Questions Posed for Today's Webcast

Alan Dye on the Latest Section 16 Developments

Q&A and Practice Tips from the Expert

Wednesday, January 18, 2006

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As reflected by the many questions posed daily on the electronic forums of and, the issues that Section 16 filers face today vary widely in scope and complexity. While this program historically has been timed to allow filers to raise issues associated with filing Form 5 and disclosing delinquencies under S-K Item 405, the questions raised this year go well beyond those subjects.   Several questions submitted raise Form 5 issues, though, so let’s start with a discussion of some Form 5 basics, including some common misconceptions about Form 5.

When Form 5 Is Required

Since the SEC amended Rule 16a-3 in 2003 to require that transactions exempted by Rule 16b-3 be reported on Form 4 rather than Form 5, relatively few transactions are eligible for reporting on Form 5.  Lots of insiders still file Forms 5, either because they engaged in a transaction reportable on Form 5 or because they want to file a Form 5 voluntarily to report transactions that were exempt from reporting.  Some filers may be filing Form 5 unnecessarily, in the mistaken belief that one is required.  Here are the circumstances under which a Form 5 is required:

  1. A Form 5 is required to be filed by any insider who engaged in a transaction during the fiscal year that has not previously been reported on Form 4 and that either (i) was exempt from Section 16(b) and permitted to be reported on Form 5 (e.g., gifts) or (ii) should have been reported on Form 4, but was not.

  2. A Form 5 is not required to be filed to report gifts or other Form 5 transactions that have already been reported.

  3. A Form 5 is not required to be filed to update the insider’s holdings of shares under a 401(k) plan, dividend reinvestment plan, or employee stock purchase plan.

  4. A Form 5 is not required to be filed to provide a list of all of the insider’s holdings of issuer securities, in Table I or Table II.

Automatic Adjustment to Conversion Price of Preferred Stock

  1. A ten percent owner owns privately placed convertible preferred stock that is convertible into common stock of the issuer.  The certificate of designation establishing the terms of the preferred stock provides that, if the issuer issues common stock at a price that is lower than the conversion price, the conversion price will be adjusted according to a formula intended to preserve the economic value of the preferred stock.  The issuer plans to issue common stock at a lower price than the conversion price.  Will the resulting amendment to the conversion price of the preferred stock require reporting on Form 4?

Adjustment of Options Following Stock Split or Spin-Off

  1. An issuer effects a stock split or a spin-off of a subsidiary, resulting in an adjustment to outstanding stock options to increase the number of option shares and to decrease the exercise price per share.  Assuming the stock split or spin-off does not have to be reported, how should the adjustment be reflected in a Form 4 filed to report the exercise of the option?  Should a footnote be added to Columns 2, 5, 7 and 9 of Table II?  Should a footnote be included in Table I?

Option Grant Date

  1. We are confused about the Form 4 deadline for reporting an option grant.  Is the Form 4 due two days after committee approval, or two days after notification of the grant is delivered to the insider?

Amendment of Vesting Terms of Outstanding Options

  1. The Compensation Committee of our Board of Directors is planning to accelerate the vesting of all outstanding underwater options so that the options become exercisable immediately.  Will the amendment require that we file Forms 4 for all affected insiders?  Will we need to report the acceleration on Form 8-K?

Option Grants During Blackout Periods

  1. Do you see any reason not to grant options to executives on an annual basis, at the same time each year, without regard for whether the company is in a blackout period?   Would it be permissible to grant options earlier, out of the usual cycle, if the company knows that positive news is about to be announced?

Dividend Reinvestment

  1. Is an insider’s purchase of company stock in a brokerage account with dividends reinvested by the broker through open market purchases reportable on Form 4?

Insider’s Resignation as Trustee of GRAT

  1. An insider is the trustee of a grantor retained annuity trust. Pursuant to the terms of the trust, upon payment of the last annuity payment, the insider’s trusteeship will terminate and a new trustee will be appointed until proceeds are distributed to the holders of the remainder interests.  Can the insider's loss of beneficial ownership following termination of his trusteeship be reported on Form 5?

Appointment of New Attorney In Fact

  1. A person within our company who is designated as attorney-in-fact for Section 16 filers has recently retired, and a new employee is taking over his Section 16 duties.  Section 16 insiders are now being asked to sign another power of attorney to reflect the new employee’s authority to sign reports on their behalf.  Do the original powers of attorney need to be revoked in writing to the SEC, or do we just need to attach the new power of attorney to each Form 4 as it becomes due?

Name Change by Attorney in Fact

  1. I file and often sign the Forms 3, 4 and 5 for our insiders. My last name recently changed due to marriage. Is it necessary for me to have all Section 16 insiders execute a new power of attorney appointing me as attorney-in-fact in my new name? 

Multiple Matching Transactions Under Section 16(b)

  1. An insider sells 500 shares at $4.00 a share in January.  In February, he purchases 500 shares at $2.00 a share.  If, after the purchase in February, the insider voluntarily disgorges the full amount of the profit ($1,000) under Section 16(b), what happens if the insider purchases another 500 shares in March at $1.00 a share?  Does the insider have to disgorge an additional $500?

Director Emeritus

  1. We have a director emeritus who attends board meetings most of the time but who is no longer an insider.  It has been our practice to continue filing Section 16 reports for this former director, even though we no longer consider him to be subject to Section 16.  We recently filed one of his Forms 4 late.  Is the company required to make Item 405 disclosure of the late filing?

Completing Column 9 of Table II

  1. When reporting a transaction involving one of an insider’s many employee stock options, what number should be reported in Column 9 of Table II as the “number of derivative securities beneficially owned following the reported transaction”?

Reporting Restricted Stock Units in Table I

  1. Is a restricted stock unit a derivative security that should be reported in Table II, or is it acceptable to report RSUs in Table I?

  1. What if the insider defers receipt of the underlying stock upon vesting?

Performance-Based Restricted Stock Units

  1. Three years ago we granted performance-based RSUs to executives, with vesting based on our achieving specified targets for revenue growth and similar measures over a three-year period. Prior to the end of that period, participants were able to elect to receive their payout in cash, stock, or RSUs.  For participants who elected to receive RSUs, the RSUs will be fully vested and will be payable only in cash and only upon the participant’s termination of employment.  Dividends will accrue on the RSUs and will be paid in cash at the same time the RSUs are paid out.
    1. Are the vested RSUs granted reportable even though they are fully vested and settle only in cash?

    2. Are the dividends accrued on these RSUs reportable?

When the Six-Month Holding Period Begins for RSUs 

  1. When does the six month holding period begin under Rule 16b-3(d)(3) in connection with restricted stock units--the date of grant (as with restricted stock) or the date of vesting?

Insider’s Transfer of Stock to Controlled Charitable Foundation

  1. One of our insiders has established a 501(c)(3) charitable foundation and has transferred some of his directly owned shares to the foundation.  He, his wife and the trust advisors are the co-trustees of the new foundation.  It's not clear to me whether I should treat this as a gift or instead as a change in form of beneficial ownership.

Specific Approval of Tax Withholding Transactions

  1. Our company has issued restricted stock and restricted stock units to several Section 16 insiders.  The awards may vest during a closed trading window. We would like to permit shares to be tendered for taxes, but we do not want to run into any short-swing issues.  The awards were approved by a committee of two or more non-employee directors, and the plan under which they were granted provides that the plan administrator may, in its discretion, allow any or all grantees to have shares withheld upon vesting in satisfaction of all or part of their taxes.  Do you think this wording is sufficient to allow reliance on Rule 16b-3(e) to exempt the withholding?

Incorrect Designation of ISO in Form 4

  1. We recently filed a Form 4 to report the grant of an employee stock option that was part ISO and part NQSO.  The number of shares underlying the option was reported correctly, but we incorrectly stated the breakdown between ISOs and NQSOs by 72 shares.  Do we need to file an amended Form 4?

Covered Calls

  1. Model Form 145 says that the writing of a covered call by an insider is a sale of an option and therefore is reportable only in Table II of Form 4.  The Model Form also states, however, that the writing of the call is deemed a sale of the securities underlying the option for purposes of Section 16(b).  Model Form 146 then says that the counterparty’s exercise of the call is reportable as a disposition of the option and a sale of the underlying security. If writing the call was a sale of the underlying security, how can the exercise of the call be another sale of the same security, since an insider can’t sell the same security twice?

Filing the Power of Attorney

  1. We signed and filed a Form 3 and two Forms 4 for an insider before we received his signed power of attorney.  Do we need to amend each of the three reports to attach the power as an exhibit?  One of the Forms 4 was filed before the Form 3. 

Rule 10b5-1 Transactions

  1. Are transactions effected for an insider’s account pursuant to a broker-administered Rule 10b5-1 plan subject to Section 16?

Directors by Deputization

  1. Can a director by deputization rely on Rule 16b-3 to exempt an acquisition of securities from the issuer?

Insider’s Sale of Entity that Owns Issuer Stock

  1. One of our insiders, a ten percent owner, holds some of our stock indirectly through a wholly owned subsidiary.  If the insider sells the subsidiary, resulting in the insider’s disposition of our stock held by that subsidiary, will the sale be reportable on Form 4?  If so, will the sale be subject to Section 16(b)?

Limited Partnership’s Pro Rata Distribution of Issuer Securities

  1. An investment fund owns more than ten percent of our common stock.  The general partner intends to distribute the shares to the partners (including the general partner) in a pro rata distribution based on their percentage interests in the partnership.  Will the fund’s distribution be a “sale” by the partnership, matchable with any purchases by the partnership within less than six months?

Deemed Execution Date

  1. Is it necessary to report a deemed execution date for an eligible transaction where the Form 4 is filed within two business days of the actual execution date?  What if the actual and deemed execution dates are the same?

Early Item 405 Disclosure

  1. Several of our insiders filed late Forms 4 during 2004, and we disclosed those reporting delinquencies in the proxy statement we filed for the 2005 meeting of shareholders.  One of our insiders also filed a late Form 4 in February 2005, and we disclosed that delinquency in the 2005 proxy statement, even though we may not have had to.  Do we need to disclose that delinquency again in our 2007 proxy statement?  We have no other Item 405 disclosures this year and therefore would rather not include the disclosure if we don’t have to.

Former Insider’s Resumption of Insider Status

  1. One of our vice-presidents was considered a Section 16 officer until 2002, when we re-evaluated our list of Section 16 officers and concluded that he should no longer be considered subject to Section 16.  Since then, the vice-president’s policy-making function has been expanded, and we plan to designate him as a Section 16 insider at the next board meeting.  The vice-president never filed an exit report indicating that he was no longer subject to Section 16.  Do we need to file a new Form 3, or can we just resume filing Forms 4?

Hybrid Securities

  1. Is the conversion of hybrid preferred stock, which is convertible at a fixed price or, if lower, a floating price, exempt from Section 16(b) under Rule 16b-6(b), as the conversion of a derivative security?

Counting Two Business Days

  1. Our compensation committee has scheduled a Saturday meeting to approve option grants.  Will the Forms 4 to report the grants be due two business days after Saturday (i.e., Tuesday) or two business days after Monday (i.e., Wednesday)?

Multiple Gifts on Same Day

  1. If a Section 16 filer makes four gifts of 100 shares of common stock on a given day, do I need to list each gift separately or can I just list it as a gift of 400 shares? Would it help to add a footnote?