Ner York Bar Association and the American Bar Association Views on 16 (b)

Below are two letters which show the views of the  NY States Bar Association and the ABA as to what is required for an exemption from 16 (b) when dispositions are made to the company (i.e. the issuer) by insiders.

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New York State Bar Association One Elk Street
Albany, N.Y. 12207
518 463-3200

Business Law Section Committee on Securities Regulation August 9, 2004

Re: File No. S7-27-04
Proposed Rules: Ownership Reports and Trading by Officers, Directors and Principal Security Holders
Release No. 34-49895

Ladies and Gentlemen:

The Committee on Securities Regulation (the "Committee") of the Business Law Section of the New York State Bar Association appreciates the Commission's invitation in Release No. 34-49895 (the "Release") to comment on proposed amendments to Rules 16b-3 and 16b-7 under the Securities Exchange Act of 1934.

The Committee is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was reviewed by certain members of the Committee, and the views expressed in this letter are generally consistent with those of the majority of members who reviewed and commented on this letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association or its Business Law Section.



\\\NY - 79545/0420 - 850159 v1




Securities and Exchange Commission August 9, 2004
Page 2

Summary
Rules 16b-3 and 16b-7 exempt certain transactions from Section 16(b) of the Securities Exchange Act of 1934. In its 2002 opinion in Levy v. Sterling Holding Company, LLC.1 ("Levy v. Sterling"), the U.S. Court of Appeals for the Third Circuit (the "Third Circuit") cast doubt as to the nature and scope of transactions exempted from Section 16(b) short-swing profit recovery by Rules 16b-3 and 16b-7. The Commission has proposed amendments to Rules 16b-3 and 16b-7 in order to clarify the exemptive scope of those Rules, consistent with statements in previous Commission releases.

We urge the Commission to adopt promptly the proposed amendments to Rules 16b-3 and 16b-7. Adoption of the amendments is necessary because of the confusion created by the Levy v. Sterling opinion, and would accord with the purposes of Section 16(b) and the clear intent of the Commission in adopting such Rules. We also have suggested some minor additional changes that we believe would further clarify the intended meaning of the Rules.

Rule 16b-3

Rule 16b-3 relates to transactions between an issuer and its officers and directors. Rule 16b-3(d) exempts from Section 16(b) "any transaction involving a grant, award or other acquisition from the issuer", subject to certain conditions. In Levy v. Sterling, the Third Circuit construed the Rule to require that transactions involving "other acquisitions" must be compensation related in order to be exempted by Rule 16b-3(d). As the Commission noted in the Release, this construction of Rule 16b-3(d) is inconsistent with the clearly expressed intent of the Commission in adopting the Rule, staff interpretations of the Rule consistent with the adopting release, and the 2002 decision of the Second Circuit Court of Appeals in Gryl v. Shire Pharmaceuticals Group PLC.2

The effects of the Levy v. Sterling opinion have been unsettling and profound. An overwhelming percentage of United States public companies are incorporated under the laws of the State of Delaware. The opinion of the Third Circuit, which includes Delaware, potentially subjects Delaware corporations to the reach of that opinion. The implications of the opinion are neither subtle nor academic, removing from the exemptive scope of Rule 16b-3 entire categories of transactions that, prior to the opinion, were uniformly construed, both by the staff of the Commission and by securities law practitioners, as being squarely within the ambit of the Rule. The Release notes that the staff has provided interpretive letters in two situations involving the acquisition of acquiror equity securities by acquiror officers and directors through the conversion of target equity securities in connection with a corporate merger, and also in the context of an officer's or director's indirect pecuniary interest in transactions between the issuer and certain other persons or entities. In addition to those

1 314 F.3d 106 (3d. Cir. 2002), cert. denied, Sterling Holding Co. v. Levy, 124 S. Ct. 389 (U.S., Oct. 14, 2003). 2 298 F.3d 136 (2d Cir. 2002)


Securities and Exchange Commission August 9, 2004
Page 3

transactions, the Rule has been applied to a wide range of acquisitions of issuer equity securities from the issuer by officers and directors in non-compensatory transactions. By removing non-compensatory acquisitions otherwise meeting the requirements of Rule 16b- 3(d) from the scope of the Rule, Levy v. Sterling has subjected officers and directors to the risk of significant personal liability, as well as reputational harm, with respect to transactions involving the sale of such equity securities occurring within six months of the transaction with the issuer. As the Release notes, a similar change should be made to Rule 16b-3(e) to clarify that dispositions to the issuer should be treated in the same manner as the Commission intends for acquisitions under Rule 16b-3(d).

Furthermore, we believe the proposals are consistent with the purposes of Section 16(b). Congress enacted Section 16(b) to deter insiders from using confidential corporate information for personal trading gain. Testimony at Congressional hearings indicated that unscrupulous insiders had misused such information on a regular basis in market transactions in which they had taken advantage of traders not having access to the same information. 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. Market transactions are not exempted by the Rule, and gate-keeping conditions exist to prevent overreaching. 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. Accordingly, it is entirely appropriate for the Commission not only to adopt the proposals as drafted, but also to extend them to Rule 16b-3(e) as well.

In view of the foregoing, we strongly recommend that the Commission adopt the proposed amendment. We would urge that the adoption occur as promptly as possible, because of the cloud of doubt that now hangs over Rule 16b-3. In addition, we would suggest that the Commission consider the following modifications:

1. The exception should be set forth in the text of Rule 16b-3(d). This can be accomplished either by amending the initial part of the first sentence of the Rule to provide "Any transaction involving a grant, award or other acquisition (whether or not such acquisition is intended for a compensatory or other purpose) from the issuer ...", or by adding a subclause (f) to Rule 16b-3 to set forth the language included in the proposed Note (4). Although we are of the view that the Notes to the Rule should be considered by a court reviewing the Rule as integral to the Rule itself, the inclusion of the clarifying language in the Rule itself will eliminate possible claims that the notes are not to be accorded the same consideration as the text of the Rule.
2. We believe that a note to the Rule should be added that states that reference in Rule 16b-3(d) to the clause "whether or not such acquisition is intended for a compensatory or other purpose" is intended to clarify the meaning of the Rule as in effect prior to the time that such clause was added.
Securities and Exchange Commission August 9, 2004
Page 4

Rule 16b-7

As the Commission notes in the release, Rule 16b-7, entitled "Mergers, reclassifications and consolidations" exempts from Section 16(b) certain transactions involving affiliated entities having at least 85% cross-ownership that do not involve a significant change in the issuer's business or assets. The Rule is typically relied upon where a company reincorporates in a different state or reorganizes its corporate structure. In Levy v. Sterling, the Third Circuit held that a reclassification was not exempt under Rule 16b-7 if it resulted in the insiders owning equity securities (common stock) with different risk characteristics from the securities (preferred stock) extinguished in the transaction, where the preferred stock had not been convertible into common stock; and thus involved an increase in the percentage of the insiders' common ownership.

As the Release notes, the conditions applied by the Third Circuit do not appear in the language of Rule 16b-7 and would significantly restrict the exemption's availability for reclassifications by narrowing it to the situation where the original security and the security for which it is exchanged have the same characteristics. This is inconsistent with staff interpretations of the Rule that applied the Rule to reclassifications, and imposed no requirement that securities have the same characteristics or that the proportionate ownership of common stock not be changed.

If it were to remain in effect, the Levy v. Sterling opinion would have disastrous effects on shareholders acquiring or disposing of securities in reclassification and similar transactions, subjecting such persons to significant potential liabilities. The exceptions to Section 16(b) set forth in the Commission's Rules reflect the Commission's understanding that certain transactions involving the purchase or sale of securities carry no potential for speculative abuse. In its interpretations of Section 16(b) and the rules thereunder, the staff of the Commission has been consistently cognizant of the need to distinguish between transactions having no potential for speculative abuse, and those transactions within the intended scope of Section 16(b). The amendments to be effected by the Release would confirm that prior staff positions under Rule 16b-7 were appropriate, in accord with the Rule, and in accord with the purposes of Section 16(b).

The Release proposes to add the term "reclassification" to the text of Rule 16b-7, and adds as well a new paragraph (c) that provides that the exemption is not conditioned on the transaction satisfying any other conditions. We strongly suggest prompt adoption of the proposal, subject to two suggested revisions to the Rule. As the Commission has noted, the inclusion of reclassifications within the scope of the Rule has been a matter of staff interpretation. As such, the staff was able to determine the specific nature of transactions within the scope of the term "reclassification", whether or not the transaction was formally styled as a reclassification, recapitalization, share exchange transaction or other type of transaction. We would suggest, especially in view of the decision by the Third Circuit in Levy v. Sterling, that the Commission add to the phrase "merger, reclassification or consolidation" the words "or other substantially similar transaction" for the avoidance of

Securities and Exchange Commission August 9, 2004
Page 5


doubt. Alternatively, the Commission should consider adding a note to Rule 16b-7 stating that the term reclassification is intended to include reclassifications and substantially similar transactions, regardless of the characterization of such transactions for corporate law purposes, such as recapitalizations and share exchange transactions. In addition, we would suggest that the note state that the addition of the term "reclassification" is intended to clarify the meaning of the Rule as in effect prior to the time that such term was added.

We hope the Commission finds these comments helpful. We would be pleased to discuss them with the staff.


Drafting Committee:

Jeffrey W. Rubin, Chair Michael J. Holliday Richard R. Howe


Respectfully submitted,
COMMITTEE ON SECURITIES REGULATION

By: /s/ Michael J. Holliday Michael J. Holliday

Chair of the Committee

Hon. William H. Donaldson, Chairman
Hon. Paul S. Atkins, Commissioner
Hon. Roel C. Campos, Commissioner
Hon. Cynthia A. Glassman, Commissioner
Hon. Harvey J. Goldschmid, Commissioner
Alan L. Beller, Director, Division of Corporation
Finance Giovanni P. Prezioso, General Counsel
Martin P. Dunn, Deputy Director, Division of Corporation Finance




AMERICAN BAR ASSOCIATION Section of Business Law
750 North Lake Shore Drive Chicago, IL 60611

August 16, 2004

Securities and Exchange Commission 450 Fifth Street, N.W.
Washington, DC 20549-0609
Attn: Jonathan G. Katz, Secretary

Re: Ownership Reports and Trading by Officers, Directors and Principal Security Holders Release Nos. 34-49895; 35-27861; IC-26471 File No. S7-27-04

Ladies and Gentlemen:

This letter is submitted on behalf of the Committee on Federal Regulation of Securities of the American Bar Association's Business Law Section (the "Committee")* in response to the Commission's request for comments to Release Nos. 34-49895; 35-27861; IC-26471 dated
June 21, 2004 (the "Release"). The Release sets forth proposals intended to clarify the exemptive scope of Rules 16b-3 and 16b-7 under the Securities Exchange Act of 1934, consistent with previous releases and interpretations of the Securities and Exchange Commission (the "Commission"). In addition, the Release describes a proposal to amend Item 405 of Regulations S-K and S-B to harmonize them with the two-day deadline for filing Section 16 reports.

The comments expressed in this letter represent the views of the Committee only and have not been approved by the American Bar Association's House of Delegates or Board of Governors and therefore do not represent the official position of the Association. In addition, this letter does not represent the official position of the ABA Section of Business Law, nor does it necessarily reflect the views of all members of the Committee.

We commend you for taking clear steps to reiterate the Commission's interpretations of its rules and correct the misinterpretation by the court in Levy v. Sterling Holding Company,

* References in this letter to "we" and "our" mean the Committee.


August 16, 2004 Page 2

LLC, 314 F.3d 106 (3d Cir. 2002), cert. denied, 124 S.Ct. 389 (U.S., Oct. 14, 2003). It is extremely important to resolve the uncertainty caused by the court's ruling, which has made it impossible for insiders to engage in legitimate transactions in reliance on prior Commission interpretations of these two rules without exposing themselves to the risk of significant liability. It is equally important as an indication to the courts that the Commission stands behind the validity of its interpretations of all of its rules under Section 16. Accordingly, we heartily support the proposed rulemaking. We have a few comments regarding ways in which the proposed amendments might be further clarified as discussed below.

Rule 16b-3
We believe that the proposed amendments accomplish the goal of clarifying the exemptive scope of Rule 16b-3 and would have precluded the result in Levy v. Sterling Holding Company, LLC. In response to your question, it should not be necessary to add that participation in an extraordinary transaction (such as a merger, reclassification or exchange offer) is exempt under the rule if the exemptive conditions are met because the note and the rule already state that "any transaction" that satisfies those conditions is exempt.
We believe strongly that Rules 16b-3(d) and (e) should not be limited to compensatory and extraordinary transactions. There may be instances beyond these two categories in which shareholders, the board, or a committee of non-employee directors determines that it is appropriate for the issuer to engage in a transaction in issuer securities with an officer or director. As the Commission stated in its 1996 Release amending Rule 16b-3, transactions between the issuer and its officers and directors "do not appear to present the same opportunities for insider profit on the basis of non-public information as do market transactions by officers and directors." We agree 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. They do not involve market transactions and, because the other party is the issuer, they do not give rise to the type of concerns regarding misuse of insider information that are appropriately addressed by a strict liability statutory scheme. 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. This is consistent with the Commission's view as reflected in the 1996 Release when it stated: "However, unlike the current rule, a transaction need not be pursuant to an employee benefit plan or any compensatory arrangement to be exempt, nor need it specifically have a compensatory element."

In the 1996 Release, the Commission pointed to the insider's fiduciary duty to the corporation as a constraint on self dealing, and as a further safeguard against the abuses to which Section 16(b) is directed. In fact, the two most commonly relied on "gate keeping conditions" in the rule - approval by the full board or by a committee of non-employee directors - involve an exercise of fiduciary duty not only by the insider engaging in the transaction, but also by the directors approving it. Thus we believe that there is no policy reason for the Commission to allow the Rule 16b-3(d) and (e) exemptions to be narrowed. Moreover, any attempt to limit these exemptions to compensatory transactions would create numerous interpretive issues over
August 16, 2004 Page 3

whether particular transactions were "compensatory" in nature. For these reasons, in response to your question, we believe proposed Note 4 should apply to Rule 16b-3(e) as well as (d), and that both rules should apply to all transactions between an officer or director and the issuer that meet one of the conditions for exemption.

We also believe that the Commission should consider taking this opportunity to codify in Rule 16b-3 two interpretations of the rule issued by the Commission staff. One is the interpretation issued in the February 10, 1999 letter to the American Bar Association that, upon satisfaction of its conditions, Rule 16b-3 also exempts an officer's or director's indirect pecuniary interest in transactions with the issuer engaged in by the officer's or director's immediate family members or certain related entities. The second interpretation is the one reflected in the January 12, 1999 letter to Skadden, Arps, Slate, Meagher & Flom LLP and acknowledged by the Second Circuit Court of Appeals in Gryl v. Shire Pharmaceuticals PLC (298 F.3d 136 (2d Cir. 2002)) that for purposes of Rule 16b-3, dispositions "to the issuer" include dispositions to an acquiring company pursuant to a merger or similar transaction. We believe that this clarification should be included in a simple manner, without incorporating all of the procedural requirements of the Skadden letter.

Rule 16b-7

We believe that the proposed changes to Rule 16b-7 are consistent with the statements by the Commission staff in the 1981 Interpretive Release and the Commission's 1991 amendments to Rule 16b-7 and with the Commission's amicus brief in Levy v. Sterling. Reclassifications are little different in effect from the mergers and consolidations used to implement corporate reorganizations that have been uniformly accepted under Rule 16b-7 as being eligible for exemption from Section 16(b). Reclassifications and similar changes in capital structure do not present opportunities for the type of abuse to which Section 16 is directed. Nevertheless, we believe that the Commission could better accomplish the goal of clarifying the scope of the
Rule 16b-7 if the text of Rule 16b-7 were further amended to define the term "reclassification" by redesignating current paragraph (b) as subparagraph (b)(1) and adding a new subparagraph (b)(2) to read as follows:

(2) A reclassification within the meaning of this section shall include any transaction in which one or more classes or series of a company's outstanding securities are replaced with securities of a different class or series of securities of a company involved in the reclassification, or the terms of such class or series are changed, through an exchange, conversion, amendment or other action having a similar effect.

No specific conditions for exemption should be required to be satisfied for a transaction to be deemed to be a reclassification. Rather, the term reclassification should be liberally construed in order to effectuate the intent of the exemption. Such a change would preclude a court from misinterpreting the scope of the rule and provide a basis for comfortably relying on the rule in appropriate circumstances.

August 16, 2004 Page 4

Item 405

The proposed amendments to Item 405 are completely appropriate. ** *

We further urge the Commission to state explicitly in the release adopting the amendments to Rules 16b-3 and 16b-7 that the amendments are simply clarifications of what the rules have always meant, and, accordingly, that the rules as amended are intended to apply to exempt transactions effected before adoption of these clarifying amendments. Such a statement would help to provide certainty for transactions that have been completed in reliance on Commission interpretations.

Again, we wish to thank you for undertaking this rulemaking. We appreciate the opportunity to provide the foregoing comments to the Commission. Members of the Subcommittee on Employee Benefits, Executive Compensation and Section 16 are prepared to meet and discuss the matters addressed in this letter with the Commission and the staff, and to respond to any questions that may arise. Please contact Scott P. Spector at (650) 335-7251 or Anne G. Plimpton at (617) 248-7514, if further information is desired.




Respectfully submitted,
/s/ Dixie L. Johnson

Chair, Committee on Federal
Regulation of Securities


Drafting Committee

Sharon J. Hendricks
Keith F. Higgins
Stanley Keller
Gloria W. Nusbacher
Anne G. Plimpton
Louis Rorimer
Scott P. Spector


 

Edited Sun, Nov 26, 2017 7:15 AM

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