Shareholder Challenging 16(b) Status of Shares Withholding....NASPP view


Below is an article written by Barbara Baska of NASPP from Dec 6, 2016

Just when you thought it was safe to withhold shares to cover taxes, a shareholder has started issuing demand letters to companies claiming that share withholding is a nonexempt sale for purposes of Section 16b.


Yep, I say "shareholder" because apparently it's just one guy and he's representing himself, he's not even engaging the services of the plaintiffs' bar.

What the Heck?

But wait, you say, that's ridiculous. Share withholding is exempt from Section 16(b) pursuant to Rule 16b-3(e), which covers dispositions back to the issuer that are approved in advance by the board or compensation committee (and approval of the grant agreement allowing said disposition counts as approval of the disposition).

You are correct, but the shareholder is claiming that Rule 16b-3(e) applies only if shares are withheld automatically. His claim is that if the insider could pay the taxes in some other way (e.g., cash), the transaction isn't exempt.

Is My Company Going to Hear from this Guy?

Only if the share withholding transaction can be matched against a nonexempt purchase that occurs within six months before or after it. A nonexempt sale by itself is nothing to be alarmed about; the sale has to be matched against a nonexempt purchase to trigger profits recovery.

Also, since the shareholder's argument hinges on the share withholding transaction being at the election of the insider, if you don't allow insiders a choice in how to pay their taxes (and the shareholder can figure this out), you may not hear from him.

What Does Alan Dye Say?

I'm not sure lawyers ever use the term "ridiculous" but Alan doesn't believe the shareholder's position has merit. From his blog "Shareholder Challenging Availability of Rule 16b-3(e) to Exempt Elective Exercise of Tax Withholding Right" (August 23, 2016):

"For what it's worth, Peter Romeo and I disagree strongly with the shareholder's position, as do the attorneys I've spoken with who are responding to similar demand letters."

Alan also notes that the shareholder has just issued demand letters, he hasn't filed any complaints yet. But Alan says that he has been litigious in other Section 16(b) contexts.

What Should We Do?

If you allow insiders to use share withholding to cover their taxes on either awards or stock options, you should make sure your in-house legal team is aware of this, so they can decide how to proceed.

In addition, at the time shares are withheld to cover taxes, it is a good idea to check (or have whoever is responsible for Section 16 filings check) for nonexempt purchases by insiders in the past six months. Even though you might still allow the insiders to go ahead with the share withholding, it will be helpful to know ahead of time that the transaction might attract a demand letter, so your legal team can be prepared for it.

- Barbara Baska

Miss Baska is essentially saying that there is someone trying to enforce Section 16 (b) by pointing out that officers or directors often have discretion to choose

a) delivering cash or

b) delivering shares

to pay the exercise price of ESOs or for a tax liability from RSUs.

The person enforcing 16 (b), since the SEC does not enforce Section 16 (b), is claiming that when grant agreements give the  officer or director the choice and the issuer must accept the choice, the officer or director can use inside information against the interest of the issuer and the share holders.

For example: Assume the officer or director has inside information of a pending very negative event to be announced soon, and he/she exercises some ESOs two years before expiration. He/she then delivers 60% of the stock, acquired from the exercise, to the issuer to pay the exercise price, when he/she could have paid cash for the exercise price. 

The officer or director was surely able to trade on inside information as he /she had superior standing to the issuer, who is required to purchase the disposition. And if that transaction was at a price higher than he paid for the stock in the market 5 months earlier, any profits from the non exempt stock purchase and the disposition to the issuer is recoverable by the issuer.

Miss Baska claims Romeo and Dye refute the liability of a possible disgorgement by the issuer. But the American Bar Association, the New York State Bar Association and the SEC refute what Romeo and Dye assert.

Here is a quote from the New York State Bar Association on the topic:

"Rule 16b-3 is entirely consistent with the intent of Congress in enacting Section 16(b), since it exempts only transactions involving parties on an equal footing from the standpoint of knowledge of inside information............................. Given these circumstances, it is irrelevant to the purposes of Section 16(b) whether the transactions covered by the Rule are compensation-related or not. What is critical is that the Rule does not present the opportunities for the misuse of inside information, which the statute is intended to prevent. "

And here is a statement by the American Bar Association on point which the SEC adopted:

The American Bar Association in its August 16, 2004 letter to the SEC on Page 2 said:

‘Whether the transactions are compensatory in nature should be irrelevant to the purposes of Section 16, because the key consideration of the statute is the absence of the ability to take advantage of the other party on the basis of inside information.'




John Olagues



Edited Tue, Sep 18, 2018 10:01 AM

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