Morrison & Foerster : Legal Updates & News : Legal Updates : Sarbanes-Oxley Act of 2002: New Section 16 Reporting Requirements for Insiders

Any of the attorneys in our Corporate Department can assist you in reviewing your procedures and establishing a program that will be effective in meeting these new requirements.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Sarbanes-Oxley Act of 2002: New Section 16 Reporting Requirements for Insiders

August 2002

On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the "Act") was signed into law and effected significant changes in the federal securities laws. (For a summary of the Act, please see our Update, Dramatic Changes to Corporate Governance for Public Companies and New Framework for Oversight of Auditors, July 2002.) Section 403 of the Act amended Section 16(a) of the Securities Exchange Act of 1934 to accelerate considerably the time period for filing reports of changes in beneficial ownership by officers, directors and 10% stockholders of reporting companies.

Effective August 29, 2002, most insider transactions must be reported on Form 4 within two business days after the date on which the transaction occurs. The transactions reportable on Form 4 will be expanded to include several types of transactions previously reported on a delayed basis on Form 5. By no later than July 30, 2003, insiders will be required to file these reports in electronic format, and issuers will be required to post the reports on their website (if they maintain one) by the end of the business day following the filing.

SEC Proposals

The Act permits the Securities and Exchange Commission to promulgate rules to extend the two business day deadline for transactions which the SEC determines that the two-day deadline is not feasible. On August 6, 2002, the SEC issued a release providing limited guidance on the rules it will adopt to implement Section 403 of the Act. Without proposing specific rules, the SEC indicated that it intends to eliminate the ability of officers and directors to report certain transactions with the issuer on a delayed basis on Form 5, which under current rules is not due until 45 days after the end of the fiscal year in which the transaction occurs. Under the new rules, which the SEC said would be adopted in final form in an implementing release shortly prior to August 29, 2002, transactions such as grants, exercises, cancellations and regrants of stock options (including repricings) will be reportable on Form 4 within two business days. Presumably, the SEC will leave in place existing exemptions from Section 16 reporting for transactions (other than discretionary transactions) under tax-conditioned plans.

While Form 5 will likely be preserved for limited purposes (such as reporting de minimis acquisitions and a limited class of other transactions exempt from Section 16(b) short-swing liability), the SEC intends to amend Form 4 to eliminate references to the report as a "monthly" report. The SEC also indicated that it may extend the filing deadlines for narrowly defined transactions in which the reporting person has limited knowledge or control of the timing of such transactions. These may include single market orders that are executed over a period of several days, certain pre-existing arrangements (such as a 10b5-1 trading plan) under which the timing of the transaction is "outside the knowledge of the insider," and certain discretionary transactions involving employee benefit plans where there is a delay in notice to the insider of the transaction.

As a result of the changes effected by the Act, the SEC has suspended its April 2002 proposal to require issuers to report transactions by their insiders on Form 8-K. The SEC is continuing to consider related proposals to require issuers to disclose information about the adoption, modification or termination of 10b5-1 plans by its officers and directors and information relating to any loans or guarantees to directors and officers that are not otherwise prohibited by Section 402 of the Act. We expect that the SEC's adopting release will provide guidance on transition to the new reporting system, including whether pre-August 29 transactions should be reflected on Forms 4 filed after the new filing rules take effect, as well as clarification on the continued applicability of the rules, forms, exemptions and interpretations that were in effect prior to August 29 except to the extent they are inconsistent with the Act or the implementing rules.

Procedures for Compliance with Section 16 Changes

Based on the changes effected by the Act and forthcoming SEC rules, it is more important than ever for issuers to adopt or revise compliance procedures for their insiders and to take an active role in assisting insiders in completing and filing reports of transactions. Companies should act now to review existing policies and inform their insiders of the new filing requirements and revised internal compliance procedures, which may include the following:

Designate Compliance/Reporting Personnel. Issuers should designate an individual or group of individuals who can be contacted with notices of transactions and can prepare reports promptly upon receipt of such information for review by the insider. These individuals should be familiar with the Section 16 reporting requirements and may include inside or outside counsel.
Mandatory Pre-Clearance of Transactions. Many issuers have existing pre-clearance requirements for trades by the company's insiders and others whose transactions may be attributable to those insiders. Issuers should strongly consider adopting or expanding pre-clearance policies that extend to option exercises, transactions in other benefit plans, and other reportable transactions.
Designated Brokers and Broker Interface Procedures. Issuers may want to specifically identify the brokers permitted to execute trades for insiders and institute procedures to ensure prompt notice of transactions from these brokers to the issuer's compliance personnel and to execute trades only after confirming pre-clearance with the issuer. Procedures for 10b5-1 trading programs, such as broker notice requirements, should also be implemented.
Internal Communications with Compliance Personnel. Because of the expanded number of transactions that are subject to two-day reporting, issuers should create channels for prompt communication between internal compliance personnel and the board (or compensation committee) and plan administrators to ensure that stock option activity and other transactions under the issuer's benefit plans (including deferred compensation plans involving issuer stock) are communicated in time to meet filing deadlines.
Powers of Attorney for Insiders. Issuers may want to obtain powers of attorney from its insiders to permit the issuer to execute a filing on behalf of the insider. This may help to avoid delays in filing in emergency situations in which the insider is not available to sign the report.
Adopt Electronic Filing Procedures. While electronic filing is not mandated immediately, filing in paper format will effectively reduce the two day filing period to one day, given the time it will take to deliver paper filings to the SEC by overnight courier. Electronic filings will also satisfy requirements to file copies of the reports with the national exchange on which the issuer's securities are listed. Before obtaining new EDGAR filer numbers and passwords for their insiders, companies should first inquire as to whether any particular insider has already obtained EDGAR identification codes.