company’s equity securities – from trading in their companies’ equity securities on the basis of nonpublic information. To achieve these ends, Section 16 takes a three-pronged approach. First, Section 16(a) requires insiders to publicly disclose holdings of and transactions in the company’s equity securities. Second, Section 16(b) renders insiders liable to the company for the amount of any “short-swing” profits garnered in transactions involving the company’s equity securities. Finally, Section 16(c) prohibits insiders from engaging in short sales of the company’s equity securities.
There are three types of corporate insiders for purposes of Section 16: officers, directors, and greater than 10% shareholders. We refer to these three types of corporate insiders collectively as Section 16 insiders.
The company officers subject to Section 16 are: • the president;
• the principal financial officer;
• the principal accounting officer (or, if there is no such accounting officer, the controller);
• any vice president in charge of a principal business unit, division or function (such as sales, administration or finance);
• any other officer who performs a significant policy-making function; and • any other person who performs similar policy-making functions for the
company.
18Leff v. CIP Corp., 540 F. Supp. 857 (S.D. Ohio, 1982); Liberty National Insurance Holding Co. v.
Officers of a company’s parents or subsidiaries are deemed to be “officers” of the company for purposes of Section 16 if they perform policy-making functions for the company. Additionally, there is a presumption that the persons whom the company has identified as “executive officers” in the company’s proxy statement or on its annual report on Form 10-K are also covered officers for purposes of Section 16.
For purposes of Section 16, a “director” includes any director of a company or any person performing similar functions with respect to any organization. This definition should be broadly understood to encompass any person who performs the functions of a director, irrespective of the person’s formal title. In addition, any person or entity that deputizes another to serve as its representative on a company’s board of directors is also considered a “director” for purposes of Section 16.
A greater than 10% shareholder subject to Section 16 is any person who
beneficially owns, directly or indirectly, more than 10% of any class of the company’s equity securities registered under Section 12.
One frequent source of confusion is that beneficial ownership essentially has two meanings under Section 16. For purposes of determining whether a person is a greater than 10% shareholder subject to the reporting requirements of Section 16(a), a person is generally deemed to beneficially own any security over which the person has or shares voting or investment power. This is the same definition of beneficial ownership that is applicable under Section 13(d). As explained above, under this definition a person will generally be deemed to beneficially own a security if that person has or shares the power to: (i) vote, or direct the voting of, the security; or (ii) dispose, or direct the disposition of, the security. A person will also be deemed to beneficially own any equity securities that the person has the right to acquire within 60 days, as well as any shares beneficially owned by members of a Section 13(d) group of which the person is a member.
In contrast, for all other purposes under Section 16, including the determination of liability for short-swing profits under Section 16(b), a person will generally be deemed to “beneficially own” any equity security in which the person directly or indirectly, through any contract, arrangement, understanding, relationship or
Practice Tip:In order to avoid confusion about who is an “officer” for purposes of Section 16, the board may consider passing a resolution to identify by name those persons who fall within this category.
otherwise, has or shares a direct or indirect “pecuniary interest.” A person will be deemed to have a “pecuniary interest” in any class of equity securities if that person has the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction in such securities. In determining whether a person has an indirect pecuniary interest in a security, there are special rules that apply in the following circumstances, among others:
• Family Members. There is a rebuttable presumption that a person has an
indirect pecuniary interest in any securities held by members of that person’s “immediate family” sharing the same household. For these purposes, a person’s “immediate family” includes the person’s spouse, children, stepchildren, grandchildren, parents, stepparents, grandparents, siblings, mother-in-law, father-in-law, sons-in-law, daughters-in-law, brothers-in-law and sisters-in-law.
• General Partners of Investment Funds. The general partner of a general or limited partnership that holds portfolio securities is deemed to have a proportionate beneficial interest in those securities equal to the greater of: (i) the general partner’s share of the partnership’s profits; or (ii) the general partner’s share of the partnership capital account.
• Trusts.Depending upon the nature and structure of a trust, any of the trust or its settlor, trustees, beneficiaries or remaindermen may be deemed to have a pecuniary interest in securities held by the trust. However, a settlor, beneficiary or remainderman will not be deemed to beneficially own the securities held by the trust unless the person exercises “investment control” over such securities. Trustees, who generally have investment control over the trust’s securities due to the nature of their duties, will be deemed to have a pecuniary interest in securities held by a trust in a variety of circumstances. For example, a trustee will be deemed to have a pecuniary interest in the trust’s holdings if it receives certain non-qualifying performance-related fees. Likewise, a trustee will have a pecuniary interest in the trust’s holdings if at least one beneficiary of the trust is a member of the trustee’s immediate family. In the latter circumstance, the pecuniary interest of the immediate family member will be attributed to and reportable by the trustee.
The reporting obligations of Section 16(a), the liability provisions of Section 16(b) and the prohibition on short sales contained in Section 16(c) apply
generally to all equity securities of or relating to a public company which has any class of registered equity security. For purposes of Section 16, the SEC has by rule adopted a definition of “equity security” that is broader than the definition used for other purposes under the Exchange Act. Under Exchange Act Rule 3a11-1, the term “equity security” includes:
. . . any stock or similar security, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust; any security future on any such security; or any security convertible, with or without consideration into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another without being bound to do so.
This definition encompasses not only the company’s common stock, but also preferred stock, derivative securities (e.g., stock options, warrants, convertible securities, and stock appreciation rights) and any other instrument that represents an equity stake in the company.
Section 16(a): Reporting Transactions by Insiders
As noted above, Section 16 insiders must file reports with the SEC disclosing their beneficial ownership of and transactions in a public company’s equity securities. The three forms on which Section 16 insiders must make these reports – Forms 3, 4 and 5 – are described in greater detail below.
Form 3: Initial Statement of Beneficial Ownership of Securities. Section 16 insiders must file an initial report on Form 3 with the SEC within 10 days of becoming subject to Section 16. For a person who is elected an officer or director of a company that already has a class of equity securities registered under Section 12, the 10-day period begins when the person becomes an officer or director. Persons who are officers, directors or greater than 10% shareholders of a company that registers a class of equity securities (and did not previously have a class of registered equity securities) are required to file a Form 3 on the effective date of the company’s registration statement. In any case, the Form 3 must disclose all equity securities of the company
that the Section 16 insider beneficially owned on the date the person became subject to Section 16. Even if a director or officer owns no securities on the date he or she became a Section 16 insider, he or she is still required to file a Form 3.
Recent Development:Section 929R of the Dodd-Frank Act amended Section 16 of the Exchange Act to authorize the SEC to establish by rule a shorter time period within which a new Section 16 insider would be required to file a Form 3. As this handbook goes to publication, the SEC has not proposed any rule change that would shorten the current 10-day reporting window.
In certain circumstances, the Section 16 insider should file an initial Form 3 earlier than is required. As discussed below, a Section 16 insider generally must report changes in his or her beneficial ownership of the company’s equity securities within two business days. If the Section 16 insider’s beneficial ownership of the company’s equity securities changes between the date the Section 16 insider becomes subject to Section 16 and the date he or she must file a Form 3 (e.g., where a new director is granted restricted stock upon his or her appointment), the SEC recommends that the Section 16 insider file an initial Form 3 concurrently with a Form 4 reporting the change, notwithstanding that the rules permit the Form 3 to be filed at a later date.
Form 4: Statement of Changes in Beneficial Ownership. After filing a Form 3, a Section 16 insider must report any subsequent change in his, her or its beneficial ownership of the company’s equity securities by filing a Form 4 within two business days, unless the transaction is exempt from reporting or is eligible for deferred reporting.
Practice Tip:In order to assist incoming directors and officers in meeting their compliance obligations, companies generally require such persons to complete a questionnaire that requests information about their beneficial ownership of the
Stock options are derivative securities for purposes of Section 16(a). Therefore, a Section 16 insider must report on Form 4, within two business days, any grant of options or any other acquisitions of the company’s equity securities. Similarly, the Section 16 insider must report on Form 4 any exercise or conversion of a derivative security of the company.
Transactions that must be reported on Form 4 include, but are not limited to: • non-exempt purchases and sales of equity securities held in the Section 16
insider’s name;
• transactions involving equity securities held by others but that the Section 16 insider is deemed to beneficially own (i.e., equity securities in which the Section 16 insider has a “pecuniary interest,” as discussed above);
• exercises or conversions of derivative securities;
• acquisitions and grants of any of the company’s equity awards (including options), even if not presently exercisable;
• entry into various other derivative transactions, including equity swaps and similar hedges;
• awards to non-employee directors made pursuant to equity incentive plans; • equity securities received from a non-exempt dividend reinvestment; and • dispositions of equity securities to the company (e.g., the company’s
retention of shares to pay the Section 16 insider’s tax withholding obligation upon the exercise of stock options).
Following an IPO, the directors and officers of the previously non-public company may be required to report certain pre-IPO transactions in the company’s equity securities. Such a filing obligation may arise if the director or officer engages in a reportable transaction less than six months after the date that the company’s registration statement became effective. In such event, the director or officer is
Practice Tip:In the case of an open market purchase or sale, it is the date the transaction is executed, not the settlement date, that triggers the two-business-day deadline. Therefore, a Section 16 insider and its broker should develop a system to ensure prompt communication as soon as any transaction is executed.
required to “look back” for a period of six months from the date of the reportable transaction and report on its first required Form 4 any transactions in the company’s equity securities that occurred during that period. Persons who are Section 16 insiders by virtue of being greater than 10% shareholders are not subject to this six-month look-back period.
Depending upon the circumstances, a covered officer or director may also be required to report transactions in the company’s equity securities that occurred after the termination of that person’s officer or director status. An otherwise reportable transaction occurring after the cessation of a person’s officer or director status will be reportable on Form 4 if (and only if) the transaction is not exempt from Section 16(b) and occurs within six months of an “opposite way” transaction that was also subject to Section 16(b) and occurred while the person was still a director or officer. For purposes of this rule, an acquisition and subsequent disposition (or vice versa) are considered “opposite way” transactions. In contrast, a person who is a Section 16 insider solely by virtue of being a greater than 10% shareholder ceases to be subject to Section 16 reporting requirements once the person ceases to be a greater than 10% shareholder.
The SEC has adopted a variety of exemptions from the reporting requirements of Section 16(a) based upon the nature of the transaction. These exemptions apply to the following types of transactions:
• any increase or decrease in the number of equity securities held as a result of a stock split or a stock dividend applying equally to all securities of a class; • the acquisition of rights, such as shareholder or preemptive rights, pursuant
to a pro rata grant to all holders of the same class of registered equity securities;
• transactions that effect only a change in the form of beneficial ownership without changing the person’s pecuniary interest in the subject equity securities (note, however, that this exemption does not cover the exercise and conversion of derivative securities or deposits to and withdrawals from voting trusts); • certain transactions pursuant to tax-conditioned employee benefit plans; • acquisitions made pursuant to a dividend reinvestment plan, provided that
the plan meets certain requirements specified in Rule 16a-11 under the Exchange Act;
• acquisitions or dispositions of an equity security pursuant to a domestic relations order;
• the disposition or closing of a long derivative security position as a result of cancellation or expiration, provided that the Section 16 insider receives no value in exchange for the expiration or cancellation;
• transactions effected by a person who was not a director, officer or greater than 10% shareholder at the time of the transaction;
• under certain circumstances, transactions occurring after the termination of insider status (see above discussion); and
• transactions by a greater than 10% shareholder that occur after the company’s termination of its registration under Section 12 of the Exchange Act, or transactions by a director or officer that occur not less than six months after such termination.
In addition to the above exemptions, the SEC has adopted a number of exemptions based upon the status of the Section 16 insider. Depending on the circumstances, certain of these exemptions may be available to executors and other fiduciaries, odd-lot dealers, market makers, arbitrageurs, and underwriters and other persons who participate in a distribution of the company’s equity securities.
Form 5: Annual Statement of Changes in Beneficial Ownership. A Section 16 insider must report certain transactions on a year-end report on Form 5 within 45 days after the end of the company’s fiscal year. Some transactions, most notably gifts, are not required to be reported on Form 4, but must be reported on Form 5. A Section 16 insider is required to file a year-end Form 5 to report any transaction that the person should have reported during the fiscal year on Form 3 or Form 4, but did not. Transactions reportable on Form 5 are limited to the following:
• certain transactions occurring during the most recent fiscal year that are exempt from short-swing profit liability under Section 16(b), such as bona fide gifts of the company’s equity securities, but excluding exempt transactions which involve the company;
• qualifyingde minimisacquisitions of the company’s equity securities;19and
• transactions that the Section 16 insider should have reported on Form 3 or Form 4 during the most recent fiscal year, but did not.
Disclosure of Reporting Delinquencies; Compliance Programs. Item 405 of Regulation S-K requires a company to disclose in its annual proxy statement and annual report on Form 10-K certain information regarding the failure of any Section 16 insider to timely file a Section 16 report during the previous fiscal year or prior fiscal years. For each such delinquent Section 16 insider, the company is required to set forth the number of late reports, the number of transactions that were not reported on a timely basis, and any known failure to file a required Form 3, 4 or 5. Although there is no official sanction placed upon the company as a result of the filing delinquencies of its insiders, such disclosures are potentially embarrassing.
Accordingly, every public company should develop and implement a strong compliance program to ensure that its directors and officers timely file all required reports. In addition to minimizing the potential for embarrassing disclosures of the type described above, a strong compliance program will assist the company’s directors and officers in avoiding both short-swing liability under Section 16(b) and SEC enforcement actions to enforce Section 16(a)’s reporting requirements.
Filing Procedures and Website Posting. All Section 16(a) reports must be filed with the SEC electronically using the SEC’s EDGAR filing system, and all reports become publicly available immediately upon filing. In order to file electronically, a Section 16 insider must first file a Form ID and obtain EDGAR filing codes, including a Central Index Key (CIK), a CIK Confirmation Code (CCC) and an EDGAR password. Information on becoming an EDGAR filer is available at the SEC’s EDGAR Filer Management website at https://www.filermanagement.edgarfiling.sec.gov/
19Ade minimisacquisition of the company’s securities is eligible for deferred reporting on a year-end
Form 5 if: (i) the acquisition, when aggregated with all other unreported and non-exempt acquisitions of securities of the same class within the prior six months, does not exceed $10,000 in market value; and (ii) the Section 16 insider does not, within six months thereafter, make any disposition of the securities,