Mergers and SEC Rule 16 b-3(a), with conditions (d), and (e)

Mergers and Acquisitions and Section 16 (b) exemptions.

Section 16 (b) of the Securities Exchange Act of 1934 is below:

"(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)------

 
Section 16 (b) is designed to prevent the unfair use of inside information by officers and directors and greater than 10 % owners of the issuers.

An officer or director of a publicly traded company is required by Section 16 (b) to disgorge to the issuer, profits that he/she made from buying issuer equity securities and selling issuer equity securities within a period of less than 6 months.

Section 16 (b) allows the SEC to exempt certain transactions that are not comprehended within the purpose of Section 16 (b). These exemptions of transactions are created by the SEC through Rule making. The most notable SEC Rule is SEC Rule 16 -b 3 which contains 16 b-3(a), 16 b-3(d) and 16 b-3(e). Below are these rules. These Rules can not be interpreted in a manner which exempts transactions that are comprehended within the purpose of Section 16(b).

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

 
(a)General. A transaction between the issuer (including an employee benefit plan sponsored by the issuer) and an officer or director of the issuer that involves issuer equity securities shall be exempt from section 16(b) of the Act if the transaction satisfies the applicable conditions set forth in this section.

 
(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;
(2) The transaction is approved or ratified, in compliance with section 14 of the Act, by either: the affirmative votes of the holders of a majority of the securities of the issuer present, or represented, and entitled to vote at a meeting duly held in accordance with the applicable laws of the state or other jurisdiction in which the issuer is incorporated; or the written consent of the holders of a majority of the securities of the issuer entitled to vote; provided that such ratification occurs no later than the date of the next annual meeting of shareholders; or
(3) The issuer equity securities so acquired are held by the officer or director for a period of six months following the date of such acquisition, provided that this condition shall be satisfied with respect to a derivative security if at least six months elapse from the date of acquisition of the derivative security to the date of disposition of the derivative security (other than upon exercise or conversion) or its underlying equity security.

 
(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.
--------------- End of the SEC Rules (a), (d) and (e) 

 
All interpretations of (d) and (e) must be consistent with SEC Rule 16 b-3(a).
For example (d) says "Any transaction involving an acquisition from the issuer". This also incorporates the part of (a) which requires that the transaction be between the officer or director and the issuer.
So if the "transaction involves an acquisition from the issuer" but the transaction is not a transaction between the officer or director and the issuer, there is no exemption for the transaction pursuant to (d).
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All of the exemptions in the Rules above must be for transactions between the issuer and the issuer's officers or directors of issuer equity securities.

The requirements for exemptions for transactions that are Grants, awards or acquisitions from the issuer are stated in Rule 16 b-3(a) and (d).
For example if there is a transaction between the issuer and an officer or director of the issuer that involves the acquisition of issuer equity securities and the acquisition transaction is approved with sufficient specificity 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, the transaction is exempt from 16 (b).

The requirements for exemptions for transactions that are Dispositions to the issuer of issuer equity securities are stated in Rule 16 b-3(a) and (e).
For example if there is a transaction between the issuer and an officer or director of the issuer that involves the disposition of the issuer equity securities, the transaction shall be exempt from section 16 (b), 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.

The SEC does not enforce Section 16(b) but leaves it up to the issuer or a shareholder to try to enforce the law. The SEC will not assist the issuer or the insider to enforce the law.

A number of the elements of the above rules are unclear.

For example:
Is a purchase by an officer from the issuer the same as a transaction between the officer and the issuer?
How specific does the issuer approval have to be in order to achieve an exemption from 16 (b)?
Is the exemption for a purchase of issuer equity securities by an officer, that are held for more than 6 months (as claimed in Rule 16 b-3(d)(3), a transaction that is not comprehended within the purpose of Section 16 (b). What makes it not comprehended within the purpose of section 16 (b) of the 1934 Act?

Is a disposition to the issuer of shares of stock for the payment of an IRS tax liability a transaction from the officer or director to the issuer or to the IRS. Or is it a transaction between the officer or director and the issuer or the IRS.

 
In a merger, whereby the officer/ holder of target shares disposes the target shares to the acquirer in exchange for acquirer shares, is the disposition exempt from 16 (b)?

 
Are the acquisitions of acquirer shares by officers or directors through the conversion of target shares exempt from 16 (b) by SEC Rule 16 b-3(a) or (d)?

The answer is that the exemption is available only if the transaction is between the officer or director of the issuer and the issuer. In most mergers or acquisitions, the transaction is not between the officer or director of the issuer and the issuer. So the acquisitions are not exempt from 16 (b).

But some law firms cite an SEC staff person in the Jan 12, 1999 No-Action letter to Skadden Arps dealing with conversions within Mergers. The law firms claim that there is an exemption from section 16 (b), even when there is no transaction between the officer or director of the issuer and the issuer as required by SEC Rule 16-3(a) for an exemption. They are essentially saying that if 16 b-3(d) is satisfied, there is no need to satisfy SEC Rule 16 -3(a).

John Olagues