|
Leveling the Playing Field
- Restricting Executive Stock Trades During Retirement Plan Blackout
Periods
By Stuart
Harris
[March 2003]
Effective Jan. 26, 2003, the Sarbanes-Oxley Act limits
corporate executives' ability to buy or sell company stock during
a retirement plan "blackout period." The following two
scenarios highlight the new law's effect:
- During the past three years, Mr. Green, a director of ABC, Inc.,
a private company, acquired 6,000 shares of ABC common stock in
connection with his service as a director. In January 2003, ABC
was acquired by XYZ, Inc., a public company. As a result of the
transaction, Mr. Green received 1,000 shares of XYZ common stock
in exchange for his 6,000 shares of ABC common stock. In addition,
Mr. Green became a director of XYZ.
As part of changing-plan record keepers, the XYZ, Inc. 401(k)
Plan will impose a temporary trading suspension on plan participants
and beneficiaries from March 1 to March 17. Under the 401(k) Plan
employees can invest in XYZ stock. Assume Mr. Green disposes of
his 1,000 shares of XYZ common stock on March 13. Does this sale
constitute a prohibited trade?
- QRS, Inc., a private company, hired Ms. Blue as its Chief Financial
Officer. In connection with Ms. Blue's hiring, QRS issued her
5,000 shares of QRS common stock. In January 2003, QRS completed
an initial public offering, after which Ms. Blue remained the
Chief Executive Officer.
The QRS 401(k) Plan offers employees the ability to invest in
a family of mutual funds and/or QRS stock. To facilitate a move
from one mutual fund family to another, the QRS 401(k) Plan imposed
a temporary trading suspension on plan participants and beneficiaries
from February 21 to March 5. Assume Ms. Blue disposes of her 5,000
shares of QRS common stock on March 3. Does this sale by Ms. Blue
constitute a prohibited trade under Section 306(a) of the Sarbanes-Oxley
Act?
Under both examples, the individuals selling the shares would be
in violation of Section 306(a) of the Sarbanes-Oxley Act.
For specific information or to seek guidance about specific issues,
please contact either of the authors of this article or another
Davis Wright Tremaine (DWT) corporate finance or employee benefits
attorney.
What is the Sarbanes-Oxley Act of 2002?
The Sarbanes-Oxley Act (also referred to as the "Act")
is a federal statute passed in the wake of Enron and a number of
other recent corporate governance and accounting scandals. Its general
aim is to improve corporate governance and responsibility. To accomplish
this goal, the Act imposes new rules on financial reporting, conflicts
of interest, corporate ethics and private oversight of accounting
firms that perform public company audits.
The Sarbanes-Oxley Act also provides that retirement plan participants
and beneficiaries (collectively referred to as participants) be
given 30 days' notice before a blackout period. (See below for the
definition of a "blackout period."). If certain circumstances
exist, an additional requirement prohibits executive officers and
directors from buying and selling "compensatory" company
stock during the blackout period.
What are the retirement plan blackout provisions
of the Sarbanes-Oxley Act?
As stated above, Section 306 of the Sarbanes-Oxley Act requires
all retirement plan administrators to provide 30 days' advance notice
before any blackout period. A "blackout period" is defined
as any period of more than three consecutive business days during
which participants are unable to direct or diversify their account
balances, obtain plan loans or obtain distributions. A blackout
period typically occurs when there is a change in a retirement plan's
trustee, recordkeeper, or investment manager. During such events,
participants are often restricted from accessing their accounts
in the company's retirement plan. The 30-day notice requirement
applies to all retirement plans.
A secondary blackout period rule can apply to publicly traded companies.
For these purposes, a company is considered "publicly traded"
if it has registered its securities, is required to file reports
with the Securities and Exchange Commission (SEC), or has filed
a registration statement with the SEC that is not yet effective.
This additional blackout period rule only applies to publicly traded
companies that sponsor individual account retirement plans (essentially,
all 401(k), profit-sharing, and other defined contribution plans),
in which employees can invest in the equity securities of the company.
And for these purposes a "blackout period" is any period
of three or more consecutive business days during which at least
50 percent of the employees at the company are precluded from purchasing
or selling their interests in company securities held in the plan.
If these factors apply-i.e., a publicly traded company, with an
individual account plan that holds company stock, which experiences
a blackout period-then the company's executive officers and directors
are also precluded from buying or selling, during the blackout period,
any company stock they acquired in connection with their employment
with the company.
The intent of this provision of the Sarbanes-Oxley Act is to equalize
the treatment of corporate executives and rank-and-file employees
with respect to their ability to engage in purchases and sales of
company stock during a blackout period.
When did these provisions become effective?
As mentioned above, the retirement plan blackout provisions of
the Act became effective on Jan. 26, 2003. This applies to both
the basic blackout period notice requirement, as well as the secondary
requirement applicable to publicly traded companies.
Do executive trading restrictions only apply to
publicly traded companies?
Yes. As described above, the basic blackout period notice requirement
applies to all retirement plan administrators, regardless of whether
the employer that sponsors the plan is privately held or publicly
traded. However, the secondary blackout restriction, which restricts
non-plan sales of company securities during the blackout period,
only applies to public companies. Again, a public company is any
company "whose securities are registered under Section 12 of
the Exchange Act, or that is required to file reports under Section
15(d) of the Exchange Act, or files or has filed a registration
statement that has not yet become effective under Securities Act
of 1933 and that has not been withdrawn."
Note that under certain circumstances the shares issued by a private
company may become subject to the trading ban as well. For example,
assume privately issued shares are later registered with the SEC.
If the shares were issued to a director or executive officer "in
connection with service or employment as a director or executive
officer," then a subsequent disposition of the shares by the
director or officer during a blackout period would trigger the application
of the Act's restrictions.
Who is a "director" or "executive
officer"?
For purposes of the blackout provisions, "director" has
the meaning set forth in Section 3(a)(7) of the Exchange Act, meaning
any director of a corporation or any person performing similar functions
with respect to any organization, whether incorporated or unincorporated.
In general, the term "executive officer" includes a company's
president, principal financial officer, principal accounting officer
(or, if there is no such accounting officer, the controller), any
vice-president of the company in charge of a principal business
unit, division or function (such as sales, administration or finance),
any other officer who performs a policy-making function, or any
other person who performs similar policy-making functions for the
company.
Are there any exceptions to the blackout period
trading ban?
The plan blackout period rules list several exempt transactions,
including:
- acquisitions of equity securities under dividend or interest
reinvestment plans;
- purchases or sales of equity securities pursuant to a trading
arrangement that satisfies the affirmative defense conditions
of Exchange Act Rules 10b5-1(c);
- purchases or sales of equity securities other than discretionary
transactions (as defined in Exchange Act Rule 16b-3(b)(1) pursuant
to certain "tax-conditioned" plans);
- increases or decreases in the number of equity securities held
as a result of a stock split or stock dividend applying equally
to all equity securities of that class;
- compensatory grants and awards of equity securities (including
options and stock appreciation rights) pursuant to a plan that,
by its terms, permits directors or executive officers to receive
grants or awards, provides for grants or awards to occur automatically
and specifies the terms and conditions of the grants or awards;
- exercises, conversions or terminations of derivative securities
that were not written or acquired by a director or executive officer
during the blackout period in question or while aware of the actual
or approximate beginning or ending dates of the blackout period,
and where (i) the derivative security, by its terms, may be exercised,
converted or terminated only on a fixed date, with no discretionary
provision for earlier exercise, conversion or termination, or
(ii) the derivative security is exercised, converted or terminated
by a counterparty and the director or executive officer does not
exercise any influence on the counterparty with respect to whether
or when to exercise, convert or terminate the derivative security;
- acquisitions or dispositions of equity securities involving
a bona fide gift or a transfer by will or laws of the descent
and distribution;
- acquisitions or dispositions of equity securities pursuant to
a domestic relations order;
- sales or other dispositions of equity securities compelled by
the laws or other requirements of an applicable jurisdiction;
and
- acquisitions or dispositions of equity securities in connection
with a merger, acquisition, divestiture or similar transaction
occurring by operation of law.
Are there situations where retirement plan accounts
are frozen, but the blackout period rules do not apply?
Yes. Two types of temporary trading suspensions are excluded from
the definition of "blackout period." These exceptions
are for:
- a regularly scheduled period in which the participants and beneficiaries
may not purchase, sell or otherwise acquire or transfer an interest
in an equity security of a company, if such period is incorporated
into the individual account plan and timely disclosed to employee
participants; and
- any temporary trading suspension that would otherwise be a "blackout
period" imposed solely in connection with persons becoming
participants or beneficiaries, or ceasing to be participants or
beneficiaries, in an individual account plan by reason of a corporate
merger, acquisition, divestiture or similar transaction involving
the plan or plan sponsor.
What type of notice is the company required to
give in connection with a blackout period?
In the event of a plan blackout period, the plan sponsor must give
at least 30 days' advance notice. The notice should give the reason
for the blackout period, the expected duration of the blackout period,
and other relevant information. If the blackout period falls into
the category that restricts executive trades outside the plan, then
additional notice is required as well. A company is required to
provide notice to its directors, executive officers and to the SEC.
A company's notice is deemed timely if provided at least 15 days
in advance of commencement of the blackout period, and is deemed
"provided" as of the date of mailing, or electronic transmission,
of the notice. The notice to the SEC is accomplished by filing Form
8-K upon the earlier of receipt of notice of the blackout period
from the plan administrator, or actual knowledge of the blackout
period by the person overseeing the company's pension plans. Note
that plan administrators who fail to provide proper notice to companies
can face civil penalties of up to $100 per day per participant.
The company's failure to provide notice will not preclude a SEC
enforcement action for violation or a private action to recover
profits under the blackout provisions. In addition, the failure
of the company to provide notice may result in a SEC enforcement
action against the company for violating the Exchange Act regardless
of whether a director or executive officer subsequently violates
the trading prohibition under pension fund blackout provisions.
When must companies comply with the Form 8-K filing
requirement?
Companies must comply with the filing of a Form 8-K with the SEC
by giving notice of the proposed blackout period beginning March
31, 2003.
What are the remedies to the company in the event
of a violation by a director or executive officer under the retirement
plan blackout provisions?
There are two sets of remedies:
- A violation of the trading prohibition during a blackout is
treated as a violation of the Exchange Act and is subject to all
sanctions, including a possible SEC enforcement action. Consequently,
a director or executive officer would be subject to possible civil
injunctive actions, cease-and-desist proceedings, civil penalties
and all other remedies available to the SEC to redress violations
of the Exchange Act, and possible criminal liability.
- In addition, a company, or shareholders on behalf of the company,
could bring an action (within two years of the violation) for
disgorgement of profits realized by a director or executive officer
in violation of the trading prohibition.
Can you give me an example of how this all works?
In the initial example given at the start of this article, Mr.
Green is a director of XYZ, Inc., a public company, who has disposed
of shares of XYZ during a blackout period. Whether Mr. Green violated
the blackout period trading prohibitions will turn on whether he
acquired his 1,000 shares of XYZ common stock in connection with
his service as a director. At first blush it would appear that the
blackout period rules would not apply because Mr. Green acquired
his 1,000 shares of XYZ common stock in exchange for his 6,000 shares
of ABC common stock. However, because Mr. Green's 1,000 shares of
XYZ common stock can be traced back to his 6,000 shares of ABC common
stock, which were acquired in connection with his service as a director,
Mr. Green's 1,000 shares of XYZ common stock will be subject to
the blackout period rules. As a result, the trading of the 1,000
shares of XYZ common stock during the blackout period would constitute
a prohibited trade under the blackout period rules.
In the example concerning the disposition of 5,000 shares of QRS
common stock, Ms. Blue is an executive officer of QRS, a public
company, who has disposed of shares of QRS during a blackout period.
As with the prior example, Ms. Blue's potential violation turns
on whether she acquired her 5,000 shares of QRS common stock in
connection with her service as an executive officer of QRS. Even
though QRS was a private company when Ms. Blue acquired her shares,
the shares will still be deemed acquired in connection with her
service as an executive officer and therefore the transaction would
be subject to the blackout period rules. As such, the trading of
the 5,000 shares of QRS common stock during the blackout period
would constitute a prohibited trade under the blackout period rules.
Finally, for specific information or to seek guidance about a specific
issue, please contact DWT's corporate finance or employee benefits
attorneys.
For more information, please contact:
Stuart Harris, Portland, (503) 778-5428, stuartharris@dwt.com
This Corporate Finance
Advisory Bulletin is a publication of the Business Transactions/Corporate
Finance Group of Davis Wright Tremaine LLP. Our purpose in publishing
this Advisory Bulletin is to inform our clients and friends of developments
in business, corporate finance and securities laws. It is not intended,
nor should it be used, as a substitute for specific legal advice
as legal counsel may only be given in response to inquiries regarding
particular situations.
Copyright © 2005, Davis Wright Tremaine LLP.
return to Advisory Bulletins
main page
|
