July 12, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-09-02
Release Nos. 33-8090; 34-45742
Form 8-K Disclosure of Certain Management Transactions
Ladies and Gentlemen:
This letter is submitted in response to the Securities and Exchange Commission's request for comments on its April 12, 2002 release entitled "Form 8-K Disclosure of Certain Management Transactions" (the "Proposing Release").
These comments have been prepared by the Subcommittee on Employee Benefits, Executive Compensation and Section 16 (the "Subcommittee") of the Committee on Federal Regulation of Securities (the "Committee"), Section of Business Law (the "Section") of the American Bar Association. A draft of this letter was circulated for comment among other members of the Committee, including the Chairs and Vice-Chairs of Subcommittees and Task Forces of the Committee, the Officers of the Committee and the Advisory Committee of the Committee and the Officers of the Section. A substantial majority of those who have reviewed the letter in draft form have indicated their general agreement with the views expressed. However, this letter does not represent the official position of the American Bar Association, the Section, its officers, the Committee or the Subcommittee, nor does it necessarily reflect the views of all who reviewed it.
We appreciate the opportunity to comment on the Commission's proposals to require companies to file current reports on Form 8-K under proposed new Item 10. The proposed reports would disclose (i) insiders' transactions in company equity securities ("Item 10(a) Reports"), (ii) insiders' entry into and modification and termination of any contract, instruction or written plan for the purchase or sale of stock intended to satisfy the affirmative defense under Rule 10b5-1(c) (a "Rule 10b5-1 Plan"), and (iii) company loan arrangements with insiders (collectively, "Item 10 Reports"). We acknowledge that there is great interest from investors for more current information on certain insiders' transactions and that advances in the trading markets and in technology make it possible to disclose such information earlier than required under the Securities Exchange Act of 1934 ("Exchange Act"). However, as discussed below, we believe that the proposals as drafted are unnecessarily broad, will impose substantial burdens and costs on companies and insiders and will generate disclosures that are in many instances of questionable significance. Accordingly, we suggest modifications we believe achieve the Commission's objectives without these disadvantages.
At the outset, we want to recognize the existence of concerns over the Commission's use of rulemaking authority over company disclosure obligations to require reporting of inside transactions that differ from the existing statutory time frames established by Congress in Section 16(a) of the Exchange Act. We believe that it would be inappropriate for the Commission to utilize Section 13(a) solely to shift the responsibility for and timing of reports required under Section 16(a). Instead, Commission rulemaking should be based on sound disclosure policy consistent with the authority delegated to it and should address company information that is significant to investors. We believe that these proposals, if properly structured and limited in scope, could satisfy that standard because there is sufficient nexus between the nature of the information proposed for disclosure and the company1 and because that information is reasonably related to other information already required to be disclosed.2 However, we believe that the proposals must be assessed in this context. The goal of disclosure of insiders' dealings in their company's stock (prompt disclosure of transactions which investors may view as significant) differs from the principal statutory goal underlying Section 16 reporting (preventing the manipulative use of information through short-swing trading). Therefore, while our comments embrace aspects of the existing Section 16(a) reporting regime as a familiar and effective reporting format that, for efficiency, should be utilized for Item 10(a) Reports, there are a number of areas where the appropriate disclosure obligations under Section 13(a) differ from the reporting obligations imposed directly on insiders under Section 16(a).
In light of the foregoing considerations, our comments on the proposals contained in the Proposing Release reflect the following basic tenets:
To promote these goals, we recommend that the proposed Item 10 reporting rules be revised to incorporate the following elements:
We elaborate on these points below and set forth our other comments in response to the proposals and the questions raised by the Commission in the Proposing Release.
We acknowledge the Commission's goal of increasing the timeliness and availability of public disclosure about certain insiders' stock transactions. However, we believe it important that the Commission clearly state the objectives of the enhanced disclosure requirements and acknowledge the limitations on the information that will be disclosed in Item 10(a) Reports. Specifically, Item 10(a) Reports may provide investors more timely access to information about changes in an insider's investment in his or her company's equity securities, and these disclosures may contribute helpful information to investors' understanding of an insider's financial stake in a company. However, the information contained in Item 10(a) Reports will not be any more material and will not likely provide any greater information regarding an insider's views of his or her company's performance and prospects than is currently provided under Section 16 reports. Instead, the Item 10(a) Reports will result in earlier and more accessible disclosure.
We believe that it is misleading to investors to suggest, as the Proposing Release does in a number of places, that Item 10(a) Reports will provide reliable information on management's views of a company's performance and prospects.3 As the Commission is aware, there are many factors affecting the timing of insiders' transactions that have no relationship to a company's performance or prospects.4 For example, insiders often sell shares to realize a portion of their compensation that has been provided through stock options or other equity-based compensation arrangements, to diversify their personal portfolios or to pay tax or other liabilities. In addition, most companies have implemented insider trading policies that are designed to prevent insiders from effecting transactions while they are aware of material non-public information. Existing research in fact indicates that insiders' transactions are not a reliable guide for the public's investment decisions. For example, the study cited by the Commission at footnote 24 of the Proposing Release concluded that "insider selling appears to have no predictive ability" on stock price performance.5
Therefore, we believe that the Commission should affirmatively state that the information disclosed in Item 10(a) Reports is not deemed to be "material" solely by reason of the Item 10 reporting requirements.6 In addition, we believe the Commission should specifically caution public investors that they should not presume, without further analysis, that information disclosed about insiders' transactions indicates the insider's view about the company's performance or prospects.
Companies attempting to satisfy the Item 10 reporting obligations as proposed would encounter numerous obstacles because implementation of the proposals would require insiders, companies, brokerage firms, stock and retirement plan administrators and others to change the manner in which they operate. Some of the difficulties presented by the proposed reporting regime are set forth below.
The proposals would require companies to change the nature and extent of their involvement with insiders' stock transactions. Contrary to some suggestions, most companies do not have procedures in place that would allow them to satisfy the proposed Item 10(a) reporting requirements. Instead, most companies will need to develop new or alter existing procedures in order to be able to collect transaction information in a timely manner.
Most companies are involved with insiders' stock transactions in the context of insider trading compliance procedures. Companies typically maintain one or both of two different types of insider trading compliance procedures: a "window period" or "blackout" system, where the company prescribes periods during which open market purchases or sales are permitted or proscribed, and/or a "pre-clearance" system, where a company compliance officer must be notified of and approve a proposed transaction before it is effected. These procedures focus on advance clearance of the general timing of a transaction and typically do not encompass an after-the-fact reporting mechanism that enables a company to learn the details of transactions once they have actually been executed. Under either procedure, companies typically allow a clearance to be effective for a number of days, and do not require the insider to notify the company when or whether the pre-cleared transaction is effected. For this reason, many companies will not be able to rely on their existing insider trading procedures to implement the Item 10 reporting regime.7
Companies currently learn of and address reporting of specific transactions when assisting insiders in preparing and filing reports under Section 16(a).8 Many companies, when they provide such assistance, conduct a month-end survey of their insiders, either in writing or telephonically, in which the company (1) verifies information that it already has on insider transactions that may have occurred during the month, such as transaction information relating to employee stock option exercises and other employee benefit plan transactions, and (2) inquires whether the insider engaged in any other transactions. Again, these procedures are not designed to monitor for and promptly collect transaction data on every possible type of transaction that an insider may conduct, but instead focus specifically on transactions that are reportable under Section 16. If, as recommended below in Part IV.B. of this letter, all Item 10(a) Reports are required on a standardized weekly basis, then this routine survey procedure could be adapted to encompass Item 10(a) reporting.
Another practical consideration that would make the proposed Item 10(a) reporting problematic is the fact that, under Exchange Act Rule 10b-10, brokerage firms are not required to confirm and generate a report containing the details of a transaction until the date the transaction is "completed" (within the meaning of Rule 15c1-1), which is generally the third business day after the trade date ("T+3") and, in the case of transactions for insiders that require special handling under Rule 144, is often a later date. Although the Commission has indicated its desire that the brokerage industry move to a T+1 settlement and reporting cycle, that goal is not expected to be met until June 2005, and the change is expected to cost brokerage firms in excess of $8 billion. While insiders at large companies who hold high dollar value stock positions in some cases may be able to obtain information about their trades to make Item 10(a) filings within the time periods proposed in the Proposing Release, the Commission should not presume that such service will be available to all insiders at all companies. Many insiders and companies will not be in a position to obtain, verify, format and file information in an Item 10(a) Report on a deadline that is shorter than the regulatory deadline applicable to brokerage firms for providing that information to the insiders themselves.
Many tax-qualified employee benefit plans operated for a large number of employees may not be able to generate information on transactions effected for a single participant within the time frame contemplated by the Proposing Release. Companies typically have contracted with third parties to obtain plan administration services for these types of broad-based retirement and savings plans as well as for stock option plans. The responsibilities of third-party administrators are governed by existing contracts, which in many cases specify how much time the administrator is allowed to generate transaction reports. Plan administrators will need to revise their systems to accommodate accelerated reporting, and companies in many cases will need to negotiate revisions to their contracts with the plan administrators to obtain insiders' transaction information on an accelerated schedule. We expect that the cost of enhancing the plan administrators' systems to permit accelerated transaction reporting for insiders will be significant and will be passed through to companies.
The above situations illustrate just a few of the factors that will affect companies' ability to satisfy the proposed Item 10 reporting regime. We believe that the foregoing issues reinforce the need for the new Item 10 reporting system to focus on disclosure of transactions that are most likely to be of interest, to build on the existing Section 16 reporting regimes, and to establish clearly defined reporting standards with achievable reporting deadlines. By recognizing and responding to systems and procedures that currently are in place and to the practical limitations of those systems and procedures, we believe that the Item 10 reporting system can result in more timely disclosure of information that is informative to and readily understood by investors without imposing unnecessary costs and burdens.
For the reasons discussed below, we recommend that the persons whose stock transactions and Rule 10b5-1 Plans are subject to Item 10 Reports be limited to specified executive officers. We oppose including non-employee directors as persons whose transactions are subject to Item 10(a) Reports, but concur it may be appropriate with respect to company loans. Finally, we concur with the Commission's proposal that companies should not be obligated to report on transactions by greater than ten percent stockholders.
We believe that Item 10 Reports should be limited to transactions effected by specified senior executive officers. Specifically, we believe that the list of covered executive officers should encompass:
We believe it is appropriate to limit the executives covered by Item 10 for a number of reasons. First, as with the Commission's executive compensation and beneficial ownership disclosure rules, stockholders are more likely to have an interest in transactions by only certain members of senior management. Second, by enumerating specified senior executives, instead of applying the expansive Rule 16a-1 or Rule 3b-7 officer definitions, there will be greater comparability in reporting by various companies. Without a uniform list of executive officers subject to Item 10 Reports, the number of Item 10 Reports filed by companies could vary widely based solely on its second tier executive management structure. This could send the wrong message to investors when a company files a large number of Item 10(a) Reports merely because the company has more executive officers subject to the requirements of Item 10(a). Third, because one aspect of the proposed rules is to provide earlier and more timely information that may reveal shifts in the alignment of management's and shareholders' economic interests, we do not see the need for providing that information with respect to lower level executives whose economic relationship with a company is not otherwise subject to comprehensive disclosure. Finally, stock transactions by all other executive officers and any other person subject to Section 16 would continue to be publicly reported under Section 16.11
If the Commission determines not to limit Item 10(a) Reports to a designated list of executive officers, we believe the Rule 16a-1(f) definition of "officer" should be applicable, in order to eliminate the need to make fine distinctions as to which executive officers are covered by Section 16 but not by Item 10.
Companies should not be required to report transactions by directors who are not also executives subject to Item 10 reporting (referred to herein as "outside directors"). Instead, disclosure of outside directors' transactions should be left to the monthly Section 16 reporting regime.
We believe that requiring Item 10(a) Reports on outside director transactions would greatly increase the costs and effort required of companies. Companies have much less interaction with their outside directors than with their executive officers. Directors often reside far away from a company's executive offices and often do not advise companies as to their day to day business and travel schedules. In addition, companies often have more members on their board of directors than they have executive officers. As a result of these factors, a greater effort would be required of companies to constantly monitor (or even to survey weekly) their outside directors' stock transactions, and to obtain, verify and report information on any transactions that have occurred.
These burdens would be greater in cases where companies may not have close and cooperative working relationships with some of their outside directors. In particular, "dissident" directors may refuse to share information on their personal transactions with the company before the time they are themselves required to publicly disclose those transactions.12 Even where outside directors are not "hostile" to company management, it may still be difficult for a company effectively to police compliance with procedures it implements to promote compliance with the Item 10(a) reporting requirements. For example, unlike executive officers who can be disciplined or fired for violating a company policy, there is little a company can do to discipline outside directors.13
Even in cases when it is possible for companies to obtain timely and reliable information from outside directors about their personal stock transactions, we question whether that information is of sufficient significance to require accelerated company disclosure. Because outside directors are less involved with the day-to-day operations of a company than its senior management, and because outside directors' stock holdings tend to be smaller and represent a smaller portion of their wealth than is typically the case with senior management, any information to be gleaned from accelerated reporting of their transactions will be even more attenuated than with executives' transactions.
To the extent that the Commission concurs that stock transactions by outside directors are not sufficiently significant to require inclusion on Item 10(a) Reports, likewise their use of Rule 10b5-1 Plans should not be viewed as significant. Accordingly, we do not believe that outside directors' Rule 10b5-1 plans should be reportable under Item 10.
For ease of administration as to who is covered by Item 10 reporting, we would also take the view that loan arrangements with outside directors should not be subject to Item 10(c) disclosure. However, one of our main arguments for excluding outside directors from Item 10(a) disclosure - that the company may have no involvement with the outside director's transactions and thus would have to commit substantial time, money and efforts to report information that may be of little significance to investors - does not apply with respect to company loan disclosure reportable under Item 10(c). In addition, we believe that company loans to outside directors are sufficiently infrequent that a company reporting obligation would not be often triggered. Accordingly, we could understand the basis for the distinction if the Commission were to make Item 10(c) loan disclosure applicable to outside directors.
We support the Commission's proposal not to include greater than ten percent beneficial owners ("10% holders") among those whose transactions would be subject to Item 10 reporting. We believe that disclosures by these persons are already comprehensively addressed under Regulation 13D-G and Section 16, which adequately balance the need for public disclosure with concerns for the reporting person's ability to manage its holdings of the subject company's stock. Moreover, to a greater degree than even outside directors, 10% holders typically operate completely independently of a company, making it unlikely that they would voluntarily cooperate with a company by disclosing their stock transactions any sooner than they otherwise are required to directly under Section 13(d) or Section 16.
We do not believe that Item 10 should cover persons who have ceased to hold the position that initially subjected their transactions to Item 10 reporting. Unlike the Section 16(b) rules, where post-termination transactions by former executives and directors are matched with pre-termination transactions to produce liability, we believe it is unlikely that post-termination transactions will convey meaningful information for purposes of Item 10(a) Reports. Moreover, obtaining data from former executives after their termination of service would in many cases be difficult, if not impossible, as companies often do not have on going contact with those individuals or otherwise have a legal basis for requiring them to provide information on their personal securities transactions.
The Commission has requested comments on several questions regarding which companies should be subject to the proposed Item 10 reporting requirements. For the reasons discussed below, it is our view that any new reporting regime should be limited as follows:
It would be anomalous to require foreign private issuers to report executive officer and director transactions when executives and directors of foreign private issuers are not themselves required to report their own transactions. Rule 3a12-3(b) of the Exchange Act provides that transactions by officers and directors of a foreign private issuer are not subject to reporting under Section 16.14 This exclusion reflects a policy decision that would be defeated if companies were required to report such transactions. In addition, as noted elsewhere in this letter, companies would be dependent on their executive officers and directors to notify them of transactions triggering most Item 10 Reports and to provide the information required to be filed. Because executive officers and directors of foreign private issuers are not themselves subject to Section 16(a) reporting requirements and have no attendant liability for delinquencies, it seems unlikely that they would be reliable at informing foreign private issuers of transactions that trigger Item 10 reporting obligations or in providing complete, timely and accurate information for filing.
Small business issuers should not be subject to Item 10 reporting obligations because the substantial compliance costs of such reporting would disproportionately affect them. While "small business issuers" would face the same hurdles as other companies in attempting to satisfy the proposed Item 10 reporting requirements, they are likely to be less well equipped to be able to satisfy the reporting demands. As a result, such companies would need to increase their corporate compliance staff so as to constantly maintain capable personnel available to prepare Item 10 Reports. Once prepared, the Item 10 Reports would need to be converted into a format suitable for filing with the Commission via EDGAR. Many such public companies do not currently maintain an in-house EDGAR filing capability and instead bear the expense of hiring a financial printer to submit such filings on their behalf.15 Therefore, in addition to hiring more general corporate compliance personnel, companies would need to hire and train in-house EDGAR personnel and incur the technical expenses related to EDGAR, or bear the expense of hiring a financial printer for such filings. As a result, the substantial compliance expenses of Item 10 reporting would disproportionately affect small business issuers. In order to avoid this burden, it is our view that small business issuers should be exempt from Item 10 reporting.
The Commission has proposed that an Item 10(a) Report be filed within two business days following "any event . . . with an aggregate value of $100,000 or more," unless the "event" is a grant or award pursuant to an employee benefit plan. As proposed, any other reportable event not required to be reported within two business days would be included on an Item 10(a) Report due on or before the end of the second business day of the week following the week in which the event occurred, unless the "aggregate value" of the event and of all other events that have not previously been reported is less than $10,000, or the event is otherwise exempt from the Item 10(a) reporting requirements.
As discussed further in Part V.D. of this letter, we oppose using the "aggregate value" of acquisitions or dispositions as a basis for determining whether or when a transaction is reportable. An "aggregate value" reporting standard does not currently exist under the transaction reporting requirements of either Section 16 or Section 13(d). Therefore, creating a novel concept for Item 10(a) Reports would require companies to develop entirely new systems for tracking and calculating the value of transactions and would give rise to a wide range of interpretive issues regarding when and how various types of transactions are to be aggregated for purposes of determining whether there has been an acquisition or disposition of any equity security or derivative security with a specified "aggregate value".
We believe that the proposed reporting deadlines are unnecessarily complex and will impose significant administrative and financial burdens on companies. In the majority of cases, the information contained in Item 10(a) Reports will not be inherently material but instead will contribute incrementally to the mix of other publicly available information regarding a company. Thus, we do not believe that the benefit of two business day reporting justifies the burdens. We believe instead that all reportable transactions should be reported on an Item 10(a) Report due no later than the third business day of the following week, regardless of the size of the transaction.16 This proposal would substantially accelerate the current system of reporting these transactions.17
We believe that weekly reporting of Item 10(a) transactions would provide sufficiently timely information about executive officer transactions. In contrast, reporting insiders' transactions within two business days would impose significant compliance costs and would not necessarily improve the quality or informational content of Item 10(a) Reports.18
In evaluating a two business day reporting requirement for Item 10(a) Reports, we believe it important for the Commission to recognize that, in contrast to most reporting obligations imposed on companies under the Exchange Act, companies often will not be a party to or, but for the Item 10(a) reporting obligation, involved with the transactions that will be reportable on Item 10(a) Reports. Because a company often will be dependent on others to notify it that an Item 10(a) Report is due, two business day reporting would not give a company adequate time to obtain the required information, prepare the filing, review the filing for accuracy, and EDGARize the filing.
If companies were required to report insiders' transactions within two business days, companies would need to employ "firehouse staffing," maintaining someone available who could prepare and file an Item 10(a) Report on Form 8-K promptly after an insider engages in a reportable transaction. It would no longer be possible for one person to coordinate and finalize all director and executive officer reports. Unlike monthly reporting on Form 4, companies would be obliged to employ additional staff to handle more frequent filings and to provide backup during periods of intense business activity, or when the person who typically handles filing responsibilities is not available to prepare an Item 10(a) Report because of out-of-town travel, vacation, sickness, or other responsibilities and commitments. We believe that this need for additional staffing will substantially increase the cost of the proposed reporting regime.19 While the Commission has proposed only limited consequences for a company's failure to timely file Item 10(a) Reports, companies will nonetheless need to incur the cost to maintain an appropriate reporting infrastructure both as a result of their own good faith intention to be in a position to comply with the reporting rules and in order to be able to satisfy the standard required under the proposed affirmative defense from liability for late reports.
Companies attempting to report insiders' transactions within two business days also would face other administrative hurdles, several of which were addressed in Part II of this comment letter. These hurdles include the fact that brokerage firms may be unable to provide full trade information within a period shorter than their required confirmation delivery date and the fact that transaction administration for broad-based employee benefit plans and stock option plans often is outsourced to a third-party administrator. We believe that the foregoing factors, plus the fundamental fact that Item 10(a) Reports often will be triggered by transactions or events of which a company is unaware and that companies at times will be entirely dependent on third parties for obtaining the information required to be reported, justify applying a following week reporting standard that may differ from the deadlines imposed for other, traditional Form 8-K events.
We believe that many of the foregoing concerns could be avoided or mitigated, while maintaining the utility of the information provided to investors and achieving accelerated disclosure, by modifying the proposal to provide that the proposed weekly reporting scheme cover all Item 10(a) Reports. The weekly report would thus become the principal source of current information regarding transactions by specified executive officers. By grouping all transactions that occur within a single week, Item 10(a) Reports will present investors with a more comprehensive and therefore more informative perspective on insiders' trading and stock-related activity. We also believe that a company will be better able to administer a cost-effective system if the company knows that it needs to survey its insiders at the end of each week and needs to be prepared to make an EDGAR filing on a specified day of each week.20 Under this system, many companies will be able to adapt their existing Section 16 reporting procedures to the accelerated reporting scheme by conducting a survey of insiders' transactions on a weekly basis instead of on a monthly basis. While this will still result in increased compliance costs to companies, companies at least will be able to better plan their staffing needs in light of the more predictable reporting schedule.
The Commission has requested comment on whether it should eliminate deferred year-end reporting on Form 5 of certain transactions under Section 16(a). While we believe that Form 5 has been appropriate for many of the transactions that it currently encompasses, we recommend below that only a targeted list of specifically identified transactions be subject to disclosure on Item 10(a) Reports. If that recommendation is adopted by the Commission, we believe it would be acceptable to require all Section 16 reportable transactions to be included on a monthly Form 4 and to eliminate insiders' ability to defer transaction reporting to year-end Forms 5. We do not believe this will be unduly burdensome because we believe that many counsel currently advise companies and their reporting persons to report Form 5-eligible transactions on a Form 4 to avoid a transaction "slipping through the cracks" at year-end.21 Therefore, Forms 5 could be used only for late reports, or eliminated completely so that late reports are disclosed on Forms 4 by checking the "late filing" box.
For consistency and ease of administration, we believe that Item 10 Reports filed under Item 10(b) or 10(c) also should not be subject to two business day reporting, but instead should have the same filing deadline as Item 10(a) Reports. We note also that frequently insiders enter into Rule 10b5-1 Plans well in advance of the first transactions being effected under the plans, making accelerated reporting unnecessary. As discussed below, we view reports under Item 10(c) as solely isolating a single type of compensatory arrangement. Therefore, we question whether the information proposed to be reported under Item 10(b) and 10(c) is sufficiently significant to justify two business day reporting. Nevertheless, because companies will be involved in establishing any loans that are to be reported under proposed Item 10(c), we do not believe that it would be unduly burdensome if reports under proposed Item 10(c) were due within two business days.
The Proposing Release sets forth expansive and unique company reporting obligations that would require monitoring for and reporting of any transaction in company stock or in derivative securities, unless the transaction falls within a narrow list of exceptions. Under the Proposing Release, Item 10(a) reporting would differ from, and be more expansive than, the reporting regime that currently exists under Section 16(a): proposed Item 10(a) reporting would depend on the "aggregate value" of a transaction, a concept not embodied in existing reporting requirements under Section 16, and proposed Item 10(a) reporting would apply to transactions that are not reportable under Section 16. We believe that attempting to implement a wholly new disclosure regime, without regard to whether the transactions required to be reported are of interest or significance to investors, will raise numerous interpretive issues and impose unnecessary costs and burdens without producing significant benefit to the public. We believe instead that the Commission should:
The Commission, companies, insiders and investors already are familiar with and have a substantial investment in the Section 16 reporting system, and the current standardized format for disclosing insider transactions provided by Forms 3, 4 and 5 under Section 16(a) has worked relatively well. Any deficiency in the present transactional disclosure scheme noted in the Proposing Release appears to be a function of the timing and accessibility of those reports, not their content. Accordingly, revisions to the existing disclosure scheme should primarily be addressed to accelerating dissemination of information currently disclosed about particularly significant transactions, instead of adopting a novel and distinct disclosure format.22 Deviations from Section 16 reporting standards would create a dual system of reporting that would be costly and time consuming to companies and investors who would be required to sort through and reconcile the differences, without any substantial enhancement to the information furnished. Therefore, we believe that working within the Section 16 framework can accomplish the objectives that the Commission expressed in the Proposing Release without forcing companies and investors to learn a different and potentially conflicting system of securities transaction reporting.
We believe that it is highly important that the regulatory text of Item 10 affirmatively list those transactions that are required to be reported in order to clearly delineate the transactions subject to the new Item 10(a) Reports. The approach taken in the Proposing Release, which would require every acquisition or disposition of an equity security or derivative security to be reported and then would exclude a narrow list of transactions by means of language in an Instruction to proposed Item 10, results in unnecessary complexity and uncertainty that (as discussed in Part V.C. below) would give rise to a significant number and variety of novel interpretive issues.23 Requiring companies to report every transaction in company equity securities unless specifically exempted also will impose an unnecessary burden to establish procedures for monitoring, detecting and reporting insignificant transactions (or events that may be deemed to constitute a "transaction" 24) that do little or nothing to promote the objectives of the Item 10 reporting regime. In addition to the complexity of attempting to determine whether any change in beneficial ownership constitutes a transaction that triggers an Item 10(a) Report, the approach set forth in the Proposing Release would result in greater uncertainty over whether a transaction that is comparable to, but does not fall precisely within, the list of excluded transactions set forth in the proposed Instructions to Item 10, needs to be reported. Together, the unique reporting scheme set forth in the Proposing Release, lack of specificity on reportable transactions and narrow exemptions would lead to inconsistent interpretations and increased compliance costs.
The reporting regime set forth in the Proposing Release would result in Item 10(a) Reports covering most transactions that are already subject to Section 16(a) reporting requirements as well as additional transactions that are not required to be reported under Section 16(a). Not only is this result unduly burdensome, it would result in a significant number of filings without any distinction as to whether the transaction triggering the Item 10(a) Report would be viewed as significant by investors.25 As a result, the filing of an Item 10(a) Report would be less likely to signal significant information and the objective of requiring Item 10(a) Reports would be diluted. Therefore, regardless of whether the Commission adopts our recommendation that all Item 10(a) Reports be due in the week following the transaction, we recommend that the Form 8-K be limited to transactions that are likely to be significant and that those that are less significant be subject to current reporting on Form 4 pursuant to Section 16(a). For instance, reports of most benefit plan transactions, such as option grants, deferral elections and stock (or phantom stock) awards, are unlikely to be regarded as important time-sensitive information justifying the Form 8-K approach. Under our proposal, insiders would publicly disclose all Section 16 reportable transactions on or before the tenth day of the following month pursuant to Section 16,26 and companies would provide accelerated Item 10(a) Reports of only specified transactions.
For the reasons discussed in Part V.C. below, we do not support using a dollar threshold to determine which transactions are subject to Item 10(a) Reports. We believe instead that Item 10(a) Reports should be triggered only by certain types of transactions that are both likely to be viewed as significant and that justify accelerated reporting. Accordingly, we believe that reportable transactions should be limited to the following transactions (except to the extent otherwise exempted, as discussed below):
We believe that the foregoing list enumerates the broad categories of transactions in company equity securities that are most likely to be of interest to investors.
In determining whether a transaction that comes within one of the three categories enumerated above is attributed to an insider for purposes of Item 10(a) reporting, we endorse applying the same "pecuniary interest" standards that currently are used under Section 16. In other words, the company would report transactions in which the insider had a pecuniary interest (whether direct or indirect) and as to which the insider possessed some measure of investment control.
In addition to the foregoing transactions, we also recommend that transactions that occur pursuant to a Rule 10b5-1(c) Plan be excluded from Item 10(a) reporting if the existence of the plan was previously reported under Item 10(b) of Form 8-K. If the existence of the plan already has been publicly disclosed, it should not be necessary to provide Item 10(a) information about the execution of transactions under the plans because by their very nature the transactions are beyond the insider's control. As a result, these transactions do not convey time-sensitive information about the insiders' investment decisions beyond that reflected in the disclosure of the existence of the Rule 10b5-1 Plan . In addition, by definition, once a Rule 10b5-1 Plan is established, insiders generally have no influence over how, when or whether to effect transactions under a Rule 10b5-1 Plan. Insiders often would have no knowledge of when a transaction is executed under their Rule 10b5-1 Plans. Therefore, companies would have difficulty planning in advance for reporting a Rule 10b5-1 Plan transaction and would be entirely dependent on brokers who are executing Rule 10b5-1 transactions to provide complete, timely and accurate information on transactions that are effected. Because of these limitations on the significance of and ability to report Rule 10b5-1 transactions, we believe that they should not be subject to accelerated company reporting under Item 10(a) and instead should remain subject to end-of-month reporting under Section 16 if already disclosed on Item 10(b).
Under our proposal, there would not be any uncertainty over whether an event relating to equity or derivative securities is a "transaction" that is reportable under Item 10(a) even though not reportable under Section 16. In addition, the following types of transactions would not be subject to Item 10(a) reporting but would remain subject to the Section 16 reporting regime:
If the Commission decides not to accept our recommendation that Item 10(a) specifically enumerate a targeted list of company reportable transactions, we believe that additional reporting exemptions should be added to the list of exempt transactions in the Proposing Release. Specifically, we would recommend inclusion of the following additional exemptions from Item 10(a) reporting:
In addition, we believe that the exemptions should be set forth in the text of Item 10(a) itself, instead of being relegated to instructions to the rules.35
We do not support the standard set forth in the Proposing Release which would apply an "aggregate value" test to determine whether and when transactions are reportable under Item 10(a). The proposed reporting standard would represent a unique obligation without any guiding precedent under the federal securities laws to determine when an acquisition or disposition of either an equity security or a derivative security constitutes a reportable "event" and without any precedent on how to calculate the "aggregate value" dollar thresholds. We believe that interpreting these standards, together with related issues such as whether different transactions need to be aggregated or integrated, and developing a system to monitor and report transactions under these unique standards, would give rise to significant interpretive and administrative difficulties, resulting in unnecessary expense and complexity as companies attempt to comply with the requirements. As described above, we believe that the appropriate manner in which to avoid this issue is to eliminate reporting thresholds based on transaction valuations and instead to require Item 10(a) Reports for all transactions falling within specifically enumerated and well-defined categories.
A regulatory approach that would create a new category of reportable "events" subject to a dollar threshold would raise a variety of interpretive issues. The Proposing Release's request for comments on this issue only touches the surface of these issues. One area where interpretive issues would arise under the proposed standard revolve around when acquisitions or disposition transactions constitute a single "event" that is subject to reporting. A second area where interpretive issues would arise involves when transactions occurring over several days are to be aggregated. Another area where interpretive issues would arise relates to how the $100,000 threshold would apply for determining when an event or transaction needs to be reported. Examples of these types of interpretive questions include the following:
Even after these interpretive issues are resolved, administration of the proposed system will be complex due to the need to track the value of transactions and apply the applicable interpretations, as they are issued, regarding aggregation. The record keeping required to track the aggregation of transactions to meet the $10,000 and $100,000 thresholds is likely to be complex and may be prone to miscalculations.
If the Commission requires only a specifically enumerated list of transactions to be included on Item 10(a) Reports, certain of our members believe that it would also be appropriate to adopt a de minimis reporting exception that companies could elect to apply to avoid reporting insignificant Item 10(a) transactions. While application of a de minimis exception would potentially raise some of the same interpretive questions set forth above, those issues would be much less significant if they are relevant only to obtain relief from Item 10(a) reporting, as opposed to being applied to trigger a mandatory reporting requirement. In addition, if the Commission were to adopt a de minimis exception in the context of a reporting regime that requires only specifically identified transactions to be reported, companies would not be required to implement a system for monitoring and calculating the aggregate value of transactions, but instead would use the exemption in instances involving simple purchases or sales that occur in isolated transactions or as a last resort for handling inadvertent reporting omissions.
If, however, the Commission determines to require all transactions to be reported subject only to an "aggregate value" threshold, effectively requiring companies to go to the effort of calculating transaction values, then we believe strongly that the Commission should (i) set forth in its adopting release clear guidance on whether and how different types of transactions or transactions occurring over several days are to be aggregated, and (ii) establish a de minimis exception to ease the burdens of the reporting system and reduce the incidence of inadvertent failures to report. Any such de minimis exception should apply to both acquisitions and dispositions of equity securities and, because the existing $10,000 exception under Section 16(a) has not been increased to reflect inflation and the increased prevalence of stock-based compensation, should have a significantly higher threshold (for example, $60,000 or $100,000).
Similarly, if the Commission determines to require two business day reporting for certain transactions notwithstanding our strongly held view as to the infeasibility of such a standard, then we believe that the Commission should specifically identify a list of transactions subject to that two business day reporting standard (as discussed above in Part V.B.1.)36 and should provide a high reporting threshold (such as the greater of $500,000 or 25% of the shares beneficially owned by the insider). By taking both of these steps to focus the reporting obligation on transactions that investors would view as unquestionably extraordinary and significant, the Commission would be able to reduce the costs and burdens that would be imposed on companies to constantly monitor and track transactions and would reduce (but not eliminate) the significance of the interpretive issues that the unique dollar reporting threshold would generate.
We believe that the information that companies should report on an accelerated basis should be the same information that insiders report on Section 16(a) reports, other than their end-of-period holdings.37 We believe that this consistency would help achieve the goal of keeping the accelerated company reporting system simple and more readily understood. In addition, we believe it is critically important that the requirements of the two systems - one for companies and one for insiders - be phrased exactly the same.38 Minor differences in language can cause needless interpretive questions and headaches that will result in inefficiencies and confusion. Similarly, the information should be reported in the same tabular format as is used on Forms 4. This will simplify the reporting regime, promote investor understanding, facilitate electronic data-mining and assist the public in reconciling transactions that are included on both Item 10(a) Reports and Forms 4.
The following table compares the information about a particular transaction in equity securities (other than derivative securities) as outlined in the Proposing Release with the information required under Section 16(a):
|Proposing Release||Form 4|
|Name and title of director or executive officer||Introduction, #1 - Name and address of reporting person|
Introduction, #6 - Relationship of reporting person to the company
|Date of transaction||Table I, #2 - Transaction date|
|Title and number of securities acquired or disposed of||Table I, #1 - Title of security
Table I, #4 - Securities acquired or disposed of (amount)
|Per share acquisition or disposition price, if any||Table I, #4 - Price|
|Aggregate value of the transaction||Not required|
|Nature of the transaction||Table I, #3 - Transaction code|
|Any other material information regarding the transaction||Not required|
As is evident from the comparison, the only difference between the information proposed for accelerated Item 10(a) reporting and the information currently provided in a Section 16(a) report relates to the aggregate value of the transaction and the "other material information" category. The aggregate value of the transaction easily can be derived from the other information in the form. The Proposing Release does not address what is intended to be encompassed by the requirement for "other material information" and does not explain why a company preparing a Form 8-K should be required to consider and potentially disclose more information than is required to be reported under Section 16. Therefore, we believe this type of "catch-all" request is not appropriate for an accelerated reporting requirement in which the company is dependent on others for supplying all of the information that it needs to report. The open-ended nature of applying a materiality standard to reports regarding transactions that in many cases may not be material will leave companies guessing about what the Commission might consider to be material. Furthermore, we believe that it is unlikely that there will be anything material about these transactions other than the information already specifically requested. Reporting persons have made use of the "Explanation of Response" section on Section 16(a) reports in those cases where additional information would be helpful to explain transactions. We suspect that companies would do so here as well without any specific requirement to do so.39
We agree that end-of-period holdings information should not be required in Item 10(a) Reports. Such information would be difficult to compile and report on an accelerated basis under Form 8-K and we believe that such information is not necessary to fulfill the objectives of the Item 10(a) reporting regime.
We likewise believe that derivative securities should be treated the same as equity securities for purposes of Item 10(a) Reports. Just as we believe that the same pecuniary interest standard for disclosure should apply under both Item 10 and Section 16, we believe that the same standard as to what types of arrangements constitute reportable "derivative securities" should be applied. We recognize that applying the Section 16 definitions would mean that Item 10(a) Reports would not include options and other arrangements without a fixed exercise or conversion price as well as certain other arrangements that are subject to performance conditions.40 In our experience, these types of derivative securities are relatively rare and are not often held by insiders. Moreover, without any evidence that these types of arrangements have been subject to any abuse, we believe it would be unwise and inefficient to create a separate reporting scheme that differs from the one that currently applies under Section 16.
The proposed text for Instruction 1 to Item 10 relating to the definition of derivative securities, as currently drafted, also raises interpretive questions about what is covered by the term "derivative securities". The proposed Instruction states that the term "derivative security" "includes" certain items not currently encompassed in the Rule 16a-1(c) definition of "derivative securities" but does not set forth an exclusive list of the additional instruments that are "included". For example, the proposed Instruction does not address whether all of the arrangements excluded from the definition of "derivative security" under Rule 16a-1(c)(1) through (7) are likewise excludable from reporting under Item 10(a). Therefore, if the Commission determines not to apply the exact same definition of "derivative security" under both Section 16 and Item 10(a), then (as with our view on the regulatory text for Item 10(a) reportable transactions generally) we believe the Commission should specify an exclusive list of arrangements that, in addition to those covered by Section 16, constitute Item 10(a) reportable arrangements, and should delete the open-ended "including" language from the definition of "derivative security".
The information required in the Proposing Release for derivative securities is consistent with the information currently required on Forms 4. Again, and for the reasons stated above, we urge the Commission to use the exact language of Section 16(a) reports to elicit the information required under the new Item and to require reporting to follow the same format as is used on Forms 4. The following table compares the additional information required under the Proposing Release with the current Section 16(a) reporting system for derivative securities:
|Proposing Release||Form 4|
|Per share exercise or conversion price||Table II, #2 - Conversion or Exercise Price of Derivative Security|
|Date(s) on which each derivative security becomes exercisable (or subject to termination) and its date of expiration||Table II, # 6 - Date Exercisable and Expiration Date|
|Title and number of underlying securities (or cash equivalent) that would be acquired or disposed of upon exercise, conversion, termination or settlement||Table II, #7 - Title and Amount of Underlying Securities|
|Nature of the transaction, indicating whether the transaction involves a collar or other hedge, and if so describing all material terms||Table II, #4 - Transaction Code|
|Any other material information regarding the transaction, including contingencies to exercise||Not required|
The only significant differences in the proposed Item 10(a) information and the required Section 16(a) disclosures concern the specific identification of a collar or hedge, along with a description of the material terms, and the "catch-all" category of all other material information. We believe that these differences are not significant and, in any event, the company and reporting person will likely provide this information voluntarily if the nature of the transaction is not clear from the face of the report. However, if the Commission determines that it is necessary to specifically identify a collar or hedge, we believe that should be addressed through adoption of a Section 16 transaction reporting code specifically for such transactions, which could then be used both on Item 10(a) Reports and on Forms 4.
Because we believe that the format of Item 10(a) Reports and the information required to be disclosed on reportable transactions should be standardized and integrated with the Section 16(a) requirements to the greatest extent possible, we believe that the Item 10(a) Reports should use the same transaction codes as are used for reports filed under Section 16. A standardized reporting format, using the same codes as used for Section 16 reports, will reduce potential confusion engendered by a different reporting methodology (particularly with respect to transactions that are reported once on a Form 8-K and again on a Form 4), will assist in accurate compilation and dissemination of insider trades by data-mining firms and will facilitate understanding of the reports among investors, the press and the public.
Additional codes could be devised where present codes either do not cover the transaction or do not provide sufficient information. For instance, the existing "S" code for and sales that are not exempt under Rule 16b-3 (and the corresponding "P" code for purchases) could be replaced with codes "S/O," "S/N" and "S/C" to indicate transactions that occur in the open market, in privately negotiated transactions with unrelated persons and in transactions with the company, respectively.41
We believe that, if the Commission adopts a new Item 10 reporting regime, it should minimize the need for duplicative disclosures by companies and Section 16 insiders to the greatest extent possible. In order to accomplish this goal, we have a number of recommendations.
We recommend that a company not be required to file an Item 10(a) Report on Form 8-K for any transaction previously reported on a Form 4 that an insider files via the EDGAR system on or before the due date for the Item 10(a) Report. This can best be accomplished by amending the definition of "previously reported" in Rule 12b-2. This approach has several advantages. It will encourage the filing of Forms 4 earlier than the statutorily mandated deadline, it will reduce the potential confusion caused by duplicative filings, and it is more consistent with the statutory framework of the Exchange Act pursuant to which Congress imposed on insiders, instead of companies, the obligation to report their transactions in company securities.42
If the Commission views it desirable for transaction reporting to be set forth on a company-filed report, we recommend that insiders be permitted to incorporate by reference from Item 10 disclosures into their Section 16(a) reports. This approach would reduce the likelihood of transactions being double-counted by investors, recognizing that not all Forms 4 will be filed within the accelerated time frame proposed for an Item 10. It should not be necessary for the incorporated information to be filed as an exhibit to the Section 16(a) report since the Form 8-K reports will be easily accessible on EDGAR. Similarly, we also recommend adding to Form 4 a column that insiders could use at their option to indicate that a transaction was previously reported on a Form 8-K but we do not believe it necessary to require insiders also to indicate the date of the Form 8-K filing.
We believe that the alternatives outlined above are superior to either of the approaches suggested in the Proposing Release, namely, allowing insiders to satisfy their Section 16 reporting obligations by attaching a Form 4 to the company's Item 10(a) Report or permitting a company to satisfy its reporting obligation by adding a Form 8-K header to the insider's Form 4. Treating Section 16(a) reports as "previously reported" (provided that they have been filed through EDGAR and thus are readily available) will be consistent with the approach to all other Form 8-K items already incorporated in General Instruction B.3 of Form 8-K, and permitting incorporation by reference into Section 16(a) reports will be consistent with the approach set forth in Rule 12b-23 with respect to reports under Sections 13(a) and 15(d) of the Exchange Act. These changes would take advantage of existing reporting principles and avoid the additional complexity that the alternative approaches would involve.
In Release No. 34-46084, in the text at note 99, the Commission requested comment on whether it should create a separate form, other than Form 8-K, for disclosure by companies of insiders' transactions in the companies' securities. We support this proposal, because we believe it furthers the objectives of a number of our other comments. For example, it will be easier to clarify that the reports should not be presumed to contain material information or reflect an extraordinary corporate event, to provide a safe harbor from Rule 10b-5 liability, to clarify that failure to file a report does not affect the availability of Forms S-2, S-3 and S-8 or Rule 144, to provide that the information in the reports is not automatically incorporated by reference into other filings and is not deemed to be filed under the Exchange Act and to exclude the reports from any requirement that other Exchange Act filings be posted on a company's website. Consistent with our comments above, we believe that the new form should consist of a cover page, the identical reporting tables from Form 4 (with a different set of tables for each covered person's transactions), and a company signature page.
Because we view the information proposed to be disclosed under Item 10(b) regarding Rule 10b5-1 Plans to be closely related to the transaction reports under proposed Item 10(a), and because companies will be dependent on their insiders to provide information on Rule 10b5-1 Plans, we believe that disclosures required under proposed Item 10(b) should likewise be reportable on a form other than Form 8-K.
The Commission adopted Rule 10b5-1 in 2000 to prevent improper insider trading by adopting a knowing possession or awareness test instead of a use test for trading on the basis of material nonpublic information. Simultaneously, the Commission provided an affirmative defense for transactions made in accordance with strict guidelines.43 The affirmative defense is available to any person who can demonstrate that the transaction occurred pursuant to a binding contract, trading instruction or written plan that was entered into before the person became aware of the material nonpublic information. An additional condition of the affirmative defense is that the arrangement does not permit the person "to exercise any subsequent influence over how, when or whether to effect purchases or sales". Rule 10b5-1 brought greater clarity and certainty to the existing state of the law on insider trading. The affirmative defense has been welcomed and increasingly is used to provide an efficient mechanism for stock transactions by directors and executive officers. The affirmative defense has also quelled investor and media concerns about transactions by insiders during times when they are likely to have material nonpublic information. Most importantly, Rule 10b5-1 has promoted exactly the type of trading by insiders that is most beneficial to the markets: measured amounts of stock gradually made available to the market over a period of time with minimal market disruption.
Proposed Item 10(b) of Form 8-K would require companies to report on Form 8-K each time one of their insiders enters into an arrangement intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to provide more detailed reports when a Rule 10b5-1 Plan is modified or terminated, while Proposed Item 10(a) would require companies to report each trade under a Rule 10b5-1 Plan on an accelerated basis. We believe that Proposed Item 10(b) should be carefully limited to avoid discouraging use of Rule 10b5-1 Plans and creating opportunities for unfair arbitrage on an insider's transactions. As previously discussed in Part V.C., we also strongly believe that the Commission should not require trades pursuant to a previously reported Rule 10b5-1 Plan to be reported on Form 8-K.
Proposed Item 10(b) would require companies, when one of their covered persons enters into a Rule 10b5-1 Plan, to report the insider's name and title, the plan's execution date and a "description of the contract, instruction or written plan, including its duration, the aggregate number of securities to be purchased or sold, and the name of the counterparty or agent".44 If the insider subsequently terminates or modifies the plan, the company would be required to file another more detailed Form 8-K to report the date of the change and a description of the modification to the plan, "including" any changes to the three items above and to the intervals at which transactions would occur, the number of securities to be purchased or sold per interval, and the price at which securities are to be bought or sold.45 In the Proposing Release, the Commission clarifies that an increase or decrease in the applicable price, the number of shares to be sold per interval and the duration of the intervals could be reported in general terms without requiring disclosure of the specific price, number of shares or duration of interval.46
By requiring a "description" that "includes" certain items in Proposed Items 10(b)(1)(iii) and 10(b)(2)(iii), the Commission implies that an Item 10 Report may require information beyond the specified terms but leaves companies guessing about what other terms should be included. We strongly encourage the Commission to limit reporting to a list of items specifically identified in the text of Item 10. We believe these items should be the following:
We do not believe there is a general expectation of privacy with respect to the existence of a Rule 10b5-1 Plan. However, we strongly believe that there is an expectation of privacy regarding the specific economic terms (especially price information) of a Rule 10b5-1 Plan. We believe that Rule 10b5-1 Plans are entered into for a variety of personal financial reasons, including portfolio diversification, mortgage payments and tuition due dates. Many of the plans use sophisticated pricing formulas to determine when sales will be made. This information is not useful to investors and directors and executive officers should not be forced to reveal it. We believe that, if pricing information or the full terms of any plan are required to be disclosed, use of Rule 10b5-1 Plans will sharply decline.
We do not believe there should be a requirement to disclose the counterparty or agent to a Rule 10b5-1 Plan. There is no value to the investor in knowing the broker or other counterparty implementing a Rule 10b5-1 Plan on the insider's behalf; it does not reflect any information about the insider's knowledge about the Company or his or her reasons for selling. This extraneous disclosure does not further the goal of the Proposing Release to provide investors with meaningful information about the market for the company's stock.
We believe these items provide sufficient information to investors of the existence of a Rule 10b5-1 Plan. Further disclosure would not advance the purposes of the Proposing Release and as discussed below may harm the overall objectives of the Commission by discouraging insiders from utilizing Rule 10b5-1 Plans.
As previously noted, proposed Item 10(b) would require disclosure of more information for modifications to Rule 10b5-1 Plans than would be required when an insider initially enters into the Plan. We do not believe that there should be enhanced disclosure requirements when a Rule 10b5-1 Plan is modified, but instead that modification of a Rule 10b5-1 Plan should result in disclosure of the same items enumerated above, together with a statement that the disclosure modifies or amends the previously filed Item 10 disclosure. We believe that the additional reporting requirement for modifications will cause confusion and create incentives for terminations rather than modifications.47 Moreover, if Item 10 requires disclosure of the items enumerated above, then investors will be able to determine for themselves how the plan has been modified. The only item contained in the Proposing Release with respect to modifications that we believe should not be addressed is whether there has been an increase or decrease in the price at which securities are to be purchased or sold. As discussed below, we believe that requiring disclosure of any pricing information will undermine the utility of Rule 10b5-1 Plans by producing inaccurate market signaling and unfair arbitrage. Because we believe that pricing thresholds under plans should not be disclosed, we believe that disclosing changes in those thresholds would not be of use to investors or (to the extent it signals pricing information under the plan) would give rise to the same types of concerns as would disclosure of the price itself.
We recommend also that the Commission clarify that the only types of modifications that trigger an additional (or amended) Item 10 filing are changes in the items that are specifically required to be disclosed (i.e., changes in whether the plan involves purchases or sales, the plan's maximum duration, the interval at which purchases or sales are to occur (if applicable), or the maximum number of shares that may be purchased or sold under the plan).
We suggest the Commission clarify that the Item 10(b) reporting obligation only applies to written plans with a broker for periodic future purchases or sales. We do not believe that oral standing limit orders are intended to be or should be picked up by the proposed rule, even though they may qualify as Rule 10b5-1 Plans. The difficulties of enforcing and administrating such a rule would outweigh any benefits of requiring their pre-disclosure. In addition, we note that oral limit orders tend to be executed on a single day and tend to be in place for a very short period of time. It is likely that most orders would be completed within the weekly reporting time and therefore would be picked up under Item 10(a). Consistent with the Proposing Release, we believe that such arrangements should not be required to be identified as Rule 10b5-1 Plans, regardless of whether they have been executed by the time an Item 10(b) Report would be due. 48
Failure to limit the required disclosure to the specified items in our proposed revised version of Item 10(b)(1)(iii) could:
As a result, there could be a sharp decrease in the number of directors and executive officers using Rule 10b5-1 Plans based on a fear of unintended market consequences. For example, insiders sometimes enter into plans that allow for routine sales so long as the stock price does not go below a certain level (the "floor"). The floor price can be significantly below the price at which the stock is trading at the time the plan is entered into. The low floor price is often tied to the individual's tax basis in the shares and is utilized to ensure liquidity and allow sales to continue to be made over the duration of the contract, often with little expectation that the floor price will ever be reached. However, price disclosure to the public could lead to the impression that the insider believes the share price will sink to such a level. This misunderstanding could materially affect a company's share price. Conversely, an insider who selects a high limit price could be accused of trying to inflate the public's expectations of the share price.
By requiring detailed reporting of Rule 10b5-1 Plans, other investors could use the information to enter into hedges, short-selling arrangements or other transactions designed to take advantage of the disclosure. This risk is heightened if the Commission maintains its position that trades pursuant to Rule 10b5-1 Plans are also reportable. By providing detailed reporting coupled with current transaction reporting, it becomes possible in many cases to determine the specific provisions of the Rule 10b5-1 Plan and to use this information to engage in arbitrage that is economically unfair to the insider and may be viewed as affecting, even manipulating, the trading market for the company's stock. We do not believe there is a strong risk of unfair arbitrage if the reporting requirements are strictly limited to the items specified in our proposed version of Item 10(b)(1)(iii) and there is no transaction reporting requirement. If disclosure is required beyond the specified items, particularly with respect to intervals and price, we would expect insiders to cease to use Rule 10b5-1 Plans because of the potential that they would not receive fair prices in their transactions.
As noted above, we strongly recommend that the Commission clarify that the proposed Form 8-K disclosures should not be presumed to indicate the insider's views about the prospects and performance of the company. This is especially true in the case of the existence of Rule 10b5-1 Plans and transactions that occur under Rule 10b5-1 Plans. By definition, Rule 10b5-1 Plans cannot be entered into on the basis of material nonpublic information, and transactions that occur under such arrangements are not effected on the basis of material nonpublic information.49 Contrary to this key principle, in the Proposing Release the Commission asserts that a director or executive officer's decision to enter into or modify a Rule 10b5-1 Plan "may provide investors with more extensive disclosure of potentially useful information as to the management's views of the performance and prospects or the company".50 The Commission later states that a "director's or executive officer's . . . modification of a Rule 10b5-1 [Plan] may indicate a change regarding the company's prospects, and thus may be valuable information to investors". This assertion undermines the stated intent of the Commission in adopting Rule 10b5-1 less than two years ago - that Rule 10b5-1 Plans cannot be entered into or modified at a time when the insider is in possession of material nonpublic information.51 In fact, in our experience, because Rule 10b5-1 Plans tend to provide for transactions to be effected over a long period of time, we believe that the plans typically reflect insiders' desire for liquidity and diversification and do not reflect any view as to the prospects for a company. The Commission's statement in the Proposing Release suggests to the public exactly the opposite message: that entering into a Rule 10b5-1 Plan, and particularly modifying a Rule 10b5-1 Plan, reflects material information about the company's stock. We believe this message may lead to unwarranted reliance by investors on the mere fact that a director or executive officer has entered into or modified a personal financial plan even though such a plan is not -- and by definition cannot be -- based on material information. We believe that the Commission should specifically acknowledge this aspect of arrangements intended to satisfy Rule 10b5-1.
As discussed earlier in this comment letter, we propose that trades be reportable on the third business day of the week following the transaction and that trades pursuant to a previously reported Rule 10b5-1 Plan not be reportable on Form 8-K.
Many Rule 10b5-1 Plans provide for daily or weekly sales. As currently proposed, the rules would require daily or weekly reporting of transactions under Rule 10b5-1 Plans. For transactions exceeding $100,000, beginning two days after the first trade, the company would have to file Forms 8-K every day for the duration of the plan. For transactions exceeding $10,000, weekly reports would have to be filed. This would create a severe administrative burden and flood the market with filings that do not significantly enhance the information provided in the initial Item 10 Report disclosing the existence of the Rule 10b5-1 Plan. In addition, such disclosure also could have the unintended consequence of discouraging insiders from setting up Rule 10b5-1 Plans with more frequent transactions. Instead, directors and executive officers would gravitate towards plans with monthly or quarterly sales. This would be an unfortunate development, as steady, frequent sales generally cause the least amount of market disruption.
Moreover, requiring reporting of each trade under a Rule 10b5-1 Plan does not further the Commission's goal of providing information to the public about an insider's view of the company because the decision to enter into the plan has already been disclosed. Pursuant to the terms of Rule 10b5-1(c), the trades are not made with any subsequent input or influence by the insider and therefore do not convey information regarding the insider's view of the company.
Under paragraph (c) of proposed Item 10, a company would be required to report any transaction in which the company or an affiliate of the company agrees to lend or lends money to a director or executive officer, or enters into a guarantee or similar arrangement in favor of another person who agrees to lend or lends money to the director or executive officer. The company would also be required to report loan forgiveness, foreclosure on assets pledged to secure the loan, and the company's payment on a loan guarantee, in each case whether or not the loan or guarantee involves company stock.
Although we understand concerns over several recent incidents of abusive insider loans, for the reasons discussed below, we recommend that the proposed reporting requirements as applied to insider loans be narrowed to exclude any loans that do not involve company stock. If the Commission determines not to accept this recommendation and instead adopts a broader disclosure requirement, we recommend that it consider the following more narrow alternative requirements (in order of preference): (1) instead of requiring companies to report loan arrangements on a current basis on Form 8-K, amend the existing requirement for annual disclosure of loan transactions under Item 404(c) of Regulation S-K to require disclosure on a quarterly basis on Form 10-Q; or (2) if current reporting of loan arrangements is required on Form 8-K, including loans that do not involve company stock, then (a) raise the dollar threshold triggering this disclosure requirement to an amount that will limit reporting to arrangements that are sufficiently material to merit current reporting (which we suggest to be $250,000), and (b) exclude from the current reporting requirement the following: relocation loans, loans related to new-hire arrangements, loans made in the ordinary course of a company's business and other arrangements that currently are not required to be reported under Item 404 of Regulation S-K, each irrespective of the dollar amount involved.
The Proposing Release would require reporting of arrangements in which the company (or an affiliate) lends money directly to an officer or director, or guarantees a loan made by a third-party lender to an insider, whether or not the arrangement involves company stock. We believe that requiring current disclosure of all company loans and company guarantees of loans to insiders involving more than $10,000 is unnecessarily broad. The proposal relating to loans stands out from the other transactions addressed in the Proposing Release in that the other transactions involve company stock and the purpose of the proposed reporting requirements currently appears to be to accelerate public disclosure of insiders' company stock transactions. Based upon current practice, we believe that many of the loan transactions that would be required to be reported under the proposal would be compensatory arrangements with insiders that are more similar to cash or other incentive bonus arrangements than they are to transactions and arrangements that involve company stock or the market for company stock.
The press release (dated February 13, 2002) announcing the Commission's intention to propose new rules relating to insider reporting stated that the Commission's purpose was to "improve public disclosure of trading activities by executive officers [and] directors . . ." and that the Commission intended to propose that "companies disclose on a current basis significant transactions in the company's stock by their executive officers and directors". The Proposing Release, in addressing current reporting for insider loan transactions that do not involve company stock, expands the proposed company reporting obligations beyond the realm of insider stock transactions and into the much broader realm of general compensation.
We believe that expanding the current reporting obligations into general compensation matters takes the proposed disclosure requirements too far. We believe that the current disclosure structure that applies to insider compensation arrangements is better suited to provide clear and comprehensive disclosure on these matters. Requiring current reporting of one aspect of an insider's overall non-equity compensation package would result in piecemeal, serial presentation of compensation arrangements and draw undue attention to arrangements that may in fact be insignificant, while other aspects of an executive's compensation package would remain subject to annual disclosure. In light of the existing comprehensive disclosure regime for compensatory arrangements under Items 402 and 404 of Regulation S-K,52 we do not believe that one particular type of compensation arrangement should be isolated for Form 8-K disclosure.
The current disclosure structure that applies to the compensation arrangements of named executive officers and directors, as well as interested party transactions, results in a full disclosure of these arrangements in either the company's Form 10-K or in the proxy statement for its annual stockholders' meeting. We believe that a single annual presentation of this data results in better overall disclosure to investors than would occur with piecemeal disclosure under Item 10(c) because the existing requirements present the entire compensation package and, in the context of proxy statements, accompany them with a compensation committee report explaining the basis for the arrangements.
We believe that it is anomalous to single out insider loans and require that they be reported on a current basis. A company may make loans to an officer for a variety of reasons, including to facilitate the officer's relocation or as an advance on earned but as yet unpaid bonuses. We cannot reconcile the need to report on a current basis loans, the majority of which are required to be and are repaid by the insider, while allowing salary increases, bonus payments and other amounts, all of which may be significantly more material than reported loan amounts and the cash amounts of which are not by their terms recoverable by the company, to be disclosed on a deferred basis. This is not to suggest that current reporting of all insider non-equity-based compensation is appropriate, much less to suggest that all arrangements picked up by Items 402 and 404 of Regulation S-K should be reported currently. We think that doing so would flood the EDGAR system with innumerable filings that would not, because of the absence of any organizational presentation, provide useful information to investors.
If the Commission determines not to accept our recommendation to narrow proposed Item 10(c) to include only loans involving company stock and instead adopts a broader proposal such as the one reflected in the Proposing Release, we recommend that it consider the following more narrow alternative requirements:
Require Quarterly Reporting of Loans. If the Commission believes it is appropriate for companies to be required to report loan arrangements not involving company stock more frequently than on an annual basis, we recommend that they be required to update loan arrangements under Regulation S-K Item 404(c) on a quarterly basis in their Forms 10-Q (to the extent changes have occurred since prior filings), instead of on a Form 8-K.
If the Commission nonetheless determines that current reporting on Form 8-K of loan arrangements is appropriate regardless of whether they involve company stock, we recommend that the requirement be narrowed as follows:
Impose Appropriate Dollar Threshold for Loan Reporting Obligations. We do not believe that it will serve investors or improve corporate disclosure to require a company to file a Form 8-K when a company loans or guarantees a third-party loan to an insider where the arrangement does not involve company stock and where the dollar amount involved is not material. We suggest that loans not involving company stock where the dollar amount is below a specified threshold (which we would view as being at least $250,000) are unlikely to be material and should not trigger a current reporting obligation. For loan amounts below the threshold, we believe it would be appropriate to permit companies to disclose such arrangements as currently required under existing disclosure rules (i.e., on an annual basis under Regulation S-K's Item 404(c)).
Exclude Certain Types of Loan Arrangements. Many company loans to insiders are relocation loans or loans that arise in the context of negotiating a new employment arrangement with a prospective officer. We do not believe that current reporting of these arrangements would further overall corporate disclosure. In addition, we believe that the Commission should adopt an exemption that excludes other types of loans that are not required to be disclosed under Item 404. For example, just as ordinary course of business loans and loans made by banks and other entities that extend loans in the ordinary course of their business are excluded under Instructions 2 and 3 to Item 404(c) of Regulation S-K, such arrangements likewise should not be reportable under Item 10(c). Likewise, Item 10(c) should exclude loans that are not currently disclosed under Instruction 1 to Item 404. Under that instruction, companies do not currently disclose arrangements described under Rule 402(a)(7) (i.e., loans made under certain plans that do not discriminate in favor of executive officers and directors and are available generally to all salaried employees).53 Finally, we believe the instructions should specifically exclude loans under tax-qualified employee benefit plans, even though such plans may be viewed as affiliates of a company.
The Commission has requested comments to several questions relating to the appropriate level of responsibility that public companies should bear for reporting transactions by executives and directors as required by the Proposing Release. For the reasons discussed below, it is our view that Item 10 Reports:
In addition, we believe the affirmative defense for companies' failure to file Item 10 Reports should be set forth affirmatively in the regulatory text.
The consequences to a company for reporting delinquencies should reflect the inherent difficulties that result from requiring companies to file reports where the companies are dependent on others to notify them of the triggering event and to provide the information required to be filed. In addition, the novel nature of the proposed Item 10 reporting regime will further increase the likelihood of filing delinquencies. Accordingly, the consequences to companies for filing delinquencies should be limited only to potential enforcement action by the Commission for violations of Section 13(a) and 15(d) of the Exchange Act and Section 30 of the Investment Company Act.
In no event should either a company's ability to use short-form registration statements or its stockholders' ability to use Rule 144 be affected by Item 10 delinquencies. As the Commission has previously acknowledged, "[t]he reporting status requirements in Forms S-2, S-3 and S-8 and Rule 144 . . . were not intended to be linked to a system for dissemination of discrete information outside of the traditional periodic reporting obligations of companies".54 Traditional periodic reporting obligations are fixed. Companies can monitor efficiently these obligations and prepare for them in advance. Therefore, it is appropriate to sanction companies for violation of these periodic reporting requirements because they fairly indicate shortcomings in a company's disclosure processes.
This is not true with respect to the reporting of insider transactions. Even among companies that have a pre-clearance requirement as part of their insider trading policy, these transactions usually occur with limited advance notice to the company. Further, with the proliferation of Rule 10b5-1 Plans, the timing of insider transactions is not confined to traditional window periods following scheduled earnings releases. Insider transactions occur all year long and often at unpredictable times as a result of limit orders and complex formulas. These factors undermine the ability of a company to make preparations to comply with the proposed Form 8-K filing requirements. As a result, it would be inequitable for delinquent filings to cause a company to lose eligibility for short-form registration, which is critical for raising funds efficiently in the capital markets. Similarly, it would be inequitable if late Item 10 Reports resulted in the unavailability of Rule 144 until the Form 8-K was filed. This consequence would hurt the interests of those stockholders of a company who rely on Rule 144 for liquidity and could expose the company to various contractual liabilities.
Lastly, as a practical matter, it would be difficult for a company to ascertain whether it was delinquent in filing an Item 10 Report because, in most cases, the company is not a party to the event triggering disclosure. This is different than the situation with all of the other existing reportable items under Form 8-K. Indeed, under the proposal, an outside director with whom the company has limited contact and control may be the cause of the triggering transaction. As a result, a company typically would be unaware that a delinquency had occurred and that it had become ineligible to use the short-form registration statements or Rule 144. This problem becomes even more intractable given the imprecise nature of applying the definition of "indirect pecuniary interest". Executives and directors may not themselves be aware that persons whose transactions are attributed to them under Rule 16a-1(a)(2)(i) have engaged in transactions in company securities, thereby triggering an Item 10 reporting obligation for the company.
The liability of companies for Item 10 disclosures should reflect the fact that companies are acting solely as conduits for the reporting of information about transactions effected by their insiders. As mere conduits, companies should not be subject to liability under Section 18 of the Exchange Act, unless the company specifically indicates that the report is "filed" under the Exchange Act, nor should Item 10 Reports be automatically incorporated by reference into registration statements under the Securities Act. Any new reporting rules should not create new duties under the antifraud provisions of the federal securities laws or in private rights of action. Therefore, we believe that the Commission should adopt a provision under Item 10 comparable to Rule 102 under Regulation FD, providing that no failure to make a public disclosure required under Item 10 shall be deemed to be a violation of Exchange Act Rule 10b-5.
Except for certain compensatory transactions (e.g., stock option grants) and loans, companies are not involved directly in most of the transactions requiring Item 10 disclosure. Therefore, companies may have no independent knowledge of the transaction and very little time or means to verify information provided by an executive or director. For example, if a director sells 500,000 shares in the open market, the company will likely receive an email from the director or the director's broker containing the details of the transaction. If the email accidentally refers to the sale as a purchase or incorrectly describes share or price information, the company could be exposed to claims that it disseminated misleading information even though the company has no independent means of verifying the information. This potential liability is inherent in the reporting regime in the Proposing Release, and companies generally will not be able to effectively mitigate it. Because the company is necessarily acting only as a conduit for the reporting of information by others and would have little opportunity to verify information that it will be required to report, it would be inequitable to subject the company to liability for Item 10 disclosures.
Further, as discussed elsewhere in this letter, it our view that the information required by Item 10 is of limited disclosure value and may be misleading to investors if viewed in isolation.55 This further strengthens our view that companies should not be subject to liability for Item 10 disclosures.
For many of the same reasons described above, the Commission limited companies' liability for Regulation FD disclosures and filing delinquencies. We believe that such an approach is even more important in this context given the inherent difficulties companies will experience in bearing the burden of reporting matters that they are not directly involved in and as to which they are dependent on others for information.
We support the concept of an affirmative defense for companies' inadvertent failure to comply with Item 10. However, we believe that this affirmative defense should be set forth explicitly in the text of Form 8-K. We are concerned over the uncertainty that companies will have over whether they can rely on the Commission's proposed statement in the Instruction to Item 10 setting forth a "finding" that it would not be in the public interest to pursue public companies for reporting delinquencies unless it is evident that the company had failed to implement reasonable measures to address the new reporting requirements. The Commission has on other occasions adopted an affirmative defense that is set forth in its regulatory text.56
We believe that a 60-day transition period is not long enough for companies to adopt and implement the procedures necessary for compliance with the new reporting requirements. In our view, it will take at least 30 days for counsel to absorb the new rules and to communicate to their clients precisely what information needs to be collected and reported. It will then take significant additional time for companies to inform insiders of the scope of the final rules, to communicate with all affected parties from whom they will need to collect information for reporting (including brokers and third party plan administrators), and to design and implement procedures for collecting the required information and reporting it on a timely basis, as described in more detail below.
We believe that, given necessary in-house educational and training needs, the number of potential information sources a company will need to coordinate with, the need to educate executive officers and directors as to the additional transactions that must be reported to the company, and the much accelerated reporting deadlines required by the rules, a transition period of more than 60 days is necessary for transactions not occurring under tax-conditioned plans (we suggest at least 120 days). With respect to transactions occurring under tax-conditioned plans, we believe a longer transition period is appropriate (we suggest 180 days).57
Numerous factors make it difficult to develop and implement appropriate procedures within a 60-day period:
We believe the proposed 60-day transition period is inadequate even for gathering historical information (i.e., outstanding loans and Rule 10b5-1 Plans). Assuming a 30-day initial period for counsel to fully absorb and communicate the requirements, and at least a week for a company to compile, format and prepare the filing for EDGAR, this leaves only a few weeks for insiders to review their records for the relevant information.
We understand the public policy reason for having the information called for by Item 10 made publicly available as soon as possible, yet we believe that the proposed transition period is too short for most companies. We believe, however, that if the Commission were to establish a longer effective date, many companies would voluntarily begin to file Item 10 Reports earlier as a means of getting their insiders in the habit of timely reporting transactions to the company and of testing their reporting preparedness.
The Proposing Release solicited comments as to whether Rule 10b5-1 Plans entered into prior to the adoption of Item 10 were entered into with privacy expectations that would warrant excluding them from the required disclosure. In our experience many, but by no means all, companies have disclosed the adoption of such plans by their senior executive officers. Because Rule 10b5-1 Plans tend to provide for transactions to be effected over a long period of time, we believe that in most cases the plans reflect insiders' desire for liquidity and diversification and do not reflect any view as to the prospects for a company. Therefore, we recommend that the Commission encourage, but not require, disclosure of Rule 10b5-1 Plans that were entered into prior to adoption of the new rules.
We do not believe the Commission should require companies to post Item 10 Reports on their web sites. While a company has a limited number of Form 10-K and 10-Q filings each year with known due dates, and thus can plan for posting them on its website, the number of Item 10 Reports is unpredictable and likely to be large, making it difficult for a company to plan for such postings, and requiring additional staff resources. We believe that having the Item 10 information available on the Commission's website is sufficient to provide the market with access to this information, but expect that the information will be further disseminated by commercial services and perhaps the press, in the way Section 16 reports currently are disseminated. We also believe Item 10 Reports should be excluded from those Form 8-K reports a company needs to consider in determining whether it can say it posts on its website in accordance with the Commission's proposal in Release No. 34-45741.
We believe it is likely that companies will become more involved in coordinating their insiders' transactions in order to be able to satisfy Item 10(a) reporting requirements. In order to avoid any question as to possible collateral consequences of efforts that companies undertake in good faith to promote compliance with Item 10(a) reporting requirements, we believe that the Commission should state in any adopting release on Item 10 that company actions to monitor and facilitate reporting on insiders' transactions for purposes of complying with Item 10(a) will not be deemed to result in those insiders "acting in concert" for purposes of the aggregation provision under Rule 144(e)(3)(vi) and will not be deemed to result in the insiders constituting a "group" under Section 13(d)(3) and Rule 13d-5(b)(1).
We appreciate the opportunity to submit comments. We are available to meet with the Commission or the Staff and to respond to any questions.
/s/Stanley Keller, Chair
Committee on Federal Regulation of Securities
/s/Scott Spector, Chair
Subcommittee on Employee Benefits, Executive Compensation and Section 16
/s/Anne G. Plimpton, Vice Chair
Subcommittee on Employee Benefits, Executive Compensation and Section 16
Ronald O. Mueller, chair
David A. Cifrino
Robert E. Curley
Alan L. Dye
Matthew J. Gardella
Sharon J. Hendricks
Keith F. Higgins
W. Alan Kailer
J. Sue Morgan
Gloria W. Nusbacher
Peter J. Romeo
David A. Schuette
Beth Pagel Serebransky
Ann Yvonne Walker
cc: Hon. Harvey L. Pitt
Chairman of the Securities and Exchange Commission
Hon. Isaac C. Hunt, Jr.
Hon. Cynthia A. Glassman
Alan L. Beller, Esq.
Director of Division of Corporation Finance
1 The Commission has previously adopted rules requiring disclosure of information on transactions between insiders and third parties where there was a sufficient nexus between that information and the company. For example, Item 402(a) of Regulation S-K currently requires companies to disclose annually all compensation paid "by any person" to the company's chief executive officer and certain other highly paid executive officers "for all services rendered in all capacities to the registrant and its subsidiaries".
2 For example, Item 403 currently requires disclosure of beneficial ownership of equity securities and Item 404 requires disclosure of certain loan transactions.
3 We believe that a company's Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), which is intended to assist investors in "seeing through the eyes of management," is a far more effective vehicle for providing investors with information regarding management's views of the company's performance and prospects, and we commend the Commission's on-going efforts to reform financial reporting and disclosure practices through enhanced MD&A disclosure.
4 Courts have recognized that stock transactions of themselves do not imply the existence of inside information or other motives by insiders. For example, the Ninth Circuit recently stated, "But not every sale of stock by a corporate insider shows that the share price is about to decline. A corporate insider may sell stock to fund major family expenses, diversify his portfolio, or arrange his estate plan. He may sell stock in a pattern that has nothing to do with any inside information, such as selling stock twice a year when the college tuition for his children is due." Ronconi v. Larkin, 253 F.3d 423, 435 (9th Cir. 2001). See also, In re Theragenics Corp. Sec. Lit., 105 F. Supp. 2d 1342, 1361 (N.D. GA. 2002) ("There are many reasons why Defendants Jacobs and Smith may have sold stock during the class period.")
5 J. Lakonishok and I. Lee, "Are Insiders' Trades Informative?," Review of Financial Studies, Vol. 14, Issue 1 (Spring 2001).
6 A similar statement currently exists with respect to reports filed under Item 5 and Item 9 of Form 8-K, pursuant to Instruction B.5. of the Form ("A registrant's report under Item 5 or Item 9 will not be deemed an admission as to the materiality of any information in the report that is required to be disclosed solely by Regulation FD."). See also, Part IX.B. of this letter, where we recommend that, as with Rule 102 under Regulation FD, the failure to file an Item 10 Report should not be deemed a violation of Rule 10b-5. This point has significant disclosure implications for companies and insiders. The Commission elsewhere has stated that Forms 8-K are intended for "extraordinary" corporate events. See Release Nos. 33-8106, 34-46084 (June 17, 2002). If insider transactions are viewed as always involving material company information, an issue could arise over whether a company would be required to impose a trading black-out until an insider stock transaction is reported on Form 8-K.
7 The information obtained by a company through its preclearance procedures therefore is similar to that reported on a Form 144: information on an insiders' intention to sell up to a specified number of shares in the near future.
8 While many companies provide this assistance, others do not. Even when companies do offer assistance, insiders are free to handle the reporting themselves.
9 It may also be appropriate for the chairman to be covered by Item 10, if that person is treated as an employee.
10 We note that Release No. 34-46084 proposes to require Form 8-K disclosure of the resignation of specified executive officers; specifically, those listed above and the chief accounting officer. We believe that the executive officers whose resignations are reportable on a Form 8-K and the executives who are subject to Item 10 disclosures should be the same.
11 Section 16 reporting could occur within a reasonably short timeframe in light of our recommendation in Part V.B. that delayed reporting on Form 5 be eliminated.
12 We were unable to conceive of an effective regulatory means for identifying and excluding dissident directors from the proposed reporting scheme. If the Commission were to require Item 10 Reports for outside directors other than "dissident" directors, one possibility that may approach this result, but that would not cover all dissident directors, would be to exclude from Item 10 reports outside directors whose stock holdings are covered by a Schedule 13D filed by that director or by a group that includes that director. Alternatively, companies could be required to disclose under Item 10 of Form 8-K the name of any director who has indicated directly or indirectly that he or she does not intend to provide the company with information needed by it to prepare Item 10 Reports.
13 State corporate laws generally prohibit corporations from removing directors from office prior to the expiration of their terms without shareholder approval, absent some egregious condition, such as being declared of unsound mind by a court, being convicted of a felony or being found by a court to have committed fraudulent or dishonest acts or gross abuse of authority. See, e.g., Delaware General Corporation Law Section 141(k) and California Corporations Code Sections 302, 303 and 304.
14 See also Reed, Elliott, Creech & Roth (March 30, 1993) and Thelen, Marrin, Johnson & Bridges (December 23, 1994).
15 Approximately 68% of the companies that have responded, as of the date hereof, to an online survey conducted by The Corporate Counsel have stated that they hire a financial printer for their Form 8-K filings. Only about 18% of the surveyed companies have responded that they file their Form 8-Ks in-house. See TheCorporateCounsel.net.
16 As discussed in Part V.C. below, we also believe that only certain types of transactions which are most likely to be of interest to investors should be reportable under Item 10(a), and that all transactions should be subject to monthly reporting on Form 4.
17 For the reasons identified in this letter, if the Commission nevertheless were to require two business day reporting of any Item 10(a) transactions, those items should be limited to the transactions of greatest significance based on the insider involved and nature of the transaction, consistent with discussions elsewhere in this letter. See Part V.B. below.
18 If Item 10 Reports result in piecemeal disclosure of a series of transactions that occur over a number of days or weeks, reporting within two business days will result in more fragmented information that may take a greater effort to decipher than Section 16 reports, which report all transactions occurring within a month.
19 In this respect, we believe that the Commission's cost/benefit analysis for the rule proposals understates the cost of compliance. First, it assumes that costs are only incurred in the actual preparation of the report. Second, it does not factor in the cost of providing the necessary personnel to constantly monitor for reportable transactions or the opportunity cost of having to maintain the availability of personnel who are capable of filing an Item 10 Report within two business days, regardless of whether they are actually called upon to make such a filing at any point in time.
20 We believe that filing on the third business day of each week would provide companies time to obtain transaction information under the T+3 settlement cycle, even for Friday transactions. This will provide a more reliable flow of data and leave time for monitoring services to compile and disseminate the data to end users by the end of the week, while minimizing potential reporting difficulties under the T+3 settlement cycle.
21 The exception to this advice is typically in situations where equity securities accumulate monthly or quarterly, such as through deferred compensation plans. In those instances, aggregate year-end reporting is preferable from an administrative point of view. Nevertheless, monthly reporting of such transactions on Form 4 is preferable to a company obligation to report such transactions on weekly Item 10(a) Reports.
22 A further rationale for limiting the introduction of a new disclosure format is to minimize the need for companies and the Commission staff to expend significant resources and incur significant expense in developing interpretive guidance on the reporting regime, as was the case following the adoption of new insider reporting rules under Section 16(a) in 1991.
23 We fear that the drafting approach taken for Item 10(a) in the Proposing Release will give rise to the same overexpansive coverage of the new reporting regime adopted under Section 16 in 1991 and, depending on how the disclosure rules are structured, could surpass the complexity, confusion and administrative uncertainty that existed for several years after the 1991 Section 16 rule amendments. Similar to the proposed Item 10(a) reporting regime, the Section 16 rules that the Commission adopted in 1991 repealed a blanket exemption for transactions in qualified plans and instead provided that every qualified plan transaction was subject to Section 16 unless covered by a specific exemption. This overexpansive approach led to a flood of interpretive requests and a regime that was so complex that the Commission delayed the effective date of that aspect of the Section 16 rules for five years and allowed insiders to rely on the pre-1991 blanket exemption. In 1996, the Commission adopted new rules, which reversed the 1991 regime by specifically identifying the qualified benefit plan transactions that were subject to special requirements and reporting rules (a category of transactions called "discretionary transactions," which were determined to be particularly significant for purposes of Section 16) and exempting all other transactions in qualified benefit plans from reporting. Accordingly, in order to avoid the type of reporting problems that arose in 1991, we believe the Commission should require only specifically identified transactions, selected for their perceived significance, to be reported on Item 10(a) Reports, instead of requiring all transactions to be reported on Item 10(a) Reports unless specifically excluded.
24 For example, under the Section 16 reporting regime, if a settlor of a trust holding company securities may revoke the trust, he or she may be treated as having a pecuniary interest in those shares, and it is not necessary to report other events that may also bestow a pecuniary interest, such as becoming trustee of the trust if a family member is a beneficiary. However, it is unclear whether obtaining that additional status would be deemed a reportable event under Item 10(a).
25 For example, as proposed, Item 10(a) Reports would be triggered by events that do not reflect any investment decision by an insider, such as stock option grants, Rule 10b5-1 Plan transactions and the expiration of unexercised options.
26 See Part IV.C. of this letter, addressing the repeal of delayed reporting on Form 5.
27 This instruction states that the reporting requirements would not apply to certain transactions that are described in the text of the Proposing Release at notes 49 through 57. We note that the instruction would exempt from Item 10(a) Reports dispositions of securities under broad-based, tax-conditioned employee benefit plans and related excess benefit plans (except for dispositions pursuant to "discretionary transactions"), although the text of the Proposing Release at note 54 states that only "acquisitions" pursuant to these types of plans would not need to be reported. We believe that dispositions under these types of plans, which typically involve formulaic adjustments of prior allocations pursuant to tax rules and forfeitures and which are not currently required to be reported under Section 16, likewise should not be subject to Item 10 Reports. Because the Proposing Release does not provide any explanation for failing to also exclude these transactions from Item 10(a) Reports, since they are subject to the same exemption as dispositions under Section 16 we assume that the language in the Proposing Release is inadvertently narrower than the text of Instruction 2 to the proposed regulatory text.
28 We do not believe a Form 10(a) Report should be required if an insider pays cash to exercise an option and does not otherwise dispose of company stock (either in a sale to the company or an open market sale). This type of transaction would likely involve the exercise of an incentive stock option, in which the insider wishes to obtain certain tax benefits by satisfying a one year holding period, and thus would not be of significance to investors. Likewise, other option exercises and other conversions of derivative securities (such as conversions of stock units to shares of stock) that are not accompanied by a sale of shares in our view do not convey significant information that justify accelerated company reporting in addition to existing Form 4 reporting.
29 We are not aware of any evidence of any abuses with respect to gifts by insiders of company securities. Since gifts do not appear to be an area of significant investor concern, it seems to us unnecessary and unduly burdensome to subject them to accelerated Item 10(a) reporting.
30 These transactions represent compensation decisions that have been approved by a committee of non-employee directors or by the full board of directors, or that occur under terms that have been specifically approved by stockholders. Thus, they do not generally represent individual investment decisions by insiders. For similar reasons, for example, stock option grants are not required to be registered under the Securities Act of 1933.
31 We recognize that this position may go further than the SEC staff's interpretive position on the scope of the exemption under Rule 16a-13 but we believe that there is no need to report changes in the form of beneficial ownership, even where it may involve a shift in pecuniary interest to another family member, since the insider's pecuniary interest in the shares, and therefore his or her reporting obligations under Item 10, would continue regardless of whether the pecuniary interest is held directly or indirectly through a family member sharing the same household.
32 These transactions do not provide any indication of a person's views on a company or its prospects. They are not currently required to be reported under Section 16 and we see no reason why they would be relevant for Item 10(a) Reports. Requiring reporting would only set a trap for the unwary without providing any useful information to the market.
33 While these events are not reportable under Section 16, it is unclear whether they nevertheless would be reportable under Item 10(a) as proposed, since vesting events are not among those events specifically excluded under Instruction 2 to proposed Item 10, and as addressed above the regulatory text requires reporting of every acquisition (a term which may be broadly defined), regardless of whether the acquisition is otherwise reportable under Section 16.
34 We believe that the Commission's proposal exempts these transactions in the text of proposed Instruction 2 to Item 10 of Form 8-K but we believe that the exemption should be more clearly stated.
35 We likewise believe that the substantive pecuniary interest reporting standard should be set forth in the text of the Item itself instead of appearing in an Instruction to Item 10.
36 Even in the context of a limited two day reporting obligation, the Commission should recognize that insiders and companies may not be able to obtain accurate information on "discretionary transactions" within two days of the transaction being effected, because of the manner in which outside plan administrators handle such transactions. In the context of Section 16, the Commission has acknowledged that insiders often cannot learn on a timely basis the exact date or the transaction details of a discretionary transaction.
37 We do not view "end-of-period" holdings as constituting transaction information. In addition, the "end-of-period" holdings information on Section 16(a) reports is of dubious reliability because it is not required to reflect the effect of transactions that have not previously been reported.
38 This could easily be accomplished by cross-referencing the Form 4 reporting requirements in the Item 10 regulatory text.
39 In addition, the Commission can monitor submissions under these rules and, if it finds that changes need to be made to fine tune the disclosure, it can always do so at a later time.
40 These arrangements are discussed in note 63 of the Proposing Release.
41 If the Commission eliminates the ability to defer Section 16 reporting until a Form 5, then there will be no need for the "V" code on Form 4, which is used to indicate when an insider has voluntarily early report a transaction on a Form 4 instead of a Form 5. Instead, that column could be changed to allow insiders to insert a code indicating when they are claiming that a transaction is exempt from Section 16(b) liability.
42 As a technical matter, we believe that the Commission should clarify that, with a company's consent, insiders may use the company's EDGAR filing codes for purposes of filing Section 16 reports, instead of each insider obtaining a unique set of EDGAR filing codes. We believe that a number of companies that voluntary assist their insiders by filing Section 16 reports on EDGAR use the company's filing codes.
43 17 C.F.R. § 240.10b5-1(c)(1).
44 Proposed Item 10(b)(1)(iii) (emphasis added).
45 Proposed Item 10(b)(2)(iii) (emphasis added). These filings are in addition to the reports required by proposed Item 10(a) and by Section 16 and Rule 144.
46 Proposing Release at III.C.
47 Consider the following example: an executive enters into a plan to sell 10,000 shares each month for one year so long as the share price remained above $50. The executive later decides she wants to change the floor price to $40. If the executive amended the plan, the company would have to disclose that she had lowered the floor price. However, if the executive simply terminated the plan and, in good faith, later entered into an identical plan, except that the new plan reflected the lower $40 floor, there would be no disclosure with respect to any change in price. Although the result is the same, under the Proposing Release the reporting requirement would differ.
48 The Proposing Release notes that "[I]f a transaction is executed at the time the director or executive officer provides a Rule 10b5-1(c) instruction, such as a broker-dealer's immediate execution of a limit order, the company would report the transaction under paragraph (a), noting the director's or executive officer's use of an instruction intended to satisfy the rule's affirmative defense conditions, and would not need to report the instruction separately under paragraph (b)". Proposing Release at III.C.
49 17 C.F.R. § 240.10b5-1.
50 Proposing Release at III.A.
51 Rule 10b5-1 Adopting Release, § III.A.2. (discussing qualifications for entering into a Rule 10b5-1 Plan) n.111 (noting insider may modify Rule 10b5-1 Plan in good faith when not aware of material nonpublic information). Although the Commission staff has indicated that a person may terminate a Rule 10b5-1 Plan even if aware of material nonpublic information, it has also cautioned that terminating a Plan, and especially engaging in more than one Plan termination, could raise a question of whether the Plan was entered into in good faith without an intent to evade the insider trading rules.
52 Specifically, companies are required to report the terms and conditions of employment contracts (which can include loan arrangements) with its named executive officers, as well as severance and change-of-control arrangements involving named executive officers where the compensatory amounts involved exceed $100,000. Regulation S-K, Item 402(h). In addition, companies are required to report arrangements pursuant to which directors are compensated, both in their capacity as a director and as to separate consulting arrangements with the company. Regulation S-K, Item 402(g). Other sections of Item 402 require more detailed disclosure of named executive officer compensation arrangements, including giving historical salary and bonus data and detailed information as to option arrangements. Further, Item 404(a), (b) and (c) of Regulation S-K require disclosure of relationships and arrangements, including loans, between a company and its executive officers and directors where the amount involved exceeds $60,000 (or, where entities are involved, the amount exceeds specified percentages of gross revenues or total assets). In addition, Item 601(b)(10)(iii)(A) and Instruction 2 to Item 601(b)(10) require that contracts and written plans reflecting compensation arrangements involving executive officers (unless, in the case of executive officers who are not named executive officers, the contract is immaterial in amount or significance) be filed as an exhibit to the company's required periodic filings for the quarter in which the contract is executed or becomes effective.
53 This may include extensions of credit that are deemed to occur through "cashless" option exercise programs, where the exercise price of a stock option is advanced until the option shares are sold and (pursuant to an irrevocable election of the optionee) the proceeds from that sale are paid over to the issuer.
54 Release No. 33-7881 (August 15, 2000), Part II, B.6(b).
55 We believe that the Commission also should include a statement similar to Instruction B.5. of Form 8-K that the reporting of transactions by the company shall not be deemed an admission of materiality of that information.
56 See, for example, Rule 508 under the Securities Act, Rule 10b5-1(c) under the Exchange Act, and Securities Act Rule 144 and Exchange Act Rule 10b-18, each of which sets forth an affirmative defense or a safe harbor for compliance with the law.
57 The term "tax-conditioned plan" is any one of the plans enumerated under Exchange Act Rule 16b-3(c).