On August 27, 2002, the Securities and Exchange Commission adopted final rules implementing the accelerated Section 16 reporting
deadlines for insiders imposed by the Sarbanes-Oxley Act of 2002. The August 29, 2002 effective date of the final rules coincides
with the effective date of the Sarbanes-Oxley Act's amendment of Section 16(a) of the Securities Exchange Act of 1934. These
new Section 16 rules are the first in a series of SEC rulemaking actions that will take place over the next year to implement
various provisions of the Sarbanes-Oxley Act.
Background of the New Reporting Rules
Section 403 of the Sarbanes-Oxley Act amended and restated Section 16(a), effective August 29, 2002, to require insiders of
public companies to report any change in their beneficial ownership of the company's equity securities within two business
days after the date on which the transaction occurs. Prior to the amendment, changes in beneficial ownership were required
to be reported on Form 4 within 10 days after the end of the month in which the transaction took place, and several types
of transactions were eligible for delayed reporting on Form 5 within 45 days after the end of the issuer's fiscal year.
In addition to amending Section 16(a), the Sarbanes-Oxley Act empowers the SEC to adopt rules permitting a delayed reporting
deadline with respect to transactions for which the SEC determines that the two business day deadline is not feasible. On
August 6, 2002, the SEC issued a release providing guidance on the rules it anticipated adopting to implement the changes
authorized by Section 403 of the Sarbanes-Oxley Act. (For a summary of the August 6 release and recommended compliance procedures,
see our legal update Sarbanes-Oxley Act of 2002: New Section 16 Reporting Requirements for Insiders, August 2002.) The SEC announced the final rules in its August 27, 2002 release (Release No. 34-46421), which harmonizes
existing forms and rules with the Section 16(a) amendment.
Changes Effected by the Rules
In general, the SEC's final rule release amends existing rules to reflect the new two-business day deadline for Form 4 reports,
expands the category of transactions reportable on Form 4 to include several types of transactions previously reportable on
a delayed basis on Form 5, and makes technical amendments to Forms 4 and 5 to reflect these changes. In its final rule release,
the SEC confirmed that the new rules apply only to transactions occurring on or after August 29, 2002, and confirmed the continued
applicability of the rules, forms, exemptions and interpretations that were in effect prior to August 29 except to the extent
they are changed by the final rules. The SEC also confirmed that, as under existing interpretations, the date of execution
of a transaction is the trade date (not the settlement date).
Expansion of Transactions Reportable on Form 4. The SEC's final rules amend Rule 16a-3 to require officers and directors to report transactions with the issuer that are
exempt from short-swing liability under Rule 16b-3 within two business days on Form 4. These transactions include grants,
awards and other acquisitions from the issuer; dispositions of securities by the insider to the issuer; and "discretionary
transactions" under employee benefit plans (although delayed reporting for the last category is available under certain circumstances,
as discussed below). Under prior rules, exempt transactions of this nature were reportable on a delayed basis on Form 5 within
45 days after the issuer's fiscal year end (with the exception of exercises or conversions of stock options or other derivative
securities, which have always been required to be reported on Form 4). The new rules do not change the Rule 16b-3 conditions
for exemption of these transactions from short-swing profit liability under Section 16(b), but simply accelerate reporting
of these exempt transactions.
As a result of the rule amendments, derivative securities transactions required to be reported on Form 4 will now include
not only exercises and other conversions of derivative securities (which were reportable on Form 4 even before the new rules),
but also grants of options and restricted stock, as well as cancellations and regrants of stock options, including repricings.
The SEC stated that requiring accelerated reporting of these transactions is necessary to satisfy the purpose of Section 403
of the Sarbanes-Oxley Act--"to require immediate disclosure of insider transactions."
Extended Deadline for Certain Transactions. The SEC provided an extended reporting deadline for two narrowly defined categories of transactions under which objective
criteria prevent the insider from controlling the date of the transaction. The two categories are:
- transactions pursuant to a contract, instruction or written plan for the purchase or sale of the issuer's equity securities
that satisfy the conditions of Rule 10b5-1(c), in which the reporting person does not select the date of execution; and
- "discretionary transactions" (as defined in Rule 16b-3) under an employee benefit plan, which generally includes fund-switching
transactions into or out of an issuer securities fund and distributions of cash funded by a disposition of the issuer's equity
securities under a 401(k) plan, deferred compensation plan or similar employee benefit plan that offers multiple investment
alternatives, provided that in each case the reporting person does not select the date of execution.
Transactions falling into either of these two categories are deemed to be executed (for reporting purposes) on the earlier
of (1) the date the insider is notified of execution by the broker, dealer or plan administrator executing the transaction
or (2) the third business day following the actual execution of the transaction. A Form 4 report is due within two business
days after this "deemed" execution date. The broker, dealer or plan administrator may notify the insider using any means of
communication, including oral, paper or electronic means. To the extent that the issuer maintains employee benefit plans that
are not exempt from Section 16(a) reporting (such as non-qualified deferred compensation plans), transactions under these
plans may qualify for the extended reporting period if the transactions would satisfy the conditions of Rule 10b5-1(c).
In its August 6 release, the SEC had stated that it would consider extending the filing deadline for transactions pursuant
to a single market order that are executed over more than one day. However, in its final rules, the SEC indicated that it
believes it is feasible for insiders to report these transactions as they are executed, and therefore it did not modify the
two-business day reporting deadline for these transactions.
Amendments to Section 16 Forms. The SEC amended Form 4 to make it consistent with the new reporting deadlines and to reflect the additional categories of
transactions now reportable on the form. A new column has been added to Forms 4 and 5 to require the insider to report the
"deemed execution" date if the transaction falls within one of the categories eligible for delayed filings described above,
which will enable investors and the SEC to determine from the face of the form whether the transaction has been reported on
a timely basis. The holdings column in Form 4 has been revised to require the insider to report holdings immediately following
the transaction being reported (i.e. after giving effect to the reported transaction), rather than month-end holdings. This
is a welcome variation from the language of Section 16(a) as amended, which would have required the insider to report his
or her holdings "at the date of filing." The statutory language may have caused confusion for insiders engaging in a series
of transactions over several days. The language in the SEC's release clarifies that each individual transaction may be reported
within the two-business day period afforded by the statute. Until the SEC publishes the revised versions of Forms 4 and 5,
insiders may continue to use the current version of the forms with modifications to reflect the transaction date or "deemed"
transaction date as provided in the SEC's final rules.
In addition to the above amendments, the SEC amended Rule 16a-6, which exempts small acquisitions (aggregating less than $10,000)
from Form 4 reporting and allows delayed reporting on Form 5. The amendment requires that, in the event the conditions of
the exemption are no longer met, the insider must report the acquisitions on Form 4 within two business days after the conditions
of the exemption are no longer met.
Practical Implications of the Changes
Pre-August 29 Transactions. The final rules make clear that the amendments to Section 16 do not affect the reporting of transactions that occurred prior
to August 29, 2002. For example, if an insider was granted an option pursuant to Rule 16b-3 prior to August 29, the insider
will be permitted to report the option grant on a deferred basis on Form 5. However, if an option is granted on or after August
29, the insider would be required to report the option grant on Form 4 within two business days of the grant date.
Notification of 10b5-1(c) Transactions and Discretionary Transactions. As the final rules effectively provide no more than three additional days for insiders to receive notice from brokers, dealers
or plan administrators upon the execution of a transaction pursuant to a 10b5-1(c) trading program or a "discretionary transaction"
under an employee benefit plan, both issuers and insiders should immediately review the applicable terms of such programs
and plans and, to the extent necessary, make arrangements with the broker, dealer or plan administrator to provide prompt
notice of such transactions to help ensure timely filing by the insider.
Section 16 Rules and Interpretations that Remain Unchanged. While the Sarbanes-Oxley Act and the SEC's final rules have a seemingly sweeping effect on Section 16, most of the rules
and interpretations under Section 16 remain unchanged. For example:
- Forms 3 are still required to be filed within 10 days after a person becomes an officer, director or 10% shareholder or, in
the case of a company's initial registration, by the time the registration statement becomes effective. To address the incongruous
situation in which an individual could be required to file a Form 4 prior to filing that person's initial statement of beneficial
ownership on Form 3 (e.g., due to a new stock option grant in connection with the individual's appointment or election) the
SEC has suggested that the Form 3 be filed concurrently with the Form 4.
- Transactions previously exempt from Section 16(a) reporting, such as acquisitions under Qualified Plans (pursuant to Rule
16b-3(b)(4)), Excess Benefit Plans (pursuant to Rule 16b-3(b)(2)) and Stock Purchase Plans (pursuant to Rule 16b-3(b)(5)),
remain unaffected by the Sarbanes-Oxley Act and the SEC's final rules.
- The final rules confirm that insiders need only report their beneficial ownership of the class of securities that is the subject
of the reportable transaction, as opposed to updating holdings of all classes of securities held by the insider as of the
date of a reportable transaction (when no change has occurred in the holdings of the other classes of securities as of the
date of the reportable transaction). For example, an insider reporting the grant of a stock option on Form 4 need not update
his or her beneficial ownership of any class of the issuer's equity securities (i.e. the issuer's common stock or other existing options) other than the class reported on the form.
- In reporting holdings immediately following the transaction being reported on Form 4, insiders are still required to reflect
(in column 5, table 1 and column 9, table 2 of Form 4) the changes in holdings of the class of securities being reported,
including changes resulting from transactions that are exempt from reporting under Section 16(a) (such as routine acquisitions
under a 401(k) or other tax-qualified plan). The SEC confirmed in its release that the reporting person may continue to rely
in good faith on the most recent plan statement for purposes of reporting changes in holdings pursuant to 401(k) and other
Rule 16b-3(c) exempt plans.
- Form 5 remains available for the reporting of transactions that were previously eligible for deferred reporting prior to the
SEC's final rules, except for Rule 16b-3 transactions (such as option grants, delivery of shares to pay tax withholdings or
exercise price, and restricted stock grants, etc.) and small acquisitions from the issuer.
Electronic Filing of Section 16(a) Reports and Posting by Issuers
Under Section 403 of the Sarbanes-Oxley Act, by no later than July 30, 2003, insiders must file Form 4 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 (i.e. by 5:30 p.m. Eastern Time). The SEC has indicated that it intends to proceed "expeditiously" with rulemaking and related
internal systems modifications to implement that mandate, and expects to propose rules in the coming months to require electronic
filing of all Section 16 forms (not just Form 4) and company website posting of such electronic reports. Prior to such rulemaking,
the SEC is encouraging insiders to file Section 16 reports electronically and has reiterated its willingness to accept electronically
filed reports that are not presented in the standard box format, so long as the captions and all required information are
presented in the proper order.
Recognizing that there will likely be a tremendous amount of activity to obtain EDGAR filing numbers for insiders, the SEC
asked that in requesting EDGAR numbers, the applicant indicate whether he or she is a reporting person for more than one public
company and whether filing codes have already been obtained by or on behalf of the applicant. Duplicate EDGAR codes for any
reporting person may result in filings under prior codes being rejected by the SEC's EDGAR system.
Procedures for Complying with Section 16 Changes
Based on the changes effected by the Sarbanes-Oxley Act and the final rules discussed above, 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 designation of a compliance officer
and supporting personnel; imposing mandatory pre-clearance requirements on trades by insiders and their family members; implementing
interface procedures with one or more brokers to ensure timely notice of transactions; establishing notification procedures
with employee benefit plan administrators; obtaining powers of attorney from insiders to allow reports to be signed and filed
on their behalf; and early adoption of electronic filing procedures.
