Purpose and exemptions of Section 16 (b) of the Securities Exchange Act of 1934


Section 16 (b) of the Securities Exchange Act of 1934 is designed to reduce the ability of officers, directors and greater than 10% owners of publicly traded companies from making profits trading on inside information.

The SEC can make exemptions for transaction that are not comprehended with the purpose of the Section 16 (b). So according to the New York Bar, the SEC can give exemptions for transactions involving parties on an equal footing from the standpoint of knowledge of inside information.

And the American Bar Association agrees that transactions between the issuer and its officers and directors present little opportunity for the abuses to which Section 16(b) is directed when those transactions are subject to the "gate keeping conditions" set forth in the rule.

An exemption for transactions by officers and directors trading with the issuer is based on the assumption that the insider and the issuer are on "equal footing" and the transactions are subject to "gate keeping" conditions.

Let's assume that a plan document and the grant agreements purposely allow the insiders to have discretion as to the timing of the date of the exercise and tax payments and the method of the exercise price payment and tax payments.

Let's assume also that the issuer has no discretion as to the timing or the method of payments for the exercise and tax liabilities and must accept the timing and choices of the officer or director.

It is obvious that under the circumstances outlined above, the insider has superior standing and would not be in compliance with the gate keeping conditions set forth in the Bar Association letters.

The SEC does not enforce 16 (b) but leaves it up to the issuer or the shareholders to recover the profits made in violation of section 16 (b) .

SEC Rule 16 b-3(a) follows:

(a)General. A transaction between the issuer and an officer or director of the issuer that involves issuer equity securities shall be exempt from section 16(b) of the Act if the transaction satisfies the applicable conditions set forth in this section.

Looked at it another way:

The starting point in understanding SEC Rule 16 b-3 is to first understand Rule 16 b-3(a)

1) It refers to a purchase or sale by an insider of the issuer. 2) The purchase or sale must be of issuer securities.  3) the purchase or sale must be between the officer or director and the issuer.
Generally the transaction must be approved by the Board or a committee of the Board or the shareholders.

 So if there was a transaction where one of the 3 is missing, there is no exemption and the transaction can be matched with an opposite way purchase or  sale within less than 6 months, with the profits recoverable by the company.

So  an exemptions from Section 16 (b) is available

   1. If an officer or director of the issuer is a purchaser or seller

   2. If the transaction involves equity securities of the issuer

   3. If the transaction is between the officer or director and the issuer

   4. If the transaction is approved by the board or a proper committee with the  required specificity .

If one is missing, then there is no exemption

So: here is a question.

If a famous executive of ABC corporation disposes of shares of ABC corporation in exchange of shares of XYZ corporation in a transaction between himself and ABC corporation. Is the disposal (the sale) transaction exempt from section 16 (b).?

Answer is yes, if there is proper approval by the Board or a committee of the issuer, for the disposition of ABC shares to the ABC Corp.

But what about the XYZ corporation shares received by the famous director of ABC in exchange for the ABC shares delivered to ABC with proper approval. Is that transaction an exempt transaction. The answer is no, since the shares received (i.e. XYZ shares) are not shares of ABC, where the famous executive was a director.

If he were a director of XYZ, then the transaction would be exempt from section 16 (b) and the transaction was fully approved

John Olagues



Edited Tue, Nov 13, 2018 5:39 AM

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