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Comment Summary – Release 34-49895

Ownership Reports and Trading by Officers, Directors and Principal Security Holders Proposal

Prepared by:
Anne Krauskopf
Nina Mojiri-Azad

July 15, 2005

Table of Contents

List of Commenters

Overview

Rule 16b-3 Proposal

Commenters Generally Supporting the Rule 16b-3 Proposal

Rule 16b-7 Proposal

Commenters Generally Supporting the Rule 16b-7 Proposal

Opposition to the Rule 16b-3 and 16b-7 Proposals

Item 405 of Regulations S-K and S-B

Other Suggestions

Individual Commenters



List of Commenters (19)

(a) Law Firms (10)

    Abraham, Fruchter & Twersky LLP ("Abraham Fruchter") *
    Allen & Overy LLP ("Allen & Overy")
    Bragar Wexler, Eagel & Morgenstern P.C. ("Bragar") *
    Dechert LLP ("Dechert") **
    Hogan & Hartson LLP ("Hogan") ***
    Goodwin Proctor LLP ("Goodwin Proctor")
    Mayer Brown Rowe & Maw ("Mayer Brown")
    Simpson Thacher & Bartlett LLP ("Simpson Thacher")
    Sirianni, Youtz, Meier & Spoonemore ("Sirianni") *
    Sullivan & Cromwell LLP ("Sullivan & Cromwell")

(b) Professional Associations (4)

    American Bar Association ("ABA")
    American Society of Corporate Secretaries ("ASCS")
    New York State Bar Association ("NY Bar")
    Securities Industry Association ("SIA")

(c) Securities Quotation Service (1)

    Pink Sheets LLC ("Pink Sheets")

(d) Individuals (4)

    Mr. Larry Dupriest
    Mr. Raymond H. Gambel
    Mr. Mel Gates
    Mr. James L. Nesfield

________________
* Represent plaintiffs in Section 16(b) suits. Abraham Fruchter represented plaintiff Levy in Levy v. Sterling Holding Company LLC.
** Represented defendants Sterling Holding Company LLC and National Semiconductor Corporation in Levy v. Sterling Holding Company LLC.
*** Advisor to counsel for Sterling Holding Company LLC.



Overview

The Proposals

Release 34-49895 proposed rule amendments:

  • To clarify the exemptive conditions of Rules 16b-3 and 16b-7.

  • To eliminate the Item 405 of Regulations S-K and S-B presumption of timeliness for Section 16(a) reports filed within three calendar days of the required filing date.

Commenters Who Generally Supported the Rule 16b-3 and 16b-7 Proposals

The proposals were generally supported by a majority of commenters1 with the exception of the attorneys representing plaintiffs in Section 16(b) suits.2 Examples of supportive comments were:

"We heartily support the proposed rulemaking."3

"We welcome and applaud the Commission's proposed rulemaking."4

"SIA strongly supports the proposed amendments and believes they should be approved."5

Among the commenters supporting the proposal, there was a general consensus that this rulemaking is necessary to eliminate the uncertainty generated by the Third Circuit's construction of the rules in Levy v. Sterling Holding Company LLC ("Levy v. Sterling") 6 that has made it difficult for insiders wishing to "engage in legitimate transactions in reliance of prior Commission interpretations of these two rules."7

Several commenters supporting the proposal expressed a need for the Commission to act promptly.8 The NY Bar in particular urged prompt action, expressing a concern that since the Third Circuit includes Delaware, the ruling affects a significant number of public companies incorporated in Delaware.9

Supporters' Suggested Revisions to Rule 16b-3 of the Exchange Act of 1934 ("Rule 16b-3")

Some commenters suggested additional revisions to Rule 16b-3(d). These suggestions included:

  • Deleting the phrase "including without limitation a grant or award" from proposed Rule 16b-3(d) to avoid the possibility of courts using the "ejusdem generis" canon of statutory construction.10

  • Incorporating proposed Note 4 into the actual text of the rule to eliminate the possibility of the note not being accorded the same consideration as the text of the rule.11

  • Removing the word "specified" from proposed Note 4 since it correlates to the word "specifically" used by the court in Levy v. Sterling.12

  • Adding a note to Rule 16b-3 clarifying that the proposed rulemaking was not adding a new concept to Rule 16b-3(d) but merely clarifying the meaning of the rule in place prior to the rulemaking.13 Another commenter suggested adding similar language in the adopting release to the rule.14

Supporters' Suggested Revisions to Rule 16b-7 of the Exchange Act of 1934 ("Rule 16b-7")

Several commenters provided various suggestions to better clarify the exemptive scope of Rule 16b-7 so that transactions with equivalent economic substance are treated consistently.15 The main rationale for these suggestions was to avoid the possibility of a court following the restrictive approach employed in Levy v. Sterling and not considering other types of transactions to fall within the exemptive scope of Rule 16b-7(b).16 Suggested revisions included:

  • Adding a broad definition of the term "reclassification" as a separate paragraph to Rule 16b-7(b);17 or

  • Revising Rule 16b-7(b) to broaden the type of transactions it encompasses by adding language indicating that other substantially similar corporate reorganization transactions also fall within the exemptive scope of the rule.18

Some commenters stated that the inclusion of the substantially similar transactions would serve to recognize prior staff interpretations where transactions not formally styled as a reclassification, such as recapitalizations, conversions, share exchange transactions or other transactions, are nonetheless included within the scope of the term "reclassification."19 Alternatively, other commenters suggested adding a note to Rule 16b-7 to indicate that the term "reclassification" includes "substantially similar transactions, regardless of the characterization of such transactions for corporate law purposes, such as recapitalizations and share exchange transactions."20

Some commenters also recommended amending Rule 16b-7 to clarify that it covers transactions conducted in and governed by foreign jurisdictions.21

One commenter supported adding a sentence that specifically states that the Rule 16b-7 exemption is not conditioned on the transaction satisfying the conditions in Levy v. Sterling, although acknowledging that such reference "should not be necessary."22

Additionally, two commenters supported adding a note to Rule 16b-7 to indicate that the proposed rulemaking is intended to clarify the meaning of the rule in effect prior to the time that the proposed rulemaking was undertaken23 or include similar language in the adopting release.24

Commenters Who Generally Opposed the Rule 16b-3 and 16b-7 Proposals

Three commenters, consisting of attorneys who represent plaintiffs in Section 16(b) suits, vigorously opposed the Rule 16b-3 and 16b-7 proposals.25 Examples of opposing comments were:

    "Adopting the Proposals, would represent a betrayal of the SEC's statutory mandate and its position in the words of the former SEC Chairman and later Supreme Court Justice William O. Douglas, of being ‘the investor's best friend.'"26

    "We believe that the amendment is a serious mistake."27

    "We urge the Commission to reject its proposed amendments and adopt the Levy court's reading of the statute."28

Each commenter listed various reasons for their opposition to the proposed amendments to Rules 16b-3(d) and 16b-7. The predominant reasons cited against the proposal were:

  1. By proposing these amendments, the Commission is exceeding its authority and its regulatory discretion.29

  2. The proposed rulemaking does not represent a clarification but rather is an unlawful attempt by the Commission to engage in retroactive rulemaking.30

  3. The proposal's basis, that the court in Levy v. Sterling incorrectly interpreted Rules 16b-3 and 16b-7, is wrong.31

  4. The basic premise that there is no opportunity for speculative abuse in transactions between issuers and its officers and directors is faulty and without support.32

  5. The proposed amendment is inappropriate in the current environment because it protects rather than curbs insider trading.33

  6. The proposed rulemaking failed to provide proper notice of its effect upon passage.34

Commenters Who Supported the Proposal to Amend Item 405 of Regulations S-K and S-B

Only two commenters addressed the proposal to amend Item 405 of Regulations S-K and S-B, and both supported the proposal without further modifications.35

Rule 16b-3 Proposal

Proposal:

  1. Revise the paragraph heading to "Acquisitions from the issuer" and amend paragraph to state "Any transaction involving an acquisition from the issuer (other than a Discretionary Transaction), including without limitation a grant or award, shall be exempt if [any one of the Rule's three existing alternative conditions is satisfied.]"

  2. Add Note 4 to Rule 16b-3 to state "The exemptions provided by paragraph (d) and (e) of this section apply to any securities transaction by the issuer with an officer or director of the issuer that satisfies the specified conditions of paragraph (d) or (e) of this section, as applicable. These exemptions are not conditioned on the transaction being intended for a compensatory or other particular purpose."

Regarding this proposal, the Release solicited comments as to:

  1. Whether the proposed amendment to Rule 16b-3(d) would accomplish the goal of clarifying the exemptive scope of Rule 16b-3 as was originally intended for the rule to apply? If not, what other language would accomplish this goal more effectively?

  2. Would the proposed amendment to Rule 16b-3(d) preclude the restrictive construction applied in the Levy v. Sterling opinion?

  3. On a prospective basis, does the identical treatment of certain exemptive conditions of Rule 16b-3(d) and 16b-3(e) remain appropriate? Specifically, should a compensatory or other specified purpose ordinarily be necessary to exempt an officer's or director's disposition of issuer equity securities to the issuer, so that proposed Note 4 should apply only to Rule 16b-3(d) acquisitions?

  4. Should Note 4 be tailored more narrowly to clarify that Rule 16b-3(d) and 16b-3(e) are available to exempt officers' and directors' participation in transactions similar to the transaction at issue in Levy v. Sterling? For example, should proposed Note 4 instead state that an officer's or director's participation in an extraordinary securities transaction with the issuer (such as a merger, reclassification, or exchange offer) that satisfies the exemptive conditions of Rule 16b-3(d) or Rule 16b-3(e) is exempt?

Commenters Generally Supporting the Rule 16b-3 Proposal

Of the commenters supporting this proposal, six responded that the proposed amendments would accomplish the goal of clarifying the exemptive scope of Rule 16b-3 and would have precluded the results in Levy v. Sterling.36

Comments Regarding the Regulatory Text of Rule 16b-3(d)

One commenter suggested removing the phrase "including without limitation a grant or award" from proposed Rule 16b-3(d) paragraph.37 The commenter recommended excluding this phrase to avoid the possibility of courts using the "ejusdem generis" canon of statutory construction, as done in Levy v. Sterling. This modification, the commenter offered, would also allow Rule 16b-3(d) to more closely parallel the language in Rule 16b-3(e).

Two commenters recommended incorporating proposed Note 4 to Rule 16b-3 into the actual text of the rule.38 The reasons expressed for this suggestion were: (1) to ensure that courts consider the clarification and "eliminate possible claims that the notes are not to be accorded the same consideration as the text of the Rule,"39 and (2) the uncertainty whether "an explanatory note would be afforded the same deference as language in the body of the rule itself" under Section 23(a)(1) of the Exchange Act of 1934 ("Exchange Act").40 Commenters suggested accomplishing this 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….";41 or

  • Including the language of proposed Note 4 in an additional subparagraph to Rule 16b-3.42

Comments Regarding Proposed Note 4 Language

One commenter suggested removing the word "specified" from proposed Note 4 as it correlates to the word "specifically" used by the Court in Levy v. Sterling.43 To address the compensation element issue, the commenter suggested adding the following sentence at the end of proposed Note 4:

"Without limiting the foregoing, a grant or award may be exempt provided the conditions of paragraph (d) or (e) of this section are satisfied; however, a transaction need not have a compensatory element for these paragraphs to be applicable."44

Three commenters stated that narrowing proposed Note 4 to clarify that Rule 16b-3(d) and 16b-3(e) are available to exempt officers' and directors' participation in transactions similar to the transaction at issue in Levy v. Sterling is unnecessary.45 The rationale offered by one commenter was that the proposed note and the rule already state that "any transaction" that satisfies those conditions is exempt.46 Therefore, limiting either Rule 16b-3(d) or 16b-3(e) to compensatory and extraordinary transactions is unwarranted since the key consideration should be "the absence of the ability to take advantage of the other party on the basis of inside information."47 This commenter maintained that since there are other issuer securities transactions, beyond just compensatory and extraordinary transactions, which the issuer may deem appropriate to engage in with its officer or director, the nature of the transaction should be irrelevant. The same commenter also asserted that narrowing Note 4 to compensatory transactions would be inconsistent with the Commission's statement in the 1996 Release that "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." Commenters also raised a concern that narrowing Note 4 to refer only to "compensatory" or "extraordinary" transactions could lead to interpretive issues, litigation and uncertainty as to the meaning of these terms.48

Identical Treatment of Rule 16b-3(d) and 16b-3(e)

Four commenters supported maintaining identical treatment of the exemptive conditions of Rule 16b-3(d) and 16b-3(e).49 One commenter asserted that "not only is such treatment appropriate, but moreover that treating dispositions differently would result in unintended confusion over the exemptive relief available under Rule 16b-3."50

Suggested Additional Revisions to Rule 16b-3

Several commenters suggested that the Commission take this opportunity to codify interpretations of Rule 16b-3 previously articulated in staff letters and case law to assist issuers and insiders to plan transactions with greater assurance.51 Specifically, commenters suggested that Rule 16b-3 be amended to incorporate the following interpretations:

  • Rule 16b-3 is available to exempt 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. 52 The staff took this position in its February 10, 1999 letter to the ABA.

  • Rule 16b-3(e) is available to exempt the conversion or cancellation of target equity securities in a merger.53 The staff took this position in its January 12, 1999 letter to Skadden, Arps, Slate, Meagher & Flom LLP ("Skadden letter") and the Second Circuit Court of Appeals took the same position in Gryl v. Shire Pharmaceuticals Group PLC.54

One commenter further recommended Rule 16b-3 codification of the Second Circuit Court's position in Gryl v. Shire Pharmaceuticals PLC, which scaled back the approval specificity interpretation in the Skadden letter.55 This commenter asserted that the Skadden interpretation imposes "an unmistakable element of risk" to persons attempting to rely on that letter since it is possible for changes to the transaction or errors to occur after approval is received that require information to be obtained that would not assist the Board's decision whether the Rule 16b-3 exemption is appropriate.56 This commenter suggested adding the following note to Rule 16b-3:

"The availability of an exemption does not depend upon whether a transaction is directed by the issuer or the insider or whether the transaction takes place directly or indirectly in the name of the insider."57

One commenter58 who generally opposed the proposal suggested that the Commission take this opportunity to indicate that Rule 16b-3 does not apply to "deputized directors." 59 This commenter asserted that deputized directors should be treated as 10% shareholders rather than directors. Since Rule 16b-3 does not apply to 10% shareholders, the commenter contended that Rule 16b-3 also should not apply to deputized directors.

The commenter argued that some of the gate-keeping functions, such as board approval, and state fiduciary laws that deter directors and officers from engaging in short-swing transactions are not applicable to deputized directors. Because deputized directors rarely file reports under Section 16(a) of the Exchange Act acknowledging their deputized director status, the commenter argued that it is impossible for the board of directors to apply gate-keeping functions to deputized directors due to their anonymity. Furthermore, the commenter asserted that due to this anonymity, "traditional state fiduciary laws relating to insider trading and self-dealing do not apply" to deputized directors. The commenter asserted that the inapplicability of these protections to deputized directors further supports not exempting transactions by deputized directors from the strict liability provisions of Section 16 of the Exchange Act.

Suggested Additional Note to Rule 16b-3

Two commenters recommended adding a note to Rule 16b-3 to clarify that the proposed rulemaking and insertion of clause "whether or not such acquisition is intended for a compensatory or other purposes" is intended to clarify the meaning of the Rule as in effect prior to the time that such clause was added,60 or including similar language in the adopting release.61

Rule 16b-7 Proposal

Proposal:

  1. Replace throughout the text of the rule the phrase "merger or consolidation" with the phrase "merger, reclassification or consolidation."

  2. Insert a new paragraph specifying that the Rule 16b-7 exemption applies to any securities transaction that satisfies the conditions of the rule and is not conditioned on the transaction satisfying any other conditions.

Regarding this proposal, the Release solicited comments as to:

  1. Whether the proposed amendment to Rule 16b-7 would accomplish the goal of clarifying the exemptive scope of Rule 16b-7 consistent with the statements in the 1981 and 1991 Releases and our amicus brief in Levy v. Sterling? If not, what other language would accomplish this goal more effectively?

  2. Should we amend Rule 16b-7(b) to clarify that "merger" within the meaning of the rule also includes a reclassification?

  3. Should the proposed paragraph stating that the Rule 16b-7 exemption is not conditioned on the transaction satisfying any other conditions specify that the particular conditions applied in the Levy v. Sterling opinion do not apply?

  4. Is any further amendment or regulatory action necessary to clarify that other transactions that do not involve a merger, but could be effected by merger, also are exempted by Rule 16b-7? Should we amend Rule 16b-7(b) to clarify that transactions such as statutory exchanges, conversion to a different form of entity, and redomicile or continuance in a different jurisdiction, are also included as a "merger" within the meaning of the rule?

Commenters Generally Supporting the Rule 16b-7 Proposal

Generally most commenters, with the exception of the attorneys representing plaintiffs in Section 16(b) suits, agreed that the proposed amendment to Rule 16b-7 would accomplish the goal of clarifying the exemptive scope of Rule 16b-7 and is consistent with the statements in the 1981 and 1991 Releases and our amicus brief in Levy v. Sterling.62

Comments Regarding Proposed Rule 16b-7

Six commenters provided various suggestions to better clarify the exemptive scope of Rule 16b-7 to treat transactions with equivalent economic substance consistently.63 Voicing concern for the possibility that a court could follow the restrictive approach of the Levy v. Sterling court and not consider other types of transactions, such as amalgamations or share exchanges, to fall within the exemptive scope of Rule 16b-7(b), several commenters recommended either providing a broad definition of the term "reclassification"64 or revising Rule 16b-7(b) to clarify the broad scope of exempted transactions.65

One commenter suggested redesigning Rule 16b-7(b) to include subparagraphs with one providing a definition for the term "reclassification."66 The commenter suggested the following definition:

"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."

The commenter recommended that the term reclassification be liberally construed and not impose any specific conditions for a transaction to qualify as a reclassification.

Another commenter recommended that the definition of "reclassification" suggested in the ABA comment letter should be included in Rule 16b-7(b) and the rule should be broadened to state:

"A merger, reclassification and consolidation within the meaning of this section shall include the sale or purchase of substantially all the assets of one company by another in exchange for equity securities which are then distributed to the security holders of the company that sold its assets and any other 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 that company or another company involved in the transaction, or the terms of such class or series are changed, through an exchange, conversion, amendment or any other action having a similar effect."67

The commenter suggested this to ensure inclusion of transactions or arrangements that have "substantially similar effects that would otherwise satisfy the provisions of Rule 16b-7 but are not procedures specified in the rule."68

Comments Regarding Treatment of Other Similar Transactions

Several commenters similarly suggested adding language to Rule 16b-7 to recognize that other substantially similar corporate reorganization transactions also fall within the exemptive scope of Rule 16b-7.69 Some commenters indicated that this inclusion would acknowledge prior staff interpretations where transactions not formally styled as a reclassification, such as recapitalizations, conversions, share exchange transactions or other type of transactions, are included within the scope of "reclassification."70

Others asserted that these transactions should be exempt under Rule 16b-7 since like mergers, reclassifications and consolidations, they do not involve significant changes in the corporation's business, do not provide any potential for speculative abuse that Section 16(b) was designed to address, provide stockholders with continued ownership of the corporation (albeit in a different form), and treat all members of the affected class equally.71 Commenters suggested that the following specific language be inserted:

  • "or other substantially similar transactions"72

  • "or other substantially similar corporate reorganization transactions"73

  • "or statutory share exchange."74

Alternatively, other commenters suggested adding a note to Rule 16b-7 stating that the term reclassification also includes "substantially similar transactions, regardless of the characterization of such transactions for corporate law purposes, such as recapitalizations and share exchange transactions."75 One commenter suggested specifically identifying certain transactions as exempt in the text of the rule or note, such as share exchanges, amalgamations, schemes of arrangements and domestication transactions.76

Suggested Additional Revisions to Rule 16b-7

Some commenters also recommended amending Rule 16b-7 to clarify that it covers transactions conducted in and governed by foreign jurisdictions.77 The suggestions included:

  • Adding to Rule 16b-7 the statement "equivalent transactions with different names governed by non-U.S. law – such as amalgamations or schemes of arrangement – are covered by the rule;"78 and

  • Amending Rule 16b-7 to "expressly recognize that domestication transactions and other similar corporate reorganization transactions, however defined under local law, are eligible for exemption under Rule 16b-7 provided necessary elements are met."79

One commenter supported adding a sentence that specifically states that the Rule 16b-7 exemption is not conditioned on the transaction satisfying the conditions in Levy v. Sterling, although acknowledging that such reference "should not be necessary."80

Suggested Additional Note to Rule 16b-7

Additionally, as in the case of Rule 16b-3(d), two commenters recommended adding a note to Rule 16b-7 to clarify that the addition of the term "reclassification" is intended to clarify the meaning of the Rule as in effect before the term was added,81 or including similar language in the adopting release.82

Opposition to the Rule 16b-3 and 16b-7 Proposals

Attorneys representing plaintiffs in Section 16(b) suits strongly opposed the proposed rulemaking.83 Each listed various reasons for their opposition to the proposed amendments to Rules 16b-3(d) and 16b-7. The predominant reasons cited against the proposal were:

1. By proposing these amendments, the Commission is exceeding its authority and its regulatory discretion.

Opposing commenters generally claimed that the proposed rulemaking is an attempt by the Commission to legislate, which it does not have power to do.84 Two commenters argued that in the case of Section 16(b), Congress limited the Commission's decision-making authority by providing two statutory exemptions.85 Therefore, these commenters contended, the Commission is bound to exempt only transactions within these two statutory exemptions, and any proposals that exceed the scope of the two exemptions, such as the present proposal, are outside of the Commission's exemptive authority.

More specifically, one commenter argued that the proposal to amend Rule 16b-7 "fails to follow the limitations for exemptions imposed by Section 16."86 This commenter pointed to the fact that since reclassifications were in existence when Congress drafted Section 16, by not excluding all reclassifications from the definition of "purchase" and not providing a blanket exemption for reclassifications from Section 16(b) liability, Congress did not intend to exempt reclassifications. Therefore, this commenter asserted that the Commission is not free to exempt reclassifications from Section 16(b) liability.

Opposing commenters also attacked the theoretical underpinnings for the proposed rulemaking as "fundamentally unsound as well as inconsistent with,"87 "cannot be squared with"88 and does not "mesh with the statutory purpose of Section 16(b)."89 Two commenters asserted that the Commission mistakenly relies on fiduciary duties under state law, which Congress did not believe prevented improper insider trading, for the Rule 16b-3(d) proposals and allowing such transactions to be exempt.90 These commenters claimed that the Commission is ignoring several hurdles that exist in bringing and preserving claims under state law that are not present under Section 16(b).91 One commenter asserts that such hurdles demonstrate that "state law breach of fiduciary duty claims are no substitute for Section 16(b) and it is just as clear that Congress did not intend that they should be."92 One commenter also raised the issue that for companies incorporated in foreign jurisdictions, investors may face a different scope of fiduciary duties and available remedies.93 These commenters argued that if Congress did not believe the existence of possible state law remedies served as a means for displacing Section 16(b) liability, the Commission is unable to rely on state law protections.94

One commenter also stated that the Commission lacks enforcement or adjudicative authority over Section 16(b) and therefore courts are not obligated to give any deference, beyond persuasion, to the Commission's interpretations of Section 16(b).95

In rebuttal to the argument that this proposed rulemaking is outside the authority of the Commission, two commenters supporting the proposed rulemaking stated that under Section 16(b), the Commission is authorized to exempt transactions not comprehended within the purpose of the rule.96 Therefore, these commenters asserted, the proposed rulemaking, for the purpose of clarifying the existing rules, falls within the Commission's authority.

2. The proposed rulemaking does not represent a clarification but rather is an unlawful attempt by the Commission to engage in retroactive rulemaking.

One commenter97 stated that by calling the proposed rulemaking a clarification, the Commission's staff is seeking to disguise the fact that the proposed rulemaking is legislative and therefore outside of the statutory authority of the Commission. The commenter noted that for the proposed rulemaking to apply to the court's decision in Levy v. Sterling, Congress must grant the Commission the authority to promulgate such retroactive rules. Since Congress has not granted such authority to the Commission, the commenter alleged the Commission is engaging in unlawful activity. Furthermore, the commenter contended that the doctrine of stare decisis bars the Commission's efforts to retroactively apply the rule and such action represents "a blatant effort to interfere in the actions of the Judiciary in violation of the Separation of Powers Doctrine."

3. The proposal's basis that the court in Levy v. Sterling incorrectly interpreted Rules 16b-3 and 16b-7, is wrong.

One commenter98 asserted that the court in Levy v. Sterling correctly used "ejusdem generis" in interpreting that "other acquisitions" must relate to compensation-related transactions under Rule 16b-3(d) and reclassifications are not exempt under Rule 16b-7. This commenter stated the following to support the court's findings:

  • Principles of Statutory Construction: The phrase "if the transaction satisfies the applicable conditions set forth in this section" in Rule 16b-3(a) indicates that certain conditions must be met for the exemption to apply. The commenter argued that if the intent of the Commission is to exempt all transactions between issuers and an officer or director, it could simply have done so by not including this phrase in Rule 16b-3(a). As for Rule 16b-7, the commenter asserted that the word "reclassification" does not appear anywhere in the rule but its title. The commenter claimed that this is an insufficient basis for the Commission's position that transactions exempt under Rule 16b-7 include reclassifications.

  • Statutory policy: The commenter pointed to the statutory policy and Congress' intent for Section 16(b) to prevent speculative abuse by statutory insiders and asserted that the proposal does not explain how speculative abuse in securities trading would be curbed if all transactions with the issuer would fall under Rule 16b-3(d) rather than only those related to compensation. Another commenter also suggested that the proposal's overall intent of regulatory simplicity, while laudable, does not permit the Commission to create exemptions "not comprehended within the purpose of the Statute."99

  • Regulatory history: The commenter stated that previous Commission releases related to Rule 16b-3 support its contention that only compensation-related transactions are exempt. The commenter pointed to various statements contained in the 1991100, 1994101, 1995102 and 1996103 releases that imply, when explaining the various revisions to Rule 16b-3, that such changes were to ensure that only compensation-related transactions would be exempt under Rule 16b-3. The commenter stated: "the Commission has never stated in any release contemporaneous with the adoption of the rule that Rule 16b-3(d) provides a blanket exemption for all acquisitions of securities by a director from an issuer." Regarding Rule 16b-7, the commenter noted that the only instance where the Commission stated that Rule 16b-7(a) can apply to a reclassification was in the 1981 release and even then the reclassification was exempt only where a merger or consolidation was also involved.

The commenter also asserted that prior staff no-action letters are irrelevant to the court's interpretation, as they do not support the Commission's position or represent an official expression of the Commission.

4. The basic premise that there is no opportunity for speculative abuse in transactions between issuers and its officers and directors is faulty and without support.

The opposing commenters argued that the premise that no opportunity for speculative abuse in issuer-insider transactions is without merit.104 One commenter suggested that the premise that "an issuer-insider trade will ‘generally' not give rise to short-swing profits because ‘any profit obtained is not at the expense of uninformed shareholders and other market participants of the type contemplated by the statute'" only portrays "half the story."105 This commenter asserted that this premise does not take into account the harm that occurs when the insider subsequently sells the securities obtained in an issuer-insider transaction in the open market at the expense of uninformed shareholders and other market participants. Arguing that this is the exact situation Section 16(b) was enacted to prevent, the commenter stated: "there is no principled reason why buying the shares from the company and profiting by unloading them on the public should be exempt when liability would attach if both the purchase and sale were made on the open market." Another commenter stated: "the identical risks of insider trading, and related manipulation of share prices, exist regardless of who is on the other side of the transaction."106

5. The proposed amendment is inappropriate in the current environment because it protects rather than curbs insider trading.

One commenter107 was "shocked" that in the current environment, where frauds perpetrated by participants in the mutual fund industry and research analysts at the large investment banks have come to light, the Commission appears to be supporting insider trading.

6. The proposed rulemaking failed to provide proper notice of its effect upon passage.

One commenter108 asserted that the notice of proposed rule changes inadequately informs interested parties of the potential impact of the proposed new rules as required by the Administrative Procedures Act. The commenter called the language of the proposed amendment to Rule 16b-7 "confusing and, at worst, utterly meaningless" in that it is difficult to determine when the rule should apply since there is no clear definition of what constitutes a reclassification.

7. The proposal would overrule Rule 16b-6.

One commenter109 stated that it is unclear if proposed Rule 16b-7(c) is meant to overrule Rule 16b-6. Since the proposal does not define reclassification transactions, the commenter asserts that it is possible that many transactions considered "conversions" within Rule 16b-6 could also be considered reclassifications. Therefore, the commenter states, if it is the Commission's intent to "set aside the careful analysis and construction of rules governing conversions of derivative securities and the setting of conversion terms contained in Rule 16b-6" by the Rule 16b-7 proposal, this should be clearly stated.

8. Different treatment from Rule 144

One commenter110 asserted that at times, the Commission appears to use the term "reclassification" interchangeably with the term "recapitalization" contained in Rule 144(d)(3)(i) of the Securities Act of 1933. The commenter noted that even a small shift in economic risk results in unfavorable Rule 144 treatment.111

9. Treating reclassification as a merger would not be exempt

One commenter112 raised as an issue the proposal's discussion regarding the ability to structure the transaction in Levy v. Sterling as a merger, which would have been exempted by Rule 16b-7. Specifically, the commenter asserted that the transaction described in the proposing release would "be deemed a liquidation, and therefore not eligible for the Rule 16b-7 exemption." The commenter stated that, in the context of the Rule 16b-7 exemption, form over substance does matter. Additionally, the commenter contended that "[t]here is no merit to the Proposal's suggestion that Section 16(b) liability should not exist because there is no change in the ‘company's business.'"

Item 405 of Regulations S-K and S-B

Proposal: Amend Item 405 of Regulations S-K and S-B to delete the Item 405(b)(1) timeliness presumption, without substituting a different presumption or otherwise modifying the substance of Item 405.

Regarding this proposal, the Release solicited comments as to:

  1. Would the proposed amendment harmonize the Item 405 delinquency disclosure requirement with the accelerated filing, electronic filing and Web site posting requirements adopted by the Sarbanes-Oxley Act amendments to Section 16(a) and our rules implementing those statutory amendments?

  2. Will issuers have any difficulty monitoring and reporting if we remove the presumption?

The two commenters that provided responses to the proposal for Item 405 of Regulations S-K and S-B supported the proposal without further modifications.113

Other Suggestions

Clarification of Other Court Decisions Related to Section 16

One commenter suggested that the Commission consider other areas where recent court decisions have conflicted with Commission or Commission staff positions relating to Section 16 rules.114 For example, this commenter points to two cases holding that reporting of securities held by trusts in which persons who may have been relying upon Rule 16a-8 in reporting under Section 16 have been subjected to unexpected liability.115

Extend Section 16 Requirements to Insider Trades of Unregistered Securities

One commenter116 requested that the Commission extend the requirements of Section 16 to insider trades of securities not registered under Section 12 of the Exchange Act, noting that currently investors in unregistered securities must rely on insider trading prohibitions under the general antifraud provisions of Exchange Act Section 10(b) and Rule 10b-5. As support for its suggestion, the commenter asserted that the significant size of the market for unregistered securities117 and the greater opportunities and likelihood for abusive trading by insiders for unregistered securities warrant the Commission taking action on this matter. The commenter also suggested that imposing such requirement would make it easier for the Commission to identify pump-and-dump schemes for enforcement purposes, and would require disclosure of information comparable to Rule 144 under the Securities Act of 1933.118 The commenter also suggested that the Commission require, before insiders are allowed to trade in registered securities, that adequate information is available publicly or that the issuer is not delinquent in its reporting obligations under the federal securities laws.

Individual Commenters

Four individuals provided additional comments.119 One commenter suggested amending the reporting requirements to impose them on securities trades for all "state securities employees and all SRO employees above the level of examiner, including, but not limited to the Commissioners."120 Another commenter suggested requiring all issuers and their officers to report all changes in ownership interest to a "central repository where the regulatory time clock can determine if it is lawful for a transaction to occur," in order to identify violations in a more uniform manner.121 Another commenter stated that a company's officers, board members and "others on the Insider Roster" should not be allowed to hedge or assist each other to hedge the company's stock.122 The remaining commenter inquired about the status of requiring companies to "fund the stock options" of their officers and directors, and suggested that holders of large amounts of options who contemplate selling their options should be required to advise company shareholders of their intention.123

Endnotes

1 ABA, Allen & Overy, ASCS, Dechert, Goodwin Proctor, Hogan, Mayer Brown, NY Bar, SIA, Simpson Thacher, Sullivan & Cromwell.
2 Abraham Fruchter, Bragar, Sirianni.
3 ABA.
4ASCS.
5SIA.
6314 F.3d 106 (3d Cir. 2002), cert. denied, 124 S.Ct. 389 (U.S., Oct. 14, 2003).
7 ABA. See also ASCS, Allen & Overy, Goodwin Proctor, Hogan, Mayer Brown, NY Bar, SIA, Simpson Thacher, Sullivan & Cromwell.
8 ABA, Hogan, NY Bar, Simpson Thacher.
9NY Bar.
10 ASCS.
11NY Bar, Sullivan & Cromwell.
12 ASCS.
13NY Bar.
14 Sullivan & Cromwell.
15 ABA, Allen & Overy, Goodwin Proctor, Hogan, Simpson Thacher, Sullivan & Cromwell.
16 ABA, Mayer Brown, NY Bar, Simpson Thacher, Sullivan & Cromwell.
17ABA.
18Mayer Brown, NY Bar, Simpson Thacher, Sullivan & Cromwell.
19 Allen & Overy, Goodwin Proctor, NY Bar, Simpson Thacher.
20NY Bar. See also Hogan.
21Allen & Overy, Hogan, Simpson Thacher. All three firms identified these transactions as domestication transactions, share exchange arrangements, amalgamations, schemes of arrangement and other similar corporate reorganization transactions.
22 Goodwin Proctor.
23NY Bar.
24Sullivan & Cromwell, suggesting that "the Commission include in the adopting release an explicit statement that the amendments to the rules are intended to have retroactive effect."
25 Abraham Fruchter, Bragar, Sirianni.
26 Abraham Fruchter.
27Bragar.
28Sirianni.
29Abraham Fruchter, Bragar, Sirianni.
30 Abraham Fruchter.
31 Abraham Fruchter.
32 Bragar, Sirianni.
33 Bragar.
34 Abraham Fruchter.
35 ABA, Mayer Brown.
36 ABA, ASCS, Dechert, Goodwin Proctor, Mayer Brown, SIA.
37 ASCS.
38 NY Bar, Sullivan & Cromwell.
39NY Bar.
40Sullivan & Cromwell. Section 23(a)(1) of the Exchange Act states "[t]he Commission, the Board of Governors of the Federal Reserve System, and the other agencies enumerated in section 3(a)(34) of this title shall each have power to make such rules and regulations as may be necessary or appropriate to implement the provisions of this title for which they are responsible or for the execution of the functions vested in them by this title, and may for such purposes classify persons, securities, transactions, statements, applications, reports, and other matters within their respective jurisdictions, and prescribe greater, lesser, or different requirements for different classes thereof. No provision of this title imposing any liability shall apply to any act done or omitted in good faith in conformity with a rule, regulation, or order of the Commission, the Board of Governors of the Federal Reserve System, other agency enumerated in section 3(a)(34) of this title, or any self-regulatory organization, notwithstanding that such rule, regulation, or order may thereafter be amended or rescinded or determined by judicial or other authority to be invalid for any reason."
41 NY Bar.
42 Sullivan & Cromwell.
43 ASCS. In Levy v. Sterling, the court interpreted the term "specifically" in the following statement contained in the 1996 release "a transaction need not … to be exempt … specifically have a compensation element" to suggest that "the transaction should have some connection to a compensation-related function." 314 F.3d. 106, 124 (3d Cir. 2002).
44ASCS.
45 ABA, ASCS, Goodwin Proctor.
46 ABA.
47ABA.
48 ABA, Goodwin Proctor.
49 ABA, Goodwin Proctor, NY Bar, Sullivan & Cromwell.
50 Sullivan & Cromwell.
51 ABA, ASCS, Sullivan & Cromwell.
52 ABA.
53 ABA, ASCS.
54 298 F.3d 136 (2d Cir. 2002).
55 Sullivan & Cromwell.
56 Sullivan & Cromwell.
57 Sullivan & Cromwell.
58 Sirianni. As support for this, Sirianni stated: "[t]o the extent that a director by deputization enters into a transaction with the issuer, the transaction will almost always result from the entity's status as a stockholder (or simply an investor in the public market) and not its status as a director by deputization."
59 Courts have developed a "deputization" theory related to Section 16 of the Exchange Act. Under this theory it is possible for a person or entity, such as a corporation or partnership, to be deemed a director and therefore subject to Section 16 of the Exchange Act, even though the issuer has not formally elected or otherwise named that person a director. The theory is based on the access to inside information afforded by the "deputizing" relationship and Section 16(b)'s stated purpose "of preventing the unfair use of information by such beneficial owner, director or officer by reason of his relationship to the issuer." The courts have not formulated any definitive standards for determining when "deputization" may exist.
60 NY Bar.
61 Sullivan & Cromwell, suggesting that "the Commission include in the adopting release an explicit statement that the amendments to the rules are intended to have retroactive effect."
62 ABA, Allen & Overy, Dechert, Goodwin Proctor, Hogan, Simpson Thacher, Sullivan & Cromwell.
63 ABA, Allen & Overy, Goodwin Proctor, Hogan, Simpson Thacher, Sullivan & Cromwell.
64 ABA.
65 Mayer Brown, NY Bar, Simpson Thacher, Sullivan & Cromwell.
66 ABA.
67 Mayer Brown.
68 Mayer Brown.
69 Allen & Overy, Goodwin Proctor, Hogan, NY Bar, Simpson Thatcher.
70 Allen & Overy, Goodwin Proctor, NY Bar, Simpson Thacher.
71 Goodwin Proctor, Hogan, Simpson Thacher.
72 NY Bar.
73 Simpson Thacher.
74 Sullivan & Cromwell.
75 Hogan, NY Bar.
76 Hogan.
77 Allen & Overy, Simpson Thacher. Both firms identified these transactions as domestication transactions, share exchange arrangements, amalgamations, schemes of arrangement and other similar corporate reorganization transactions.
78 Simpson Thacher.
79 Allen & Overy.
80 Goodwin Proctor.
81 NY Bar.
82 Sullivan & Cromwell, suggesting that "the Commission include in the adopting release an explicit statement that the amendments to the rules are intended to have retroactive effect."
83 Abraham Fruchter, Bragar, Sirianni.
84 Abraham Fruchter, Bragar, Sirianni
85 Abraham Fruchter, Bragar. The two statutory exemptions referred to by commenters are: (1) "unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted" and (2) "where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase …" Abraham Fruchter quoting 15 U.S.C. 78p(b).
86 Abraham Fruchter.
87 Bragar.
88 Sirianni.
89 Abraham Fruchter.
90 Abraham Fruchter, Bragar.
91 Abraham Fruchter, Bragar. Both Abraham Fruchter and Bragar point to the following state law requirements: (1) need for proof of intent or knowledge on the part of the insider, and (2) need to demonstrate that the company's board of directors did not fulfill its fiduciary duty when it declined to initiate suit.
92 Bragar.
93 Abraham Fruchter.
94 Abraham Fruchter, Bragar.
95 Abraham Fruchter.
96 Dechert, NY Bar.
97 Abraham Fruchter.
98 Abraham Fruchter.
99 Sirianni.
100 Exchange Act Release No. 28869 (February 8, 1991)
101 Exchange Act Release No. 34514 (August 10, 1994)
102 Exchange Act Release No. 36356 (October 11, 1995)
103 Exchange Act Release No. 37260 (May 31, 1996)
104 Abraham Fruchter, Bragar, Sirianni.
105 Sirianni, quoting the 1996 Release in part.
106 Abraham Fruchter.
107 Bragar.
108 Abraham Fruchter.
109 Abraham Fruchter.
110 Abraham Fruchter.
111 The unfavorable treatment referred to is the inability to "tack" under Rule 144(d) the holding period of securities held before the recapitalization transaction to securities held following the recapitalization transaction.
112 Abraham Fruchter.
113 ABA, Mayer Brown.
114 Sullivan & Cromwell.
115 Sullivan & Cromwell refers to Morales v. Quintiles Transnational Corp., 25 F.Supp.2d 369 (S.D.N.Y. 1998), holding that an insider who exercised reacquisition rights to issuer securities previously placed in a grantor retained annuity trust (GRAT) had effected a purchase for purposes of Section 16(b) of the Exchange Act and Dreiling v. Kellett, 281 F.Supp.2d. 1215 (W.D. Wash. 2003), holding that an insider who transferred issuer securities placed in trust to personal trading accounts and to an escrow account for the satisfaction of a personal obligation had effected a purchase for purposes of Section 16(b) of the Exchange Act. Sullivan & Cromwell asserts that the ruling in Morales v. Quintiles Transnational Corp. conflicts with the staff interpretive letter issued on October 16, 1997 to Peter J. Kight.
116 Pink Sheets.
117 Pink Sheets states that although exact numbers are not known, "there are at least as many unregistered issues trading in the public markets as registered issues."
118 Rule 144(h) requires notices in certain circumstances when affiliates propose to sell securities.
119 Dupriest, Gambel, Gates, Nesfield.
120 Gambel.
121 Nesfield.
122 Dupriest
123 Gates.

 

http://www.sec.gov/rules/extra/s72704comsum.htm


Modified: 08/23/2005