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Two Wins on Share Withholding Litigation

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April 03, 2018 | Barbara Baksa

Two Wins on Share Withholding Litigation

Two courts have recently decided in favor of the defendants in suits brought by plaintiffs’ attorneys. The suits allege that transactions in which shares were withheld to cover taxes on RSUs triggered short-swing profits recovery under Section 16(b).

Background

This is an issue that surfaced in 2016: plaintiff attorneys began challenging share withholding transactions, claiming that they are only exempt from the short-swing profits recovery provisions of Section 16(b) if shares are withheld automatically. If the share withholding is at the discretion of the insider, plaintiff attorneys alleged that it was not exempt unless the specific transaction met the approval conditions of Rule 16b-3 (approved by Board, committee of nonemployee directors, or shareholders). See “Shareholder Challenging 16(b) Status of Share Withholding.”

Section 16 practitioners have long held that when an award is approved pursuant to Rule 16b-3, that approval covers subsequent transactions, such as share withholding, that are provided for in the award agreement and the SEC agrees with this position.

Eventually more plaintiffs’ attorneys joined in and, in the absence of any legal precedent, some companies settled, rather than incur the expense of going to trial. (See “Update on Share Withholding Litigation.”) Now, however, at least two suits have gone before a judge and have been decided in the defendants’ favor, and one of these decisions has survived an appeal.

Olagues v. Muncrief

In Olagues v. Muncrief, shares were withheld to cover taxes due upon payout of RSUs to two officers, both of whom had engaged in an open market purchases within six months of the payout. The defense argued that the shares were withheld automatically (the plan gave the company discretion to withhold shares to cover taxes but the award agreement made it automatic). The court issued a summary judgement in favor of the defense. Here is Alan Dye’s summary of the judgement:

The court agreed that the agreements controlled and that withholding was automatic. The court then held that the committee’s initial approval of the awards constituted specific approval of the withholding transactions, citing the note to Rule 16b-3 which states that, where the terms of a subsequent transaction are fixed at the time of an initial award, the subsequent transaction does not require further specific approval.

Jordan v. Flexton

In Jordan v. Flexton, the share withholding was not automatic; it was triggered instead by the insider’s failure to deliver cash to cover the withholding. This case had already been decided favorably by a district court back May of last year. The plaintiffs appealed that decision to the Fifth Circuit, which ruled that the withholding transactions were not “Discretionary Transactions” and therefore were eligible for exemption under Rule 16b-3(e). Unfortunately, the court did not address the question of whether the initial approval of an award that allows for elective share withholding also covers the individual transactions in which shares are withheld for taxes. (Alan Dye summarizes this decision in his blog on Section16.net, see “Fifth Circuit Affirms That Rule 16b-3(e) Exempts Elective Tax Withholding.”)

Summary

These cases are a positive development for companies that want to allow insiders to make an elective decision to use share withholding to cover taxes on awards. But we still have a way to go.  For now, it is smart to watch out for any nonexempt purchases that could be matched against share withholding transactions. If a demand letter from a plaintiff attorney arrives, you want to be prepared.

- Barbara

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