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Shareholder Challenging 16(b) Status of Share Withholding

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December 06, 2016 | Barbara Baksa

Shareholder Challenging 16(b) Status of Share Withholding

Just when you thought it was safe to withhold shares to cover taxes, a shareholder has started issuing demand letters to companies claiming that share withholding is a nonexempt sale for purposes of Section 16b.


Yep, I say "shareholder" because apparently it's just one guy and he's representing himself, he's not even engaging the services of the plaintiffs' bar.

What the Heck?

But wait, you say, that's ridiculous.  Share withholding is exempt from Section 16(b) pursuant to Rule 16b-3(e), which covers dispositions back to the issuer that are approved in advance by the board or compensation committee (and approval of the grant agreement allowing said disposition counts as approval of the disposition).

You are correct, but the shareholder is claiming that Rule 16b-3(e) applies only if shares are withheld automatically. His claim is that if the insider could pay the taxes in some other way (e.g., cash), the transaction isn't exempt.

Is My Company Going to Hear from this Guy?

Only if the share withholding transaction can be matched against a nonexempt purchase that occurs within six months before or after it. A nonexempt sale by itself is nothing to be alarmed about; the sale has to be matched against a nonexempt purchase to trigger profits recovery.

Also, since the shareholder's argument hinges on the share withholding transaction being at the election of the insider, if you don't allow insiders a choice in how to pay their taxes (and the shareholder can figure this out), you may not hear from him.

What Does Alan Dye Say?

I'm not sure lawyers ever use the term "ridiculous" but Alan doesn't believe the shareholder's position has merit. From his blog "Shareholder Challenging Availability of Rule 16b-3(e) to Exempt Elective Exercise of Tax Withholding Right" (August 23, 2016):

"For what it’s worth, Peter Romeo and I disagree strongly with the shareholder’s position, as do the attorneys I’ve spoken with who are responding to similar demand letters."

Alan also notes that the shareholder has just issued demand letters, he hasn't filed any complaints yet. But Alan says that he has been litigious in other Section 16(b) contexts.

What Should We Do?

If you allow insiders to use share withholding to cover their taxes on either awards or stock options, you should make sure your in-house legal team is aware of this, so they can decide how to proceed.

In addition, at the time shares are withheld to cover taxes, it is a good idea to check (or have whoever is responsible for Section 16 filings check) for nonexempt purchases by insiders in the past six months. Even though you might still allow the insiders to go ahead with the share withholding, it will be helpful to know ahead of time that the transaction might attract a demand letter, so your legal team can be prepared for it.

- Barbara

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