Discretionary Dispositions of shares to the issuer by officers and directors are not exempt from Section 16 (b)

Below is a copy of section 16(b) of the 1934 Securities Act

"(b) For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement involving any such equity security within any period of less than six months, unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months.

Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized.

This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security or security-based swap agreement or a security-based swap involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection."
---------------------------------------------- End of section 16 (b)

The parts in "bold" are most relevant to this article as the parts say that the SEC can exempt only transactions that are "not comprehended within the purpose of this subsection".

So, let us assume that the disposition of shares to the issuer is made by an officer or director within 6 months of a market purchase at a profit. In order for the disposition to be exempted by the SEC from section 16 (b), it must be "not comprehended within the purpose of this subsection".

                                                    1

Below is an SEC Rule 16 b-3(e) which exempts certain dispositions to the issuer by officers or directors

§ 240.16b-3 Transactions between an issuer and its officers or directors.

(e)Dispositions to the issuer. Any transaction, other than a Discretionary Transaction, involving the disposition to the issuer of issuer equity securities, whether or not intended for a compensatory or other particular purpose, shall be exempt, provided that the terms of such disposition are approved in advance in the manner prescribed by either paragraph (d)(1) or paragraph (d)(2) of this section. And

Note (3):
The approval conditions of paragraphs (d)(1), (d)(2) and (e) of this section require the approval of each specific transaction, and are not satisfied by approval of a plan in its entirety except for the approval of a plan pursuant to which the terms and conditions of each transaction are fixed in advance, such as a formula plan. Where the terms of a subsequent transaction (such as the exercise price of an option, or the provision of an exercise or tax withholding right) are provided for in a transaction as initially approved pursuant to paragraphs (d)(1), (d)(2) or (e), such subsequent transaction shall not require further specific approval.

SEC Rule 16 b-3(d) paragraph (1) is below:

 
(d)Acquisitions from the issuer. Any transaction, other than a Discretionary Transaction, involving an acquisition from the issuer(including without limitation a grant or award), whether or not intended for a compensatory or other particular purpose, shall be exempt if:
(1) The transaction is approved by the board of directors of the issuer, or a committee of the board of directors that is composed solely of two or more Non-Employee Directors;
--------------------------------------------
So for an SEC exemption from 16 (b) to be available to officers or directors for dispositions to the issuer, the transaction must not be 1) "comprehended within the purpose of this subsection" (i.e. section 16 (b)). And it must be 2) approved by the board of directors of the issuer, or a committee of the board of directors that is composed solely of two or more Non-Employee Directors;

 
                                                    2
 
When the officer or director has discretion to pay for taxes with cash or shares, the transaction is "comprehended within the purpose of section 16 (b) and can not be exempted".
When the officer or director has discretion to pay for taxes with cash or shares, the approval of the discretionary disposition has not satisfied the "specificity of approval requirements under Rule 16b-3(e)" and is not exempted from Section 16 (b).

 
The above two paragraphs also apply to discretionary dispositions to the issuer when the dispositions are for payment of the exercise prices for employee stock options (ESOs) or warrants.
When the officer or director has discretion to pay taxes or exercise prices with cash or shares, the issuer has no choice but to accept the disposition. Therefore, the officer or director has far superior standing to the issuer, which is even greater than the officer's or director's standing when selling shares to a market trader, since the market trader is not obligated to purchase the shares.
Certainly the designers of equity compensation plans and grant agreements are aware of the fact that where the officer or director has discretion, the discretionary disposition is "comprehended within the purpose of this subsection" (i.e. section 16 (b).)" and can not be exempted.

 
Certainly the designers of equity compensation plans and grant agreements are aware of the fact that where the officer or director has discretion, the discretionary disposition is not approved in a manner which satisfied the "specificity of approval requirements under Rule 16b-3(e)"

 
So why do they design the plan and grant agreements allowing discretionary dispositions?

The answer is to allow the extraction of additional wealth to the officers and directors, who pay the plan and grant agreement designers. Attorneys for the companies and their executives also are in the same game. They are in violation of their fiduciary duties to the shareholders even if the officer or director, who made discretionary dispositions did not buy shares within less than 6 months.

Law firms like Baker Botts, Skadden Arps, Hogan Lovells, and McDermott Will & Emery are all writing articles to discourage the enforcement of Section 16 (b) and perhaps to have their clients to be careful regarding future violations.

 
None of these firms nor others are willing to illustrate how approval of discretionary dispositions of shares or cash constitute the approval of each specific transaction.

                                                   

None of these firms nor others are willing to illustrate how discretionary dispositions of shares or cash to the issuer for taxes or exercise prices are not comprehended within the purpose of this subsection (i.e. section 16 (b))".

Why?  

 

John Olagues

                                                              3