December 16, 2002
Securities and Exchange Commission
Re: File No. S7-44-02-Insider Trades During Pension Fund Blackout Periods
Ladies and Gentlemen:
We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the Commission's proposed rules to implement Section 306(a) of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act").1 We commend the Commission and its staff for the high quality and speed of their efforts in carrying out the regulatory mandates of the Sarbanes-Oxley Act, and we appreciate the opportunity to comment on these proposed rules.
I. Issuers Subject to Trading Prohibition
Under Section 306(a)(4)(A) of the Sarbanes-Oxley Act, a blackout period is defined as any period of more than three consecutive business days during which the ability of not fewer than 50 percent of the participants or beneficiaries under all individual account plans maintained by the issuer to purchase, sell or otherwise acquire or transfer an interest in any equity security of such issuer held in such an individual account plan is temporarily suspended by the issuer or by a fiduciary of the plan. Proposed Regulation BTR provides that, with respect to foreign private issuers, a blackout period only occurs if restrictions on individual account plan participants' ability to transact in the issuer's equity securities exist with respect to both (a) 50 percent or more of all US individual account plan participants of the issuer and (b) 15 percent or more of all individual account plan participants of the issuer worldwide. We support the Commission's proposal in the Proposing Release to limit the statutory trading prohibition to directors and executive officers of foreign private issuers to only those instances "in which a significant portion of the issuer's overall plan participants or beneficiaries are located in the United States." However, we believe the Commission's proposed test for determining whether a blackout period applies to foreign private issuers may unintentionally cover many foreign private issuers whose plan participants or beneficiaries located in the United States do not constitute a significant portion of the issuer's overall plan participants or beneficiaries. In particular, we note that in many countries other than the United States employees customarily participate in defined benefit pension plans, rather than individual account plans. Although the Commission proposes to limit the application of Section 306(a) to instances in which "overall plan participants" are predominantly in the United States, the fifteen percent portion of the test is based on the percentage of an issuer's employees who participate in individual account plans, not the percentage of the issuer's pension plan participants generally. As a result, an issuer who maintains individual account plans only in the United States would often fail the test as a result of a suspension of trading in its US individual account plans, even if the percentage of the issuer's total employees who actually participant in those individual account plans is insignificant.
For example, assume that a foreign private issuer has 10,000 employees in Europe, all of whom participate in defined benefit pension plans, and 20 employees in the United States who participate in a defined contribution (401(k)) plan. Under the proposed rules, the foreign private issuer would be under blackout restrictions if 401(k) plan trading was suspended for the 20 US employees, even though the 20 employees who participate in the 401(k) plan represent an immaterial percentage of the issuer's employees, since 100 percent of the participants or beneficiaries in pension plans maintained by the issuer who are located in the United States (including its territories and possessions) are subject to a blackout period and the affected employees represent 100 percent of the issuer's individual account plan participants worldwide. Indeed, similarly anomalous results may arise for a US issuer (or a foreign company that is not a foreign private issuer) that has a large percentage of its employees located outside the United States.
Accordingly, we suggest that the test be revised to focus on the percentage of the issuer's employees as a whole that are subject to a blackout period, as opposed to focusing on the percentage of the issuer's individual account plan participants who are subject to a blackout period. We also suggest that the test apply equally to all issuers, whether or not they are foreign private issuers, since many issuers that do not qualify as foreign private issuers may nonetheless have the majority of their employees located outside the United States.
II. Definition of "Director" and "Executive Officer" for Foreign Private Issuers
With respect to foreign private issuers, proposed Rule 100(c)(2) of Regulation BTR defines the term "director" as any director who is a management employee of the issuer, thus excluding outside directors and non-management employees. Under proposed Rule 100(h)(2) of Regulation BTR, the term "executive officer" is defined as the principal executive officer or officers, the principal financial officer or officers and the principal accounting officer or officers (or, if there is none, the controller) of an issuer. The Proposing Release states that since foreign private issuers are not subject to Section 16 of the United States Securities Exchange Act of 1934, as amended (the "Exchange Act"), the definitions are included to specifically enumerate the directors and executive officers who would be subject to Section 306(a) rather than relying on a Section 16 definition, and to assist foreign private issuers in identifying the individuals who would be subject to proposed Regulation BTR. The Proposing Release further states that the definitions are intended to ensure that foreign private issuers are not required to take into account lower-level employee representatives who may serve on their boards of directors. We support the Commission's decision to provide foreign private issuers with a specific definition of "director" and "executive officer" for Section 306(a) of the Sarbanes-Oxley Act. We believe that similar concerns would apply to other provisions of the Sarbanes-Oxley Act, such as Section 402, that also rely on Exchange Act definitions of the terms director and executive officer and suggest that a similar approach would be appropriate for those provisions.
III. Transactions Subject to the Trading Prohibition
A. A director or executive officer should not be subject to liability under Section 306(a) for a bona fide gift or any non-volitional transaction that occurs during a blackout period
Section 306(a)(3) of the Sarbanes-Oxley Act permits the Commission to provide appropriate exemptions from the statutory trading prohibition of Section 306(a), including purchases pursuant to an automatic dividend reinvestment program or purchases or sales made pursuant to an advance election. Proposed Rule 101(c) of Regulation BTR would exempt certain transactions from the statutory trading prohibition of Section 306(a), including acquisitions of equity securities under dividend or interest reinvestment plans, purchases or sales of equity securities pursuant to 10b5-1 plans, purchases or sales of equity securities pursuant to tax-conditioned plans, other than discretionary transactions, and certain increases or decreases in the number of equity securities held as a result of certain corporate transactions (such as stock splits or stock dividends).
We agree with the Commission that it is appropriate to exempt the described transactions from the statutory trading prohibition. The Commission has asked whether it would be appropriate to exempt other transactions from the statutory trading prohibition and, if so, to provide a rationale for any such exemptions. In our view, it would be appropriate to exempt from the statutory trading prohibition any transaction that does not involve the payment or receipt of consideration, such as a bona fide gift. Similarly, we believe it would be appropriate to exempt from the statutory trading prohibition any non-volitional transaction, including the transactions enumerated in the Proposing Release (i.e., an acquisition or disposition of equity securities resulting from an involuntary event, such as the death of a director or executive officer or pursuant to an order of a court or other judicial or administrative authority), as well as any other non-volitional transaction not enumerated in the Proposing Release such as dividend reinvestment under an employee benefit plan or the grant or issuance of any equity security or derivative security by an issuer to a director or executive officer, whether pursuant to an employee benefit plan or otherwise. We believe the exemption of non-volitional transactions and transactions that do not involve the receipt of payment or consideration is consistent with the underlying purpose of Section 306(a).
The Proposing Release also asks whether it would be appropriate to exempt from the statutory trading prohibition of Section 306(a) the closing of a derivative security position as a result of its exercise or conversion, and the acquisition of underlying securities at a fixed exercise price due to the exercise of conversion of a call equivalent position, such as an employee stock option, or the closing of a derivative security position as a result of its exercise or conversion, and the disposition of underlying securities at a fixed exercise price due to the exercise of a put equivalent position and, in each case, whether the exemption should be limited to situations where the position was established without awareness of an impending blackout period. We believe that it would be appropriate to exempt those transactions because they do not give the holder of the derivative security a new opportunity to profit or a new ability to realize a profit during a suspension of trading. This is consistent with the exemptions provided by Rule 16b-6 under the Exchange Act. We believe that, if the exemption is limited in the manner suggested, the limitation should provide a bright line test. For example, the rule could be limited to derivative securities that have been held for at least six months or that were acquired in a transaction exempt under Rule 16b-3.
B. If an issuer does not deliver notice of a blackout period to directors or executive officers who do not participate in the plan subject to the blackout, then such directors or executive officers should not be subject to the trading restriction
Section 306(a)(3) of the Sarbanes-Oxley Act requires an issuer to provide timely notice to its directors and executive officers and to the Commission of the imposition of a blackout period. Proposed Regulation BTR and the Proposing Release clarify the requirements of the notice provisions. The Proposing Release states that the notice is required to indicate the beginning and ending dates of the blackout period to enable directors and executive officers to "factor the anticipated duration of the blackout into their pre-blackout period investment activities and decisions" and is also required to include a contact person designated to answer inquiries about the blackout period since, "[g]iven the potential impact of a blackout period on a director or executive officer's ability to engage in transactions involving equity securities of the issuer, it is likely that they may have questions about a blackout period." However, neither Section 306(a), proposed Regulation BTR nor the Proposing Release address the consequences for the directors or executive officers who do not receive notice and so may be unaware that a blackout period has been imposed, particularly if the director or executive officer does not participate in the plan or plans that are subject to the blackout.
We believe it would not be consistent with the underlying purpose of Section 306(a) to penalize directors or executive officers who are unaware that a blackout period is in effect. Accordingly, we suggest that if a director or executive officer does not participate in the plan or plans that are subject to a blackout and the issuer does not provide such director or executive officer with notice of the blackout period, then such director or executive officer should not be subject to liability under Section 306(a).
IV. Exceptions to the Definition of Blackout Period
Section 306(a)(4)(B) of the Sarbanes-Oxley Act excludes from the definition of "blackout period" any suspension imposed solely in connection with the commencement or termination of participation in an individual account plan by reason of a corporate merger, acquisition, divestiture or similar transaction involving the plan or the plan sponsor. Proposed Regulation BTR provides that the exception only applies to participants of the acquired or divested entity. Although we agree with the Commission that it is appropriate to provide such an exemption, it is not clear to us why the exception would not also apply to participants under the plans of the divesting and acquiring entities. In the context of corporate transactions, plans of the acquiring and divesting entities are often subject to considerations that are similar to those applicable to the acquired or divested entity, particularly if the number of employees of the acquired/divested entity is large relative to the number of employees of the divesting or acquiring entities. For example, assume that an issuer has two divisions. Division A employs 100 employees and Division B employs 900 employees. Assume further that the issuer maintains a single 401(k) plan for employees of both divisions, and that Division B is sold pursuant to an agreement under which sponsorship of the plan is transferred to the buyer, but the accounts of Division A employees remain in a new plan adopted by the issuer. Assume that in connection with the transfer of the account balances of Division A employees to the new plan there must be a suspension of trading. That suspension should not give rise to a blackout period because it arises as a result of a corporate transaction even though the suspension is not applicable to employees of the divested business. Accordingly, we suggest that the exception be revised to apply equally to participants in plans maintained by both the acquired/divested entities and the acquiring/divesting entities.
V. Calculation of Profits
The Proposing Release states that in view of the complexity associated with the calculation of profits, the Commission is not proposing a specific approach for calculating realized profits at the present time. We note that the Commission has not proposed a comprehensive rule for the determination of profits under Section 16 of the Exchange Act, and believe that it would be reasonable not to provide a comprehensive rule under Section 306(a). However, we believe that the Commission should consider the adoption of a rule that caps the amount of profits recoverable from any transaction under Section 306(a) to the change in value of the equity securities from the beginning of the blackout period to the date on which the transaction occurs. This seems consistent with the underlying purpose of Section 306(a), which is to prevent executive officers or directors from benefiting from purchases or sales in issuer equity securities during a period when participants in the issuer's plan are not permitted to engage in any such transactions.
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We thank you for the opportunity to comment on the Proposing Release. We would be happy to discuss with you our comments or any other matters you feel would be helpful in your review of the proposals. Please do not hesitate to contact Arthur Kohn or Mary Alcock in New York (212-225-2000) if you would like to discuss these matters further.
cc: The Honorable Harvey L. Pitt, Chairman