When officers or directors are given a choice of paying taxes or exercise price payments with shares or cash, the dispositions of shares are not exempt from Section 16 (b)

Let us Assume that:

1. the officer or director has inside information that the stock will drop in 5 days.
2. the officer or director has ESOs on 1,000,000 shares with an expiration in 2 years.
3. the ESOs are far in the money with a delta of 97.
4. the officer or director has the choice to dispose of the shares for tax payments to the issuer or to pay cash to the issuer for the taxes upon exercise of the ESOs.
5. the issuer must accept the shares if disposed to the issuer at the discretion of the officer or director for taxes or the exercise price payment..

Does the issuer have "equal standing" with the officer or director?

The answer is obviously NO. The officer or director has superior standing relative to the issuer, even if both have full inside information. This is true since the officer or director has a choice to trade on inside information, but the issuer must accept the officer's or director's choice.

The officer or director has far greater standing in such a transaction with the issuer. The issuer has no choice but to accept the shares in payment of the taxes or the exercise price, even when the issuer knows the bad news is coming.

The insider has greater standing with the issuer than the insider would have with the public market trader who was not required to purchase the shares from the officer or director.
-----------------------------------------------

The New York Bar Association made the following statement on August 9, 2004.

"Rule 16 b-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."

The SEC copied the quote above on page 14 of the SEC's Ownership Report and Final Rule of August 9, 2005.

It is clear that choosing the disposition of shares to the issuer to pay the taxes upon exercise of ESOs or the vesting of Restricted stock, reduces the amount of shares held compared to the amount of shares that would be held upon the payment of cash for taxes or the exercise price without a stock sale.

Effectively when the Equity Plan document gives the officer or director a choice of paying the tax and the exercise price with shares or cash, the subsequent disposition of shares to the issuer does not satisfy the conditions in SEC Rule 16 b-3 for an exemption from section 16 (b).

And the approval by the Board of Directors of such transactions where the officers and directors are allowed to force the issuer to purchase shares from the officer or director can not achieve an exemption from section 16 (b).

John Olagues