Section 16 Reporting Changes Under the Sarbanes-Oxley Act:  What You Need to Know

Ronald O. MuellerStanton P. Eigenbrodt

August 29, 2002

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Ronald O. Mueller

A corporate partner in Gibson Dunn's Washington, D.C. Office, Mr. Mueller has extensive experience in the corporate securities area with an emphasis on proxy and disclosure issues, corporate governance, executive compensation and corporate transactions. Mr. Mueller served as legal counsel to SEC Commissioner Edward H. Fleischman from 1989 to 1991, during which time the SEC comprehensively revised the section 16 reporting rules. He is a member of the ABA's Committee on Federal Regulation of Securities, and has written numerous articles and spoken extensively on executive compensation issues and the SEC’s reporting and disclosure requirements. 

Contact Information:

202-955-8671 – direct dialrmueller@gibsondunn.com

                     

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Stanton P. Eigenbrodt

Mr. Eigenbrodt is of counsel in Gibson Dunn's Dallas office, and a member of the firm's corporate department and the firm's executive compensation practice group. Mr. Eigenbrodt 's practice includes an emphasis on executive compensation matters, including the Section 16 reporting rules. Mr. Eigenbrodt also has a broad-based corporate practice, including mergers and acquisitions of public and private companies; public and private debt and equity offerings; and advice regarding disclosure issues under the Securities Exchange Act of 1934. Mr. Eigenbrodt is the co-author of “Disclosure Requirements” and “Compliance Procedure and Programs” in A Practical Guide to Section 16:Reporting and Compliance (Goodman 3d ed. 1997).

Contact Information:

214-698-3174seigenbrodt@gibsondunn.com

                      

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Overview of Presentation

• New Rules effective August 29, 2002

• What has changed and what has not

• The new reporting regime: accelerated 2 day reporting for most transactions

• Transition issues

• Responding to the new reporting rules

• Helpful reminders

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OVERVIEW

• Section 403 of Sarbanes-Oxley amended Section 16(a) to require each report on a change of ownership:

– To be filed “before the end of the second business day following the day on which the subject transaction has been executed” unless the SEC determines that 2-day reporting “is not feasible.”

– Indicate ownership by the filing person of company securities at the date of filing, taking into account the reported transactions.

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OVERVIEW

• The Act also requires electronic filing of Section 16(a) reports no later than July 30, 2003.

– At that time, the issuer will be required to make the report available through its website.

• The Act did not repeal the SEC’s general rulemaking authority to interpret and exempt transactions from Section 16.

The New 2-Day Reporting Requirement

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The SEC adopted rules to implement 2-day reporting on August 27, 2002.

• These rules implement the mandate of Sarbanes-Oxley for 2-day reporting of certain transactions while maintaining much of the pre-existing reporting regime.

• The SEC also amended Form 4 (with conforming amendments to Forms 3 and 5) to accommodate 2-day reporting.

What Has Changed Under The New Rules?

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What has changed?

The SEC Adopted Two Fundamental Changes to the Previous Reporting Rules

• Eliminate the availability of Form 5 for reportable 16b-3 transactions between the company and the insider, instead requiring Form 4 reporting.

• Amend the rules so that any required Form 4 report must be filed within 2 business days.

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What has changed?

• Eliminate the availability of Form 5 for reportable 16b-3 transactions between the company and the insider.

• Form 4 (2 business day) reporting of Rule 16b-3(d), (e) or (f) transactions.– Option grants/restricted stock grants.

– Sales of stock to the company.

– “Discretionary transactions.”Technical amendment to “small transaction” reporting rule makes it unavailable for these types of transactions.

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What has changed?

• Amend the rules so that any required Form 4 report must be filed within 2 business days.

• 2 business day reporting for transactions historically reported on Form 4:

– Open market or private stock sales.

– Open market or private purchases.

– Option exercises.

• 2 business day reporting for reportable 16b-3 transactions between the company and insider.

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What has changed?

• 2 business day reporting is triggered from the date of the transaction:

“Form 4 must be filed before the end of the second business day following the day on which the subject transaction has been executed.”

– Date of execution is likely the date the insider is irrevocably committed to the transaction and price and quantity are fixed.

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What has changed?

• SEC rules provide modified 2 business day reporting for two categories of transactions.– Rule 10b5-1 transactions (including limit orders).

– “Discretionary transactions” under plans.

IF the insider does not select the date of trade execution.

• These transactions are deemed executed on (so the 2 days runs from) the earlier of:– the date the insider is notified of the transaction,

or – the third business day after execution (T+3).

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What has changed?

A “discretionary transaction” is a participant-directed movement of a portion of his or her account balance into or out of a company stock fund under a deferred compensation plan. Discretionary transactions may occur in a tax-qualified plan, such as a 401(k) plan, or in a non-tax qualified plan, such as a SERP or a directors’ fee deferral arrangement.

WHAT HAS NOT CHANGED UNDER THE NEW RULES?

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• Exemptions from Section 16(b) liability have not changed.

– Even reportable 16b-3 transactions remain exempt from short-swing liability.

• Other reporting rules (and interpretations) are largely unchanged, except for the timing of Form 4 filings and the change to reporting transactions under Rule 16b-3(d) through (f).

What has not changed?

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What has not changed?

• Many transactions not reportable at all under a Rule 16a exemption:

– Purchases under 401(k) plans and employee stock purchase plans.

– Allocations under ERISA profit-sharing plans and employee stock ownership plans.

– Transfers pursuant to divorce decrees and domestic relations orders.

– Changes in the form of ownership that do not affect the insider’s pecuniary interest in the shares.

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What has not changed?

• Timing of Form 3 does not change.

• Form 5 survives, but with limited use:

– Gifts.

– Small acquisitions, meaning purchases aggregating less than $10,000, but excluding Rule 16b-3 reportable transactions.

– Late reports.

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The New Reporting Regime

Under the SEC rules, there are now 4 reporting categories:

• T+2 reporting.

• Tmodified+2 reporting.

• Non-reportable transactions.

– Must reflect their effects under “holdings” column on next Form 4.

• Form 5 transactions (EOY reporting).

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Transition Issues

• New reporting effective for transactions executed on or after August 29, 2002.

• Pre-August 29 transactions governed by old rules:

– Transactions reportable on Form 4 under old rules must be reported on or before Sept. 10, 2002.

– Transactions reportable on Form 5 under old rules (including Rule 16b-3 transactions) must be reported within 45 days of company’s FYE.

Responding to the New Reporting Rules

WHAT SHOULD YOU BE DOING NOW?

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Responding to the New Reporting Rules

• Inform insiders of the new reporting deadlines.

– Gibson, Dunn has prepared a sample memorandum that is available at http://gibsondunn.com/practices/publications/detail/id/523/?pubItemId=6627

– Insiders should inform family members and others whose holdings or transactions are attributed to them of the new reporting deadlines.

• Designate at least two compliance officers.

– Consider adding compliance officers to the company’s directors and officers’ insurance policy.

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Responding to the New Reporting Rules

• Tighten preclearance procedures.

– Many companies have preclearance procedures in place already, but if not they should now.

– Preclearance process should collect sufficient information to prepare the Form 4.

– Need details of any 10b5-1(c) arrangements.

– Close coordination with the broker will be necessary to promptly report execution of any trade (whether executed in whole or in part).

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Responding to the New Reporting Rules

• Coordinate with plan administrators on discretionary transactions.

– Determine extent of insider’s control over timing of transactions.

– How quickly can the administrator report transactions.

– May need to suspend or restrict discretionary transactions.

– Consider reporting insider’s instructions and amending Form 4 once information is known.

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Responding to the New Reporting Rules

• Obtain powers of attorney.

– May need broad authorization to allow compliance officers to make inquiries of brokers, others to obtain necessary information, in addition to filing authorization.

– Insider remains responsible for the filing and for disclosure of the insider’s name in the proxy if forms are filed late.

• Catalog insiders’ holdings and other filing information.

– Form is available at http://gibsondunn.com/practices/publications/detail/id/523/?pubItemId=6627

• Consider a catch-up Form 4 filing.

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Responding to the New Reporting Rules

• Consider the disclosure implications of prompt reporting.

– Timing of option grants and public disclosure of compensation decisions.

– Effect of frequent reporting of accruals under compensation plans that do not qualify under the exemption for “tax conditioned plans”.

– A shorter open trading window may help prevent transaction information from dribbling into the market over extended periods.

Helpful Reminders

Practical Tips for Filing and Reporting

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Helpful Reminders

• Need not include SSN.

• “End of period holdings” column:

– Treated as a running total, taking into account transactions reported on the form.

– Need not reflect the effect of transactions that have not yet been reported.

– Effect of transactions that are not required to be reported is based on last available statement.

– Inaccurate “end of period holdings” information is not disclosable in the proxy under Item 405.

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How to file your Forms 3, 4 and 5

• Via overnight courier (such as UPS) sent on T+1.

• By faxing the report to a filing service or GD&C in Washington, D.C. and having it hand-delivered to the SEC.

– Advance planning will be crucial.

• Via EDGAR.

• Direct fax to the SEC is NOT available.

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Tips and traps for EDGAR filing

• Use Form ID to request. http://www.sec.gov/about/forms/formid.pdf

• Different CIK code for each insider.

• Check if insiders already have a CIK code (search by last name). http://www.sec.gov/edgar/searchedgar/cik.htm If so, include that CIK on the Form ID.

• 5:30 p.m. EDT filing deadline.