brokers have been filing the Form 144 promptly, and the Form 144 appears on the insider’s EDGAR page a day before we file the Form 4 to report the same sale.  In looking at other companies’ public filings, I see a lot of Forms 4 reporting sales that exceed the Form 144 filing thresholds, but I don’t see a corresponding Form 144.  I don’t think they are overlooking the Form 144 filing requirement.  What am I missing?

Alan:  You probably aren’t missing anything, other than the fact that Form 144 applies to “affiliates,” a term that isn’t defined as precisely as the term “officer” for purposes of Section 16.  An affiliate is a person who controls, is controlled by, or is under common control with the company.  In 1997, the SEC proposed to add to Rule 144 a statement that persons who are not subject to Section 16 also are not affiliates. That proposal was never adopted, but many companies looked to that language and decided to treat all Section 16 persons as affiliates.  Surveys conducted a few years ago showed that most companies treat all Section 16 insiders as affiliates. The surveys showed that many companies don't, though, and a narrower list of affiliates may explain why Forms 4 are being filed for Section 16 officers who aren't also filing a Form 144.

Dividend Equivalent Units and Column 5

Barbara: Our company grants restricted stock units to officers, and the awards accrue dividend equivalent units as dividends are paid on the common stock. The company has a dividend reinvestment plan that complies with Rule 16a-11, so dividend accruals are not reported on Form 4 or Form 5, but they are added to Column 5 of Table I each time we file a Form 4 to report a transaction in common stock.  If we need to file a Form 4 for an insider after the record date for a dividend but before the payment date, we won’t know the number of DEUs the insider will receive, because the number depends on the closing price of the company’s stock on the dividend payment date.  Do we need to disclose anything in the Form 4, like an estimate of the number of DEUs the officer will receive? 

Alan:  No, there is no need to say anything in the Form 4 about the reporting person’s right to DEUs on the upcoming payment date.  The Form 4 needs to report only the number of shares the reporting person owns following the transaction reported in the Form 4.  Unaccrued DEUs do not represent beneficial ownership of shares until the number of DEUs becomes fixed, which won’t occur until the dividend payment date.  Rather than mention the unaccrued DEUs in the Form 4, the reporting person should just add the DEUs to Column 5 in the reporting person’s next Form 4 filed after the dividend payment date.

Sales Before Appointment as Section 16 Person

Barbara:  A candidate to serve on the board is expected to be appointed as a director on January 31.  On January 28, the candidate instructs his broker to sell of his shares of company stock.  When we file the candidate’s Form 3 after he is appointed to the board, will the Form 3 report that he doesn’t beneficially own any shares?

Alan:  Yes, if the candidate sells all of his holdings of issuer securities before his appointment to the board becomes effective, and he doesn’t acquire any issuer securities before his appointment, the Form 3 will report that the director doesn’t beneficially own any stock as of the time of his appointment.   There is no six-month lookback for people who become an officer or director of a company that already has a class of equity securities registered under Section 12 of the 1934 Act, so the director’s sale will never become reportable on Form 4, even if the director purchases company stock less than six months after the sale.

Spouse as Beneficiary of Family Trust

Barbara:  We are preparing a Form 3 for a new director whose wife is the beneficiary of a trust that holds company stock.  The insider himself has no pecuniary interest in the trust, and the trust has an independent trustee.  Do the shares of company stock held by the trust have to be reported in the director’s Form 3? 

Alan: The director would be deemed to have a reportable pecuniary interest in the trust’s shares only if the director, or the director’s spouse, has or shares investment control over the shares held by the trust.  Rule 16a-8 establishes the circumstances under which an insider will be deemed to be the beneficial owner of securities held by a trust. Where the insider or the insider’s spouse serves as trustee, and a member of the insider’s immediate family is a beneficiary of the trust, the insider will be deemed to have a pecuniary interest in the trust’s holdings.  Even if neither the insider nor the insider’s spouse is trustee, the insider or his spouse will be deemed to have investment control as a “de facto trustee” if he or she is able to influence the trustee’s decision whether to buy, sell or hold the shares held by the trust.  Any pecuniary interest the spouse has in the trust’s holdings would likely be attributable to the insider, so the spouse’s investment control over the shares would also make the trust’s holdings reportable by the insider