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Possible violations of SEC Rule 16 b) and taxes


Below is a link to  a recent U.S. Appeals Court Decision on how Section 16 b of the Securities Act of 1934 works. It tell how taxes apply to exercises of Employee Stock Options and vesting of Restricted Stock for officers and directors. I have included the first few paragraphs below the link. There is no higher Court or Court with equal standing in the U.S that has reached a contrary decision.



Mark G. Strom and Bernee D. Strom, Plaintiffs-Appellants, v. United States of America, Defendant-Appellee.

Nos. 09-35175, 09-35197.
Argued and Submitted Aug. 5, 2010. -- April 06, 2011
Before WILLIAM C. CANBY, JR., STEPHEN REINHARDTand MARSHA S. BERZON, Circuit Judges.* Darrell D. Hallett, Cori Flanders-Palmer, Chicoine & Hallett, P.S ., Seattle, WA, for the plaintiffs-appellees/cross-appellants. Kenneth L. Greene, Ellen Page DelSole, John A. DiCicco, Acting Assistant Attorney General, Tax Division, Department of Justice, Washington, D.C., for the defendant-appellant/cross-appellee.


Ordinarily, when an employee is compensated with nonstatutory stock options that do not have a readily ascertainable fair market value at the time of the grant, the employee realizes income for tax purposes upon exercising the options.1 See 26 U.S.C. §§ 83(a) & (e)(3)-(e)(4); 26 C.F.R. § 1.83-7(a).

The taxpayer is taxed on an amount equal to the fair market value of the stock on the date of exercise minus the option price paid for the stock. See 26 C .F.R. § 1.83-1(a)(1); id. § 1.83-7(a).

Internal Revenue Code § 83(c)(3), however, allows taxpayers to defer recognition and valuation of income so long as a profitable sale of the stock acquired through the exercise of the options "could subject a person to suit under section 16(b) of the Securities Exchange Act of 1934." 26 U.S.C. § 83(c)(3).

Section 16(b), in turn, forbids a corporate insider from profiting on a purchase made within six months of a sale (or a sale made within six months of a purchase) of the corporation's stock. See 15 U.S.C. § 78p(b).

If a taxpayer is permitted to defer tax consequences under IRC § 83(c)(3), the taxpayer will be later taxed on an amount equal to the fair market value of the stock on the date that § 83(c)(3) no longer applies minus the option price paid for the stock. See 26 U.S.C. § 83(a); 26 C.F.R. § 1.83-1(a)(1).


This says that if there is a "sale" of the stock received upon exercise that could create a violation of 16 b, the taxes are deferred until the possibility of a 16b violation is eliminated. If the stock is higher after the wait, the taxes will be more.

So if within 6 months before the exercise there was a "buy" of stock or options or convertible securities or if there was a reasonable possibility of a "buy" of stock or options or convertible securities within 6 months after the exercise, then there is no tax liability upon exercise. The tax liability occurs after the six months have passed from the date of exercise. Of course if the stock is sold in a manner that is not exempted from 16 b, any profits must be returned to the company if there is a non-exempt purchase within 6 months of the sale.

This opinion could very well mean that taxes, for officers and directors, do not apply to exercises of ESOs or SARs until 6 months after the exercise and do not apply until 6 months after the vesting of the RSUs, unless the stock is sold prior to the 6 months thereby making the tax liability occur at the moment of sale.

If someone has any case law of SEC Rules which state otherwise, I would be happy to see it.

John Olagues


Edited Fri, Mar 21, 2014 6:37 AM

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