Section 306(a) of the Sarbanes-Oxley Act of 2002 (the "Act") prohibits the directors and executive officers of an "issuer" (as defined in the Securities Exchange Act of 1934, as amended (the "Exchange Act")) from engaging in certain types of transactions in the company's securities during pension fund blackout periods. The Act bars a director or an executive officer from purchasing and selling equity securities of the company during a blackout period in which plan participants are prohibited from engaging in transactions in the company's equity securities under the plan, if the equity security to be bought or sold by the insider was acquired in connection with his or her service or employment as a director or executive officer. By restricting the ability of directors and executive officers to trade in an issuer's equity securities when plan participants are unable to do so, Section 306(a) seeks to mitigate the differential treatment between plan participants and an issuer's directors and executive officers.

On October 30, 2002, the Securities and Exchange Commission (the "SEC") proposed rules (the "Proposed Rules"), including new Regulation Blackout Trading Restriction ("BTR"), to clarify the application and help prevent evasion of Section 306(a). [1] In addition, the Proposed Rules would specify the content and timing of the notice that issuers must provide under Section 306(b) of the Act to their directors and executive officers and to the SEC about a blackout period. The required notice is designed to help ensure that directors and executive officers have all relevant information about an impending blackout period. In addition, requiring delivery of notice to the SEC will help ensure that an issuer's securityholders are aware of an impending blackout period.

Section 306(a) becomes effective on January 26, 2003. The Act does not specify a date by which final rules must be adopted, but requires "good faith" compliance beginning on the effective date if the rulemaking is not completed by then.

We note that the "blackout periods" contemplated by the Proposed Rules are only those that arise under certain types of pension and similar plans. In contrast, regularly scheduled "blackout periods" adopted by many publicly-traded companies as a safeguard against violations of the prohibition of "insider trading" before their quarterly financial results are released do not trigger Section 306(a) and the Proposed Rules. In addition, the Section 306(a) insider trading prohibitions do not apply to pension plans that do not invest in equity securities of the relevant company. As a result, unlike some provisions of the Act, not all publicly-traded companies will be directly impacted by Section 306. In the Release, the SEC estimates that approximately 30% of publicly-traded companies have plans that would be impacted. [2]

Issuers and Plans Subject to the Proposed Rules

Issuers Subject. Proposed Regulation BTR would apply to both domestic and foreign issuers (including "small business issuers"), banks and savings associations and, in rare instances, registered investment companies. [3] It would not apply to issuers of asset-backed securities. With respect to foreign private issuers, the statutory trading prohibition of Section 306(a) would apply to equity security transactions by directors and executive officers of a foreign private issuer when 50% or more of the participants or beneficiaries in pension plans maintained by the issuer who are located in the U.S. are subject to a blackout period, and the affected employees represent a significant portion of the issuer's plan participants. [4] It would not apply if a blackout period affected only plan participants or beneficiaries located outside the United States.

Plans Covered. Section 306(a) of the Act defines "individual account plan" according to the U.S. Employee Retirement Income Security Act of 1974 ("ERISA"). This definition includes defined-contribution pension plans providing individual accounts for each participant, in which the gains, losses and forfeitures of one participant's account may be allocated to another. The Proposed Rules would also provide that, for purposes of Section 306(a) of the Act, this definition also includes non-qualified deferred compensation plans that are similar to ERISA plans. However, a so-called "one-participant retirement plan" under ERISA would be excluded from the definition.

Persons and Securities Subject to the Trading Prohibition

Persons Subject. The trading prohibition would apply to directors (as defined in Section 3(a)(7) of the Exchange Act) and executive officers of issuers. The Proposed Rules contemplate that the executive officers covered by these restrictions will be the same group of individuals as are subject to the reporting rules for insiders under Section 16 of the Exchange Act. [5] The trading prohibition would not apply to an individual who ceases to be a director or executive officer of an issuer.

Securities Subject. In order to effect the purpose of Section 306(a) and to prevent its evasion, the Proposed Rules would cover any equity security or derivative security (such as options or warrants) relating to an issuer, whether or not issued by that issuer. As a result, consistent with the approach under Section 16 of the Exchange Act, these rules would apply to any equity security that relates to an equity security of the director or executive officer's company, even if the security is issued by a third party. [6] In the case of foreign issuers, this definition would include American Depositary Receipts ("ADRs"). The Proposed Rules would apply to transactions in these securities occurring inside or outside the U.S.

Irrebuttable Presumption. Some directors or executive officers may own both securities that are covered by the Proposed Rules and securities that are not. For example, an executive officer may own both shares purchased upon the exercise of employee stock options (which would be covered shares) and shares purchased in open market transactions (which would not be covered shares). The Proposed Rules establish an irrebuttable presumption that any equity securities sold or transferred during a blackout period were acquired in connection with service or employment as a director or executive officer to the extent that the director or executive officer holds such securities, without regard to the actual source of the securities sold. In other words, if he or she holds securities that are covered by the Proposed Rules, an individual will not be permitted to claim that the securities that were sold were different securities that are not covered. However, in a given blackout period, equity securities held by a director or executive officer that were acquired in connection with service or employment could only be counted once against all disposition transactions during that blackout period. [7]

Transition Rules. Equity securities acquired before an individual became a director or executive officer of an issuer would not be subject to the prohibition, even if the acquisition took place while the individual was a company employee. However, these securities would be subject to the prohibition if they are clearly related to service as an executive officer or director, such as a grant to induce him or her to join the board.

Equity securities acquired by an individual in connection with service or employment as a director or executive officer before the company was publicly-traded would be subject to the prohibition. Similarly, equity securities acquired in connection with an individual's service or employment as a director or executive officer before the effective date of the Act would be subject to the prohibition.

Transactions Subject to the Trading Prohibition

Section 306(a) of the Act prohibits transactions by a director or executive officer during a pension plan blackout period if the equity security was acquired "in connection with the director or executive officer's service or employment as a director or executive officer." The Proposed Rules are designed to cast a wide net, and define this term to include equity securities acquired by a director or executive officer:

• at a time when he or she was a director or executive officer of the issuer, under a contract with, or a compensation plan of, the issuer or an affiliate of the issuer;
• at a time when he or she was a director or executive officer of the issuer, as a result of one of several types of related-party transactions that must be disclosed in the issuer's proxy statement and/or annual report (without regard to the dollar value of those transactions), if he or she has a pecuniary interest [8] in the securities;
• as "director's qualifying shares" or other securities that he or she must hold to satisfy an issuer's minimum ownership requirements for management; or
• as an inducement to his or her service or employment with the issuer or an affiliate, or as a result of an acquisition transaction involving the issuer.

Please note that these provisions include a broader range of securities than those that are covered by typical compensation plans. Instead, these provisions cover any plan or arrangement that results in the acquisition of the issuer's equity securities in exchange for the performance of services for, or employment with, the issuer. In creating this definition, the SEC sought to ensure that issuers do not shift the form of their equity-based compensation programs so as to enable directors and executive officers to evade the application of Section 306(a).

Exempt Transactions

The Proposed Rules set forth several types of transactions which would be exempt from the trading prohibition:

• Acquisitions of equity securities under broad-based, non-discriminatory dividend or interest reinvestment plans;
• Purchases or sales under "10b5-1 plans," if the instruction under the plan to purchase or sell the securities in question was not made or modified during the blackout period or at the time the director or executive officer was aware of the impending blackout period;
• Purchases or sales of equity securities under certain "tax-conditioned plans," [9] subject to certain limitations; [10] and
• Ownership changes resulting from stock splits, stock dividends and pro rata rights distributions.

Definition of Blackout Period

The Act defines the term "blackout period" to mean any period of more than three consecutive business days during which the ability of at least 50% of the participants under all of an issuer's "individual account plans" to effect transactions in an equity security of such issuer in such a plan is temporarily suspended by the issuer or a plan fiduciary.

Applying the 50% Test. Under the Act, a blackout period will occur only if at least 50% of the participants or beneficiaries under all of the issuer's individual account plans are subject to the suspension. The Proposed Rules would clarify that, to make this calculation, the relevant individual account plans would include only individual account plans in which participants or beneficiaries held or could hold equity securities of the issuer, whether or not the account plan actually contained equity securities of the issuer at the time of the calculation. As a result, the definition is designed to include individual account plans that:

• permit participants or beneficiaries to invest their plan contributions in the issuer's equity securities;
• include an "open brokerage window" that permits participants or beneficiaries to invest in the equity securities of the issuer or any other publicly-traded company;
• match employee contributions with the issuer's equity securities; or
• reallocate forfeitures that included the issuer's equity securities to the remaining plan participants.

To determine which individual account plans are "maintained by the issuer," the Proposed Rules would apply the "single employer" rules under Section 414(b), (c), (m) and (o) of the Internal Revenue Code. [11] The Proposed Rules will apply these regulations to determine the individual account plans of an issuer and its parent, subsidiary and affiliated entities that should be aggregated to determine whether the 50% test has been satisfied.

Location of Participants and Beneficiaries. Under the Proposed Rules, the 50% test would be applied by comparing (a) the number of participants or beneficiaries located in the U.S. under all of an issuer's individual account plans that will be subject to the suspension to (b) the total number of the issuer's participants or beneficiaries located in the U.S. under all of its individual account plans. If this percentage is at least 50%, the trading prohibition would apply to the directors and executive officers of a domestic issuer. In the case of a foreign private issuer, a second calculation would compare the number of participants or beneficiaries located in the U.S. under all of the issuer's individual account plans subject to the suspension to the total number of participants or beneficiaries under all of the issuer's individual account plans worldwide. If this percentage is greater than 15%, and the 50% test is also satisfied, the trading prohibition would apply to the foreign private issuer's directors and executive officers.

Exceptions to Definition of Blackout Period

The Act excludes from the definition of "blackout period":

• a regularly scheduled suspension of trading in the issuer's equity securities, if that suspension is incorporated into the individual account plan, and timely disclosed to employees before they become plan participants or as an amendment to the plan; and
• a suspension described in the general definition of "blackout period" imposed solely to allow persons to become, or to cease to be, participants or beneficiaries in a plan because of a corporate merger, acquisition, divestiture or similar transaction involving the plan or plan sponsor. [12]

In order for a blackout period to qualify as "regularly scheduled," the plan must include a description of the prohibited transactions, and the frequency and duration of the period. Disclosure of the blackout period to an employee would be considered timely if the employee was provided notice before enrolling, or within 30 days after enrolling, in the plan, or within 30 days after the adoption of the amendment.

In the case of a blackout imposed to consolidate plans following a merger or similar transaction, a blackout period would not trigger the trading prohibition if its main purpose is to enable individuals to participate in the plan, or to terminate participation in the plan. This exception would be available only for the participants or beneficiaries of the acquired or divested entity.

Remedies for Violations

Section 306(a) of the Act contains two distinct remedies. First, a violation of the insider trading prohibition is subject to SEC enforcement action, both civil and criminal.

In addition, where a director or executive officer realizes a profit from a prohibited transaction during a blackout period, an issuer, or a security holder of the issuer on its behalf, may bring an action to recover the profit. [13] This profit would be recoverable irrespective of the director's or executive officer's intention. The Proposed Rules also provide standing to plan participants and beneficiaries to bring such an action against the insider. Unlike Section 16 of the Exchange Act, a private right of action could be initiated against directors and executive officers of foreign private issuers with respect to these provisions, and the SEC could bring an enforcement action with respect to any violation.

Notice Requirements

Section 306(a)(6) of the Act requires an issuer to provide at least 15 calendar days' notice to its directors and executive officers of the start of a blackout period. [14] Under the Proposed Rules, the required notice would need to include the following information:

• the reason or reasons for the blackout period;
• the types of transactions impacted by the blackout period;
• the class of equity securities subject to the blackout period;
• the actual or expected beginning and ending dates of the blackout period; and
• contact information for the person designated by the issuer to respond to questions about the blackout period, or, if no such designation is made, the issuer's human resources director or a similar person. [15]

The notice could be in any graphic form that is reasonably accessible to the intended recipient. Notice would generally be considered provided as of the date of mailing or electronic transmission, as applicable. The Proposed Rules would excuse an issuer from this 15-day notice requirement in the rare instances in which it makes a written determination that unforeseen circumstances or circumstances beyond its control preclude compliance. In such circumstances, the issuer must notify the affected directors and executive officers as soon as reasonably practicable. If a change occurs in the beginning or ending dates of the blackout period, the issuer would also need to provide directors and executive officers with an updated notice as soon as reasonably practicable.

The issuer's failure to properly notify the director or executive officer will not be a defense to an SEC enforcement action or a private right of action. In addition, if the notice is not properly given, an issuer could be subject to SEC enforcement action for causing the director's or executive officer's violation.

The Proposed Rules also mandate that the notice to be given to the SEC would be provided on Form 8-K within two business days of the earlier of notice of the blackout by the plan administrator or actual knowledge of the blackout by the person overseeing the issuer's pension plans. The report on Form 8-K would have the same contents as the notice to the directors and executive officers.

The Proposed Rules also contain revisions to Forms 20-F and 40-F that would require a foreign private issuer to file, as an exhibit to the report, copies of all notices provided to directors and executive officers under Section 306(b) of the Act and the Proposed Rules during the previous fiscal year, unless the notices previously have been provided to the SEC on a Form 6-K. The SEC encourages (but would not require) foreign private issuers to make the required disclosure under cover of Form 6-K.

Section 306 of the Act will become effective on January 26, 2003. Under proposed Regulation BTR, the notice requirement would apply to blackout periods commencing on or after January 26, 2003. For blackout periods occurring between January 26, 2003 and February 10, 2003 (the date 15 days after the effectiveness of Section 306), issuers should furnish notice as soon as reasonably possible. This approach is intended to ensure that the notice is provided for blackout periods that commence before February 11, 2003.

Anticipated Timeframe for Adoption

The Commission is requesting comments on the Proposed Rules by no later than December 16, 2002. The Act does not mandate a date by which the SEC must enact final rules with respect to Section 306. However, Section 306 will become effective on January 26, 2003, and companies and their management team members will need to comply with its provisions, whether or not the final rules are enacted. Accordingly, Section 306(c) of the Act provides that good faith compliance with the Section 306 requirements prior to the enactment of final regulations will be treated as compliance with such requirements.

Possible Impact of the Act and the Proposed Rules

Companies subject to the trading prohibition will need to consider updating their "insider trading" policies in order to ensure compliance with Section 306 and the Proposed Rules. Plan documents will also need to be reviewed to determine whether they have provisions regarding regularly-scheduled blackout periods that comply with the Proposed Rules and the DOL's Blackout Regulation. Companies with plans covered by these rules will also need to create mechanisms for the plan administrator or the person designated to oversee these plans, or the issuer's human resources director, to notify management as to any impending blackout periods, and filing the required reports with the SEC.

Finally, it is possible that Section 306(a) and the Proposed Rules will further encourage plaintiffs' law firms to monitor issuers' filings, and the Section 16 filings of their directors and officers, for possible violations of the trading prohibition. It is possible that a director or an executive officer will engage in one or more transactions that do not violate Section 16 and the related SEC's rules, but are actionable under the trading prohibition of Section 306(a). As a result, the Act and the Proposed Rules could increase the number of lawsuits filed against corporate insiders if they fail to properly comply with the new trading prohibition, or if they are not properly notified of blackout periods.