REPORTING RULES: WHAT YOU NEED TO KNOW NOW
As previously reported, the Sarbanes-Oxley Act of 2002 significantly changed the reporting requirements under Section 16 of the Exchange Act for directors, executive officers and 10% shareholders of U.S. public companies. These insiders will now be required to file their Form 4 reports by the second business day after execution, instead of by the tenth day of the month following the month in which the transaction occurs. Insiders also will be required to report on Form 4 many of the transactions currently reportable once a year on a delayed basis on Form 5, such as many employee benefit plan transactions and transactions between an issuer and its executive officers and directors.
The two-day filing requirement will be effective for transactions occurring on or after August 29, 2002. While a final Securities and Exchange Commission rule has not yet been issued, the SEC recently previewed its position on the new requirements. SEC Release No. 34-46313 (August 6, 2002). The new rule does not apply to foreign reporting companies, because insiders of non-U.S. issuers are exempt from Section 16.
Despite some remaining uncertainty over the new requirements, U.S. public companies must take prompt action to avoid Section 16 reporting violations by their insiders. These companies should notify their insiders of the new two-day filing requirement soon and should assess the adequacy of their internal compliance procedures quickly, since pre-existing compliance programs – particularly in the area of benefit plan transactions – will be obsolete. Additional measures that U.S. public companies should implement now are discussed below.
New Two-Day Filing Requirement
Section 403 of the Sarbanes-Oxley Act amended Section 16(a) of the Exchange Act to accelerate the deadline for filing transaction reports by insiders of U.S. public companies. Before the amendment, insiders were required to file a Form 4 report by the tenth day of the month following the month in which a transaction occurred. The prior SEC rules also permitted many transactions to be reported on Form 5 on a delayed basis by the 45th day after the end of a company’s fiscal year. The failure to require prompt disclosure of insider transactions under the pre-amendment rules was much criticized following the Enron debacle.
The SEC has indicated that, in implementing rules under Section 403 of the Act, effective August 29:
- Form 4s accelerated. Form 4 reports will be due on the second business day following execution of the insider transaction.
- Form 5 deferred reporting substantially eliminated. Most transactions previously reportable on Form 5 under Rule 16a-3(f) – such as stock option grants and other acquisitions of derivative securities – will also be subject to the new two-day filing requirement.
- Only narrow exceptions from the two-day requirement contemplated. The SEC’s rules will provide only limited exceptions from the two-day filing requirement for yet-to-be-specified transactions. The SEC stated that it would except transactions from the two-day requirement only in very narrow circumstances “where objective criteria prevent the insider from controlling (and in many cases from knowing) the timing of transaction execution and where we have concluded that satisfying the two-business day period would not be feasible.” The SEC offered the following examples of transactions that may be permitted delayed reporting:
- transactions pursuant to a single market order that are executed over more than one day (but not exceeding a specified number of days);
- transactions involving pre-existing arrangements (such as a 10b5-1 trading plan) where the timing of the transactions is outside the knowledge of the insider; and
- discretionary transactions involving employee benefit plans, whether or not exempt under Rule 16b-3, where the delay is tied to notice of the transaction.
- Electronic filings required within one year and encouraged earlier. Section 403 of the Act requires all reports by insiders under Section 16(a) to be filed electronically on EDGAR and simultaneously made available on company websites not later than July 30, 2003. The SEC staff has indicated it may attempt to effect this change at an earlier date. Until this new requirement becomes effective, the SEC is encouraging insiders to file their Form 4s via EDGAR voluntarily. To facilitate voluntary filings, the SEC will accept electronically filed reports that do not contain all of the boxes and lines contained in the SEC forms, so long as all of the required information is presented in the proper order.
- Changes made to reporting requirements only. The new requirements imposed by the Act do not affect existing exemptions from Section 16(b) short-swing profit liability.
- No transition period. The new requirements will take effect for any transaction occurring on or after August 29, 2002. A transaction occurring earlier may be reported as previously required on Form 4 by the 10th of September or on Form 5 by the 45th day after fiscal year end, as applicable.
Compliance Measures to Consider
The speed with which Form 4 reports will need to be prepared and filed following an insider transaction means that companies will need to have solid compliance procedures in place to capture needed information quickly. A number of specific measures that U.S. public companies should consider are described below.
- Notify insiders soon. Without clear guidance and assistance from their companies, insiders will find it difficult, if not impossible, to comply. Company officials should promptly notify their insiders of the new two-day filing requirement, as well as any new internal compliance procedures applicable to insiders that may be adopted. Companies should also assess carefully whether they have appropriately identified their Section 16 insiders. Some companies may find they have been over-inclusive.
- Adopt or expand mandatory pre-clearance procedures. Companies should require their Section 16 insiders to pre-clear all transactions in company securities, including option exercises and other transactions under employee incentive and benefit plans, with a designated company official sufficiently in advance of the transaction to allow for two-day reporting. While many companies already require pre-clearance, greater advance notice – perhaps a week or more – may be required to allow company officials to meet the new filing requirements on insiders’ behalf.
- Manage reporting for insiders. If they have not already done so, companies should designate an individual or individuals to actively assist insiders with their Section 16 reporting on an expedited basis. Companies may want to establish back-up reporting procedures with capable law firms who can provide reporting support.
- Obtain powers of attorney. The individuals who have been designated to manage Section 16 filings for insiders should obtain powers of attorney from insiders allowing them to sign Section 16 filings on their behalf. If companies have powers of attorney in place, these should be reviewed to make sure they are current and provide for a sufficient number of designated signers.
- Review incentive and benefit plans for potential transaction reporting. Companies should begin a thorough review of their employee incentive and benefit plans that permit investments in company securities and should develop procedures that will permit two-day reporting of insiders’ plan transactions. Even routine option grants may prove problematic if procedures do not clearly require prompt notification of the grant on the grant date to the company’s designated Section 16 compliance coordinator.
- Establish procedures with brokers. Insiders should establish procedures with their brokers, requiring those brokers to communicate promptly to a designated company official any transaction executed on the insider’s behalf. Companies also may wish to establish such procedures with designated brokers to ease compliance.
- Get EDGAR capabilities. U.S. public companies should consider becoming capable of filing Section 16 reports on behalf of their insiders via the SEC’s electronic EDGAR system as soon as possible. For some companies, an outside law firm or vendor will be needed to make the actual filing, but companies should begin the process of getting filing numbers for each of their insiders. Electronic filing capability will give the company more time and flexibility to meet the two-day requirement on the insider’s behalf. If electronic filing is not feasible, companies should establish methods for same-day filing, through law firms with a Washington D.C. office or other agents that can file faxed copies with the SEC on the date due.
Given the dramatic nature of the changes to Section 16 reporting requirements and the expected burden this will place on insiders and their U.S. public companies, these companies must take appropriate measures without delay. For more information about these matters, contact the Dorsey & Whitney attorney with whom you work.
August 16, 2002