Transcript: 2021 Section 16 Developments with Alan Dye

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Alan:  Thank you, Barbara. The questions we’ve received show that a lot of members are thinking about Form 5 filings and Item 405 disclosures, so it’s a good time to be addressing Section 16 questions.  As always, I appreciate you moderating the discussion.

Recent Developments

We try to cover important Section 16 developments over the last year in addition to addressing members’ questions, so I’ll start by covering a few recent developments, just to make sure that everyone is up to date on issues affecting Section 16 compliance.

Electronic Signatures on Section 16 Reports

First, effective December 4, insiders can elect to submit their signatures on Section 16 reports electronically rather than providing a manually signed copy.  Before December 4, Rule 302 of Regulation S-T and Rule 16a-3 required people who file Section 16(a) reports for insiders to have a manually signed copy of the report in hand before submitting the report on EDGAR.  The staff interpreted the manual signature requirement to mean a paper copy with the actual ink signature on it. Both rules have now been amended to allow insiders the option of providing their signatures electronically instead of manually.  Companies that elect to utilize this alternative can use any of various existing platforms that meet the SEC’s technical requirements for electronic signatures, such as DocuSign.  Those requirements are set forth in a new version of the EDGAR Filer Manual, version 56, which is posted on the SEC’s website.

Before a filer can utilize electronic signatures, the filer has to manually sign an attestation agreeing that the filer’s electronic signature will constitute the legal equivalent of a manual signature.  For those who might need one, I have posted a model attestation on Section16.net, in the Compliance Officer’s Starter Kit under the “Tools” tab on the homepage. Eventually I will combined the attestation with the model power of attorney, so newly onboarded insiders can sign only one document.

An insider’s signed attestation has to be retained, in paper or electronic form, for at least seven years after the date of the filer’s most recent electronically signed report.  And signed copies of Section 16(a) reports still need to be retained for five years, but they can be retained in digital format if the company chooses.

The amendments do not affect the process for filing and authenticating a Form ID.

Proposed Amendments to Form 4 and Form 5

In another SEC action, last month the SEC proposed to amend Form 4 and Form 5 to add a checkbox which an insider could check to indicate that a reported transaction occurred pursuant to a Rule 10b5-1 trading plan. Currently, a lot of insiders elect to disclose in a footnote that a reported transaction occurred pursuant to a Rule 10b5-1 plan, to explain the reason the insider is selling or make clear that the insider didn’t control the timing of the reported transaction, in case the transaction occurs just before the company announces material news. Disclosure of a 10b5-1 plan still would be voluntary, but the proposed checkbox is intended to offer insiders an alternative to a footnote. Insiders could, though, elect to use the checkbox, a footnote or both.

Perhaps more importantly for Section 16 compliance personnel, the SEC also proposed a process for filing Forms 4 and Forms 144 at the same time.  The SEC proposing release relates mainly to proposed amendments to Rule 144, not the Section 16 rules.  The Rule 144 amendments would, among other things, mandate electronic filing of Form 144 and change the filing deadline to coincide with the filing deadline for Form 4—that is, two business days after the execution date or deemed execution date of the reported sale, rather than the current requirement to drop the Form 144 in the mail no later than the date the insider places the sell order with a broker.  The new deadline would apply whether or not the filer also is required to file a Form 4.

The Form 4 reporting process might be implicated because the SEC also proposed to add to the EDGAR system a user interface that could be used by a seller who is required to report a sale on both Form 144 and Form 4.  The interface would allow a filer to input certain information which the interface would use to create separate Form 4 and Form 144 filings.  Use of the interface would be optional, so filers could choose to continue to file their Forms 144 separately from their Forms 4.  Today, an insider’s Form 4 is usually filed by the company, and the Form 144 is filed by the broker.  If the proposed rules are adopted, it will be interesting to see whether brokers and the company choose to coordinate in any way.

Compliance with Amended Item 405

Members may be interested to know how companies addressed the new Item 405 disclosure rules in last year’s proxy statements.  As a reminder, before last year, Item 405 required companies to make required delinquency disclosures under the caption “Section 16(a) Beneficial Ownership Compliance.” Now, the disclosure has to appear under the caption “Delinquent Section 16(a) Reports.” This change was intended to reduce unnecessary disclosures by making it less likely that companies will include voluntary disclosure that no delinquencies occurred, since the caption calls attention to delinquencies, not compliance.  That objective overlooks, though, that a voluntary disclosure of compliance, with no delinquency, isn’t subject to Item 405 so the company can use whatever caption it wants.  A new instruction was added to Item 405, though, encouraging companies not to make voluntary disclosure that no delinquencies occurred.

During last year’s proxy season, I collected a pile of proxy statements that crossed my desk for one reason or another and then, after the proxy season ended, reviewed 100 of them to determine how companies were responding to the amendments to Item 405. I stopped at 100 just to keep the calculation of percentages easy. There was nothing scientific about my selection of proxy statements, I just flipped open the ones that were in my pile. Here are some of my observations, which also appear on Section16.net:

Number of companies disclosing delinquencies

A total of 42 companies disclosed at least one reporting delinquency, and 22 companies disclosed more than one.  The 42% figure is consistent with past surveys, including one by the NASPP in 2011 reporting that 46% of respondents reported at least one delinquency, and one by someone else reporting that 47% of the Russell 3000 disclosed at least one delinquency.

One company last year disclosed that a ten percent owner failed to report, until 2019, over 1,000 transactions that occurred over a period of years.  I’ve seen this kind of thing happen before.  Usually it’s a fund manager who didn’t realize that several managed funds, operating independently, acquired more than 10% of a company on an aggregate basis.  After the issue comes to light, the compliance department files a Form 3 followed by a Form 4 reporting all the unreported transactions.

Compliance with new caption requirement

Five of the 42 companies that disclosed reporting delinquencies failed to use the new caption.

Number of companies voluntarily disclosing compliance

Of the 58 companies that did not disclose any reporting delinquencies, 13 included voluntary disclosure that, to the company’s knowledge, all insiders filed all required reports.  Of the 13 companies that made voluntary disclosure, six made the disclosure under the new Item 405 caption, six made the disclosure under the old caption or a caption of their own making, and one included disclosure under both captions.  I’m guessing that was a proofreading error.

Nature of Delinquencies

Item 405 requires disclosure of late filings and failures to file required reports. Consistent with that requirement, virtually all the delinquencies involved either a late report or the omission of a holding from a timely filed Form 3. One exception was a company’s disclosure of a list of Forms 4 that were filed by the deadline but included errors in total holdings, transaction codes, exercise prices or ranges of sale prices disclosed in a footnote.  The disclosure was in tabular form, showing which Forms 4 contained each type of error.  Some might question whether these disclosures were required by Item 405.

SEC’s Section 16(a) Enforcement Program

Let me also say a few words about the SEC’s Section 16(a) enforcement program.  The SEC initiated fewer enforcement actions overall in 2020 as compared to 2019, due mainly to the slowdown in processes caused by the COVID-19 pandemic.  Not surprisingly, the SEC also brought correspondingly fewer enforcement actions alleging violations of Section 16(a), by my count six instead of the usual eight or nine.  I don’t think the slight reduction reflects any less interest in the Section 16(a) enforcement program.  The good news, though, is that the SEC still brings very few Section 16(a) actions relative to the number of reports filed late, and all of them in recent years have involved cases in which an insider has committed other, more serious violations, usually market manipulation or a fraudulent pump and dump scheme, where the insider doesn’t file reports at all or files them late, to delay reporting the transactions until the fraud has been completed.  The staff hasn’t brought an enforcement action based solely on 16(a) violations since it announced a “sweep” in September of 2014 involving insiders of 34 different companies.  No one knows, of course, when the SEC might bring more actions based solely on Section 16(a) violations, but if history is any guide, when the staff does initiate another sweep, the unlucky insiders will be ones who were regularly indifferent to their filing obligations. 

Year-end Compliance Checklist

A final reminder:  the annual year-end compliance checklist is posted on Section16.net.  The checklist is intended to cover everything a Section 16 compliance person needs to do or think about after year-end.   As a reminder for people working for calendar year companies, the deadline for filing any Forms 5 required this year is Tuesday, February 16.  The 45^th day is February 14, of course, but February 14 is a Sunday and February 15 is a national holiday.

Questions and Answers

Ok, Barbara, that’s all I have regarding recent developments.  We received a number of questions in advance, some familiar and some raising new issues.  Shall we start tackling them?

SAR Exercise Price

Barbara: I understand that when an SAR is settled, the recipient receives the spread between the market value of the shares underlying the SAR and the aggregate exercise price.  I also am aware that the exercise of an SAR for stock is treated under Section 16 as a purchase of the underlying shares at the exercise price and a simultaneous sale back to the issuer of a number of shares having a value on the date of exercise equal to the exercise price, reportable in Table I.  However, to the extent that the award does not characterize the "exercise price" as such, but instead says that upon exercise the recipient gets the spread of the FMV over the “grant price,” would exercise still be considered the same as a purchase and simultaneous sale back to the issuer, based on the grant price?

Alan:  I’m not sure what “grant price” means for this company, but if the award is an SAR, the grant price must be the same thing as the exercise price as that term is usually used in SAR award agreements.  Any SAR or similar right, by definition, will specify a fixed price per share as the baseline for measuring the increase in value the grantee is entitled to receive on the date of exercise.  That baseline price is the exercise price for purposes of reporting the exercise on Form 4, whether the award agreement calls it the exercise price, the grant price, or something else.  So, in this case, I think the grant price should be used as the exercise price in Column 2 of Table II, and also as the “price” reported in Column 4 of Table I to report the acquisition of the underlying shares.  The line reporting the disposition of the shares back to the company would show the fair market value of the stock on the date of exercise, however that is determined under the award agreement.

Former Insider’s Return to Company

Barbara:  One of our Section 16 officers left the company in early 2020 to accept an invitation from a quasi-governmental agency to assist in responding to the global health crisis.  It was understood by all parties at the time that the officer would return to the company when his work for the agency was completed, and he is now about to return to his former position, which was not filled while he was away.  The officer had no transactions in company securities while he was away.  Do we need to file another Form 3 for him, or can we just include a footnote in his next Form 4 disclosing the dates he was not subject to Section 16?

Alan:  We get some variation of this question almost every year.  The staff has been clear that, when an insider ceases to be subject to Section 16 and later becomes subject to Section 16 again, the insider needs to file a new Form 3.  This is a statutory requirement, and a new Form 3 is required whether an insider leaves the company and returns or stays with the company but is dropped from the Section 16 officer list and later put back on it. The filing obligation also isn’t affected by whether the former insider’s ownership of securities changed in the interim.  In this case, the insider should file a new Form 3 reporting ownership of the securities beneficially owned on the date he resumes employment with the company, even though he already reported ownership of those securities in his last Form 4 before leaving the company.  There is no lookback for a returning insider, so if the officer had engaged in transactions in company securities after leaving and before returning, those transactions would not become reportable as a result of the insider’s return to the company.

Hiring of Consultant to Serve as Interim CFO

Barbara:  A client terminated its CFO and is now undertaking a search for his replacement.  Until a replacement is found, the company plans to hire a consultant to serve as temporary CFO as well as principal accounting officer.  The consultant will sign the company’s periodic reports as CFO and PAO and will sign the Sarbanes-Oxley certifications required of the CFO and PAO.  The company wants to take the position that the consultant will not be a Section 16 officer because the consultant will not be an employee or executive officer of the company. Is this position supportable?

Alan:  No, I don’t think it is.  Rule 16a-1(f) expressly includes within the definition of “officer” the issuer’s principal financial officer and its principal accounting officer.  The rule doesn’t say the person has to be an employee of the company.  The SEC and the courts have always deemed a person to be a Section 16 officer if the person performs the functions of a Section 16 officer, regardless of the person’s title.  In fact, just a little over a year ago, a court agreed with the SEC in an enforcement action that a “consultant” to a company was a Section 16 officer based on the significant policy-making functions he performed.  Here, it sounds like the consultant will both function as the CFO and PAO and have the titles of CFO and PAO.  I don’t see any basis for concluding that the consultant won’t be a Section 16 officer.   And the company will need to resolve the same question when determining whether to file a Form 8-K to disclose the hiring of the consultant. 

Item 405 Disclosure Following Acquisition of Issuer

Barbara: After a merger between two public corporations, is the acquiring corporation required to include in its annual meeting proxy statement Section 16(a) reporting delinquencies by former insiders of the acquired corporation who did not become insiders of the acquiring corporation?

Alan:  No.  Item 405 requires registrants to disclose reporting delinquencies of insiders “of the registrant.”  Reporting delinquencies committed by insiders of other registrants, including a registrant subsequently acquired by the registrant, are not subject to disclosure.  That means reporting delinquencies committed by insiders of the acquired company are not disclosable even if the delinquent filers did become insiders of the acquiring company in connection with the merger.

Transfer of Stock to Spousal Lifetime Access Trust

Barbara:  At the end of last year, our founder and CEO contributed a significant amount of company stock to a spousal lifetime access trust, or SLAT, and appointed his spouse as trustee.  The trust agreement is complicated and allows the spouse to spend trust income on herself and to use other trust assets only for her health, education, maintenance, and support.  Income and other trust assets can also be distributed to the couple’s children and their descendants.  The trust assets will be distributed to the children upon the spouse’s death.  How should we report the contribution and the trust’s transactions going forward?

Alan:  I think the contribution should be reported in the same way any other contribution to a family trust is reported.   While a lot of SLATs have more complicated structures, involving corporate trustees or trust protectors, this SLAT seems relatively straightforward.  The transfer of directly owned shares to the SLAT, for no consideration, is a gift, and therefore can be reported on Form 5 on or before February 16 or on an earlier Form 4 on a voluntary basis.  How to report the trust’s holdings and transaction on a going forward basis depends on whether the insider beneficially owns the trust’s holdings indirectly through his spouse, as trustee.  Rule 16a‑8(b)(2) requires insiders to include trust holdings of issuer securities in their Section 16(a) reports if the insider is trustee and the insider or a member of the insider’s immediate family is a beneficiary of the trust. The rule does not address the situation in which the insider’s spouse is the trustee, but the staff takes the position that an insider beneficially owns the trust’s holdings if the insider can influence the spouse’s investment decisions on behalf of the trust. If the insider does influence the spouse’s investment decisions, which is usually the case because the couple makes important decisions jointly, the insider should also report the acquisition of an indirect interest in the securities contributed to the trust.  That can be done in either of two ways.  One way would be to report the trust’s acquisition on a separate line from the line on which the disposition of the shares is reported.  The other way would be to report the trust’s shares as a holding, without reporting the acquisition as a transaction, and including a footnote explaining that the reported gift was to the trust and that the insider remains the indirect beneficial owner of the gifted shares.  The insider would continue to report the trust’s transactions and holdings on his future Forms 4 and Forms 5.

Transfer of Shares to Limited Liability Company Followed by Gift of LLC Interest to Trust

Barbara:  One of our insiders is a managing member of a limited liability company to which she has contributed a significant amount of her assets over a period of years, including company stock.  Each time she contributes assets to the LLC, she receives additional LLC interests, which she later gifts to a family trust for the benefit of her children and their descendants.  On the advice of the insider’s tax counsel, the gift usually follows the contribution by at least 30 days.   How should these transactions be reported, and will the contribution of stock to the LLC be a “sale” for purposes of Section 16(b)?

Alan:  This is sort of a tough question.  While the contribution of shares to the LLC is part of a two-step gift of the securities to the trust, each step needs to be analyzed and reported separately.  The contribution of stock to the LLC in exchange for LLC interests, standing alone, technically is not a gift, because the insider receives back, in exchange for the shares, LLC interests representing an interest in all the LLC’s assets.  The contribution therefore reduces the insider’s pecuniary interest in the contributed securities and gives her an interest in the other assets held by the trust.  Because the insider receives consideration in exchange for the contributed securities, I think the contribution should be reported, not necessarily as a sale but as a change in pecuniary interest using transaction code “J,” with a footnote explaining the transaction.  Because the insider is the managing member of the LLC and therefore controls its transactions in the company’s securities, I think the insider should be considered the beneficial owner of the issuer securities held by the LLC to the extent of her pecuniary interest.  Presumably the insider has been reporting the LLC’s holdings on her Forms 4 all along, maybe with a disclaimer of beneficial ownership of shares exceeding her pecuniary interest.  If that’s the case, the newly contributed shares can just be added to the LLC’s total holdings as reported in Column 5 of Table I. 

The insider’s gift of LLC interests to the trust is clearly a gift and should be reported on Form 5 or an earlier Form 4 using transaction code “G.”  Because the number of shares owned by the LLC and reported by the insider will not change as a result of the gift, the number of shares gifted can be reported in Column 4 in either of two ways:  by showing the number of shares represented by the gifted LLC interests on a pro rata basis, or by footnoting the column and disclosing in a footnote the percentage of outstanding LLC interests that were transferred.

As a word of caution, insiders need to be wary of estate planning transactions that are structured to include potential sales.  There are lots of techniques tax advisers use to accomplish transfers of securities to the next generation, some involving outright sales of stock to trusts created for the benefit of children, with the purchase price of the stock paid by the insider through a gift or loan of cash to the trust.  Plaintiffs’ lawyers sometimes sniff out these transactions and submit demand letters to investigate them.  Sometimes they can be convinced that the transactions, considered as a whole, represent a gift and therefore aren’t worth the effort of a Section 16(b) action.  Sometimes, though, the dollars are big enough that the plaintiffs’ attorneys threaten to sue, and the insider has to choose between settling the case or litigating.

Discretionary Transactions 

Barbara:  A Section 16 officer holds common stock through a company stock fund under the company’s 401(k) plan.  The officer elects to transfer a portion of her company stock fund holdings into another investment fund offered under the plan.  The officer has not made an election to engage in any other discretionary transaction, under the 401(k) plan or any other plan, within the six months preceding the officer’s election to make the transfer.  The transfer therefore is an exempt disposition under Rule 16b-3(f).  Two days after the transfer, the officer elects to sell her remaining interest in the company stock fund, and to transfer the proceeds to another investment fund.  Is the second transfer also exempted by Rule 16b-3(f), given that there has been no opposite-way discretionary transaction (i.e., a purchase) within the preceding six months?  If so, my understanding is that both discretionary transactions can be reported using transaction code “I.”

Alan:  Yes, both transactions would qualify for exemption under Rule 16b-3(f) and would be reportable on Form 4 using transaction code “I.”  Rule 16b-3(f) exempts a discretionary transaction if the election to engage in the transaction was made more than six months after the insider’s last election to engage in an “opposite way” discretionary transaction.  Here the election to engage in the second discretionary transaction occurred less than six months after the insider’s last election to engage in a discretionary transaction, but the earlier discretionary transaction was not “opposite way” of the second one, and therefore the second transaction, too, was exempt.

Dilution

Barbara: An investor who owns 11% of an issuer buys an additional 5% of that issuer. Three months after buying the additional 5%, the issuer issues a lot more stock, as a result of which the investor is diluted to 8%. I believe the investor can sell its 8% investment without any Section 16 consequences, since immediately prior to the sale, it owns less than 10%. Do you agree, and do you also agree that whether the investor should file a Form 4 upon being diluted, and prior to the sale, to inform the world that it is no longer subject to Section 16 is entirely up to the investor, who is not required to file a Form 4 but may do so voluntarily?

Alan:  I agree completely with both conclusions.  Section 16 applies to transactions by a ten percent owner only if the ten percent owner is a ten percent owner at the time of the transaction.  That requirement is in the statute, and also is reflected in SEC Rule 16a-2.  If an issuer issues additional stock, with the effect that a ten percent owner’s holdings represent less than 10% of the class outstanding, the former ten percent owner ceases to be subject to Section 16.  Not only is the post-dilution sale not subject to matching with prior purchases, it also isn’t reportable on Form 4.  That makes a ten percent owner’s post-termination transactions different from those of former officers and directors, whose post-termination transactions may be reportable if they are matchable with a pre-termination transaction that occurred within the preceding six months.  Neither ten percent owners nor officers and directors need to file a Form 4 solely to report that they are no longer subject to Section 16, so I agree that any Form 4 filed by the investor here would be voluntary.

Joint Reporting

Barbara: Two section 16 officers, Officer 1 and Officer 2, are spouses. Officer 1 receives an award of restricted stock.  Because each spouse has a pecuniary interest in the other spouse’s securities, Officer 1 and Officer 2 plan to make a joint filing in accordance with the Form 4 instructions. Officer 1 will report the acquired shares on a line with "D" in Column 6 to reflect direct ownership. Does Officer 2 also report on a separate line with "I" in Column 6 and "Shares held by spouse" or something similar in Column 7?  Or should a footnote be included in the line reporting Officer 1’s acquisition saying Officer 2 may be deemed to indirectly own those shares?

Alan: I suppose you could report the acquisition twice, once for Officer 1 and then again for Officer 2, but I think it would be preferable and more consistent with common practice to report the acquisition only once, and to explain in a footnote that Officer 2 has an indirect interest in the shares acquired by Officer 1.  Ordinarily, in a joint filing, one filer is the lead filer, and that person’s name is included in Box 1 of the report, and other filers names appear elsewhere.  Then, reported transactions usually show the lead filer’s interest in the reported transaction, either direct or indirect, and a footnote explains the interests of all other joint filers.  That method would mean, in this case, the acquisition would be reported only once, and each spouse’s other holdings, such as 401(k) plan holdings, also would be reported only once. I think that’s the most efficient way to report when two or more insiders report jointly. 

Late Filing and Item 405 Disclosure

Barbara: In February 2019 we filed a late Form 4 for one of our executive officers to report a stock option award and the withholding of shares to pay taxes due upon the vesting of an RSU. We disclosed this late filing in our 2020 proxy statement.  We just learned that this same officer also had sales of common stock on 2/19/2019 that were not included in a Form 4 we filed on 2/21/2019 to report other transactions that occurred on 2/19/2019. Two questions: do we now need to file a Form 4/A to correct the Form 4 filed on 2/21/2019 and include a footnote saying that this amendment is being filed to report sales excluded from the filing in error, and do we need to include Item 405 disclosure again in our 2021 proxy statement for this late filing in 2019? The proxy disclosure in 2020 was generic and referenced a late filing to report a grant of options and the disposition of shares underlying RSUs.

Alan:   I think it’s clear that the Form 4 needs to be amended, or perhaps a new Form 4 could be filed, to report the open market sales, since they have never been reported. I think the filing of the report also would require disclosure of a delinquency under Item 405.  Maybe the disclosure in 2020 was drafted artfully enough to cover this late report too, but I doubt it.  Item 405 calls for the number of late reports and the number of transactions reported late. The unreported sale adds one more transaction to the number reported late, so it seems likely that the 2020 disclosure wouldn’t be adequate to cover this late transaction.  Since the late report is being filed in 2021, though, I think the company has a choice in when to disclose the delinquency—either in the 2021 proxy statement or the 2022 proxy statement.

Reporting Vesting of Performance Shares in Table II

Barbara: We voluntarily reported performance stock units in Table II at the time of grant, even though vesting was conditioned upon meeting various financial metrics. The performance period is almost over for the first half of the PSUs, and our compensation committee will be certifying the number of shares earned. I believe we should report the committee’s action by reporting, in Table II of Form 4, the conversion of the number of PSUs that were earned, and by reporting in Table I the acquisition of the earned shares, in both cases using transaction code “M.”  We would report the withholding of shares to pay withholding taxes on a separate line of Table I.   Is that the best way to report this transaction?

Alan:  I suppose that’s an acceptable way to report the transaction, in that it makes clear in Table I of the Form 4 the number of shares that were earned and the number withheld to pay taxes.  I don’t think it’s necessary, though, to report the transaction as the conversion of a derivative security, given that the staff has taken the position in a number of interpretive letters that performance shares of this type are not derivative securities.  I think an alternative, and probably better, way to report the transaction would be to report the vesting of the earned shares only in Table I, using transaction code “A,” and to report the withholding of shares on a separate line, using transaction code “F.”  I also would include a footnote to explain that the earned shares represent the vesting of PSUs previously reported, to avoid having someone think the shares are in addition to the shares underlying the PSUs that were voluntarily reported.  Again, though, if you prefer to report the transaction as the conversion of a derivative security, I think it will be clear what the transaction involved, so I don’t think the staff would object to the manner of reporting. 

Electronic Submission of Power of Attorney

Barbara: We have a new insider from whom we are getting a power of attorney.  Do the new rules allow us to accept an electronically signed POA, even if the insider has not yet signed an attestation?

Alan:  I don’t think so.  Rule 302 allows electronic submission of signature pages to filings, including exhibits included within a filing, so I think it is permissible to accept electronic signatures on powers of attorney.  First, though, as I read the rule, the insider has to sign an attestation agreeing to the electronic signature provisions.

Awards After Directors’ Retirement

Barbara: We have a situation where directors retired, a new slate of directors was elected, and the new directors voted to amend the director compensation plan to award shares of company stock to all directors serving at the end of each board term, retroactive to directors serving at the end of the previous term.  Do we need to report a share award for the directors who will receive the shares after they have retired and have no other transactions to report?

Alan:  I think the answer is no.  My thinking is that the award is being made after the directors term of service, so under Rule 16a-2 would be reportable only if it were not exempt from Section 16(b) and occurred within six months of an opposite-way, non-exempt transaction that occurred prior to termination of service.  I think the award qualifies for exemption under Rule 16b-3, because it was approved by the board of directors.  I recognize that Rule 16b-3 applies to a transaction with an officer or director, and may not necessarily apply to a former officer or director, but I believe the better view is that a compensatory transaction relating to a director’s former service as a director qualifies for the exemption.  Because the grant is exempt, I think it is not reportable. 

Form 3 Amendment for Resigned Section 16 Officer

Barbara:  A Section 16 officer resigned, and we later discovered that the officer’s Form 3 omitted a holding that should have been included as indirectly owned.  Is it necessary to file an amendment to the Form 3, when the officer is no longer subject to Section 16?

Alan:  An error in a Form 3, if material, generally should be corrected by amendment.  The insider’s obligation to report holdings correctly exists at the time the Form 3 is filed, and the failure to report holdings correctly is a continuing violation of Section 16(a) that isn’t suspended by the insider’s resignation or other termination of insider status.  Other factors may enter into the analysis of whether it’s worth amending the Form 3, such as how long ago the error occurred and whether the information is of significance to the market, particularly now, when the insider is no longer subject to reporting obligations and therefore the insider’s holdings could now be completely different from what was last reported.  In any case, the obligation to correct the report is the insider’s, not the company’s, so the insider should make the decision.  At the same time, the company may need to think about whether it has an obligation to disclose the omission of the holding under Item 405.

Detail Required in Item 405 Disclosure

Barbara:  One of our directors had a late Form 4 last year, and this is the first time I’ve had to draft Item 405 disclosure for the proxy statement.  I reviewed some peer company proxy statements to see how they handle Item 405 disclosures, and I found that the amount of information provided varies considerably.  Is there any reason I can’t just say “Director Smith was late filing one Form 4 to report one transaction in the company’s common stock”?

Alan: No, no reason at all.  All that Item 405 requires is disclosure of the name of the insider, the number of reports filed late, and the number of transactions reported late.  So, the disclosure you describe would be fully compliant.  It’s true that some companies provide additional information, and in my experience the additional disclosure is designed to mitigate or soften the impact of the disclosure.  Companies may add that a report was only one day late, or involved only a tax withholding transaction or other transaction directly with the company and not a market transaction.  Companies also downplay a delinquency by saying it was “inadvertent” or was due to “administrative error.”  Sometimes the disclosure makes clear that the delinquency was not the insider’s fault, saying that the error was due to some oversight by the company or a glitch in its electronic filing system.  In any case, as long as the required information is there, companies can include any additional information they’d like, but most disclosures are pretty succinct.    

Re-evaluation of Section 16 Officer Status

Barbara:  We are re-evaluating our Section 16 officers and have determined that, due to changes in our business, a few of them should no longer be considered Section 16 officers, although they will remain in their current roles and their duties will not change. Does any reporting need to be done to report that the officers are no longer Section 16 officers?

Alan: This is another question that we get fairly often, in one form or another.  No, no report or other disclosure is required when a Section 16 officer is no longer considered to be subject to Section 16.  Some companies like the idea of creating a public record that the former insider is no longer subject to Section 16, and they can do that by filing a Form 4 that merely checks the exit box in the upper left corner of the report.  That’s more common, though, when a Section 16 officer terminates employment, and less common when the officer’s duties are no longer considered to involve significant policy-making.  In those cases, the only public record of the decision may be the disappearance of the insider’s name from the list of executive officers required to be disclosed in the Form 10-K.

I should note that dropping an employee from the list of Section 16 officers happens all the time.  Most companies take a fresh look at their list of Section 16 officers at least once a year, usually in connection with determining who is an executive officer for purposes of the Form 10-K and proxy statement, to determine whether circumstances have changed and warrant a corresponding change to the list.  A person may have been deemed a Section 16 officer because the person was in charge of a principal business unit, division or function, or the person made significant policy decisions at the corporate level.  As the company’s business develops, a business unit or function may no longer be significant to the company overall, or a person’s policy-making functions may no longer be significant at the corporate level.  Making these judgments can be difficult, and sometimes the affected person may feel demoted, but it is common to adjust the list from time to time, and in my opinion is better than continually expanding the list without dropping those who don’t belong.

RSU Vesting and Form 144

Barbara:  Our Section 16 executives were granted restricted stock units that vest in three equal annual installments. Our plan documents require the plan administrator to "sell to cover" taxes due upon vesting and to deliver to the executive the net number of shares. The officer has no control over whether the shares will be sold, so it seems like we should not have to rely on Rule 144 for the sale and therefore should not have to report the sales on Form 144. Do you agree?

Alan: Actually, if I’m understanding the question, I don’t agree.  While the shares may never be under the insider’s control, they are issued to the insider’s account, and the proceeds of sale are credited to the insider’s tax withholding on his or her W-2.  So, the broker’s sale of the shares is for the account of an affiliate.  Rule 144 covers any sale “for the account of an affiliate,” and for that reason I think the sale needs to comply with Rule 144.  I don’t think the insider’s inability to stop the sale removes the sale from Rule 144’s coverage.  And I would be surprised if a broker were willing to sell the shares other than under Rule 144, if the broker knows the account owner is an affiliate.

Reporting Total Holdings of RSUs in Table 9 of Table II

Barbara:  In early 2020, a Section 16 officer was granted restricted stock units under the 2020-2022 long-term incentive plan. The RSUs vest in three equal installments on February 4, 2021, 2022 and 2023. We are preparing a Form 4 to report the vesting of the first tranche and will use transaction code “M” in Table II to report the disposition of the RSUs.  I plan to include in Column 9 only the remaining balance of the RSUs that will vest in 2022 and 2023.  Can you confirm that I am not required to include unvested RSUs the officer holds under other grants made under prior long-term incentive plan grants?  Practice seems to be mixed.

Alan:  I agree that you can include in Column 9 only the RSUs remaining under the 2020 award.  I also think you could, if you wanted to, include all the officer’s other RSUs, but that would require a footnote to Column 9 to disclose the range of vesting dates.  Column 9 of Table II calls for the number of derivative securities owned following the reported transaction, and the staff takes the position that derivative securities are of the same class if they have the same material terms.  So, the question is whether RSUs having different vesting dates are securities of the same class.  In some contexts, the staff has indicated that vesting provisions are not considered material terms.  The staff said, for example, that acceleration of vesting of an option doesn’t create a new security, and therefore doesn’t required the filing of a Form 4.  For that reason, it would be acceptable, I think, but not required, to include in Column 9 all an insider’s RSUs, regardless of their vesting dates.  Even including in Column 9 the remaining unvested RSUs underlying the 2020 award means that RSUs having a different vesting date from the tranche vesting in 2021 are being treated as securities of the same class.  That said, I don’t think the staff would consider either method of reporting noncompliant.  In either case, all grants are reported, so what appears in Column 9 of a particular Form 4 will not mislead anyone about the insider’s total holdings.  The same issue comes up with directors deferred compensation plans, where deferred units accrue over time, and a director elects different payout dates for some years’ accruals.  In my experience, most directors show all the deferred units in Column 9, but many don’t.  So I’m not surprised to hear the questioner say practice is mixed. In the Romeo and Dye publications, Peter and I have always said that either practice is acceptable.

Company-Mandated Liquidation of Company Stock Fund

Barbara:  Our board of directors decided to remove company stock as an investment option in the company’s 401(k) plan.  On the effective date of termination of the company stock fund, all shares of company stock held by the plan will be liquidated, and participants’ account balances will be transferred to a large cap mutual fund.  Will sales for the accounts of Section 16 officers be reportable on Form 4?  What if an insider elects to sell out of the company stock fund before the termination date and move the funds into a different investment?

Alan:  If Section 16 officers have no say in whether their balances in the company stock fund will be liquidated, the transactions will not be volitional on the part of insiders and therefore should not constitute “discretionary transactions” as defined in Rule 16b-3.  All transactions pursuant to a qualified plan that are not discretionary transactions are exempted by Rule 16b-3(c), so the dispositions will be exempt.  If the dispositions qualify for the Rule 16b-3(c) exemption, they also will be exempt from reporting.  Insiders’ will just drop their prior 401(k) plan holdings from their future Forms 4.

An insider’s election to transfer out of the company stock fund before the effective date of termination of the company stock fund would be volitional on the part of the insider and therefore would be a discretionary transaction.  As a discretionary transaction, the disposition of company stock would be reportable on Form 4 within two business days.  The disposition would be exempt from Section 16(b) under Rule 16b-3(f), however, if the election to transfer out of the company stock fund occurs more than six months after the insider’s last election to transfer plan assets into a company stock fund.