Derivatives and Section 16 b of the Securities Act of 1934

Below is:

§ 240.16b-6 Derivative securities.

(a) The establishment of or increase in a call equivalent position or liquidation of or decrease in a put equivalent position shall be deemed a purchase of the underlying security for purposes of section 16(b) of the Act, and the establishment of or increase in a put equivalent position or liquidation of or decrease in a call equivalent position shall be deemed a sale of the underlying securities for purposes of section 16(b) of the Act: Provided, however, That if the increase or decrease occurs as a result of the fixing of the exercise price of a right initially issued without a fixed price, where the date the price is fixed is not known in advance and is outside the control of the recipient, the increase or decrease shall be exempt from section 16(b) of the Act with respect to any offsetting transaction within the six months prior to the date the price is fixed.

(b) The closing of a derivative security position as a result of its exercise or conversion shall be exempt from the operation of section 16(b) of the Act, and the acquisition of underlying securities at a fixed exercise price due to the exercise or conversion of a call equivalent position or the disposition of underlying securities at a fixed exercise price due to the exercise of a put equivalent position shall be exempt from the operation of section 16(b) of the Act: Provided, however, That the acquisition of underlying securities from the exercise of an out-of-the-money option, warrant, or right shall not be exempt unless the exercise is necessary to comport with the sequential exercise provisions of the Internal Revenue Code ( 26 U.S.C. 422A).

 

Now what is the SEC saying here about derivatives?

It is saying that a purchase of a "call" or "warrant" or a "convertible note" by an officer , director or beneficial owner is considered a purchase of a "call equivalent position" and that purchase is "deemed a purchase" of the underlying shares for 16 b purposes.

This means that if there is a purchase of some calls by an officer, that purchase can be matched for 16 b purposes against sales of stock or sales of calls that were made at prices higher than when the calls were purchased. 

If a call were purchased at $500 by an insider and the stock advanced in three months to where the calls were trading for $1000 per call and the insider owner of the call sold the call for $1000, the $500.00 would be recoverable by the issuer, since all the necessary elements for a section 16 b violation were present.

Now suppose that an insider bought a call for $300 with an exercise price of $20.00 and 10 months later, the insider exercised the call when the stock was $35.00. The insider then sold the shares received from the call exercise, when the stock was trading at $45.00 five months after the exercise. Was there a matching of a non exempt purchase with a non exempt sale at any time?

 

I will put the answer up in a few weeks with full explanation.

 

John Olagues

 

Edited Sat, Oct 14, 2017 10:56 AM

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