Securities Exchange Act of 1934 — Section 16
December 20, 1996
Response of the Office of Chief Counsel
American Bar Association
You have asked the Division's views regarding the following questions of general applicability with respect to the amendments to the rules under Section 16 of the Securities Exchange Act of 1934 (the "Exchange Act") adopted in Release No. 34-37260 (May 31, 1996) [61 FR 30376] (the "Adopting Release").
1. Non-Employee Directors. For purposes of determining whether a director satisfies the tests for Non-Employee Director status set forth in Rules 16b-3(b)(3)(i)(B), (C) and (D), the issuer generally may rely on the Regulation S-K Item 404 disclosure with respect to the issuer's most recently completed fiscal year set forth in the disclosure document most recently filed with the Commission in which Item 404 disclosure is presented (the "filing").
Where a transaction or relationship disclosed in the filing (including a transaction or relationship that occurred before the issuer's initial public offering) was terminated before the director's proposed service as a Non-Employee Director, such transaction or relationship will not bar the director from acting as a Non-Employee Director.
However, because the Rule 16b-3(b)(3)(i) tests envision compliance at the time the director votes to approve a transaction, the issuer may rely on the positions stated above only where the issuer in good faith believes that any current or contemplated transaction or relationship with such director will not require disclosure under Items 404(a) and (b), respectively, based on information readily available to the issuer and the director at the time such director proposes to act as a Non-Employee Director. In making this determination, the issuer may rely on information obtained from the director, for example, pursuant to a response to an inquiry.
At such time as the issuer in good faith believes, based on information readily available, that a current (or currently contemplated) transaction or relationship with a director will require Item 404(a) or (b) disclosure in a future filing, such director no longer will be eligible to serve as a Non-Employee Director. However, a determination that a director no longer is eligible to serve as a Non-Employee Director will not result in the retroactive loss of a Rule 16b-3(d)(1) or 16b-3(e) exemption with respect to a transaction previously approved by such director while serving as a Non-Employee Director in reliance on the interpretation set forth above.
Issuers are reminded of n. 75 of the Adopting Release, which states, in pertinent part, that "[f]or purposes of the definition of "Non-Employee Director," each test that refers to S-K Item 404 will be measured by reference to the Regulation S-K disclosure Item, whether the disclosure requirements applicable to the issuer are governed by Regulation S-K or S-B."
2. Scope of Discretionary Transaction Definition: Cash Settlement of Derivative Securities.
The Division is of the view that the cash settlement of a derivative security is not a Discretionary Transaction, as defined in Rule 16b-3(b)(1), where the derivative security is not held in a multi-fund plan that permits fund switching. Such transactions include:
Accordingly, the disposition to the issuer in return for cash that occurs pursuant to these transactions is eligible for exemption pursuant to Rule 16b-3(e) and need not satisfy the conditions of Rule 16b-3(f). In reaching this conclusion, the Division notes that the terms of such instruments contemplate cash settlement as a form of compensation and do not permit fund switching. Accordingly, their cash settlement pursuant to the terms of issuance does not present the potential for abuse that the conditions of Rule 16b-3(f) were designed to prevent.
In contrast, the cash-out of a derivative security, such as a phantom stock unit, held in a multi-fund plan that permits fund switching is a Discretionary Transaction. Further, a cash-out from an issuer stock fund, such as a common stock fund, will not be eligible for exemption pursuant to Rule 16b-3(e), but instead is a Discretionary Transaction eligible for exemption pursuant to Rule 16b-3(f), whether the plan is single-fund or multi-fund.1
The following transactions do not involve the disposition of a derivative security subject to Section 16 of the Exchange Act: (1) a withdrawal of cash from an employee stock purchase plan before any equity security is purchased at the end of the purchase period; and (2) an election to take a bonus award in cash rather than stock (prior to the receipt of any award).
3. Scope of Discretionary Transaction Definition: Qualified Plans — The "Required to be Made Available" Requirement.
Rule 16b-3(b)(1)(iii) excludes from the definition of "Discretionary Transaction" a transaction that is required to be made available to a plan participant pursuant to a provision of the Internal Revenue Code (the "Code"). This exclusion applies to a distribution pursuant to a provision of a plan, qualified under Section 401(a) of the Code, that:
4. Approval of Subsequent Transactions/Phantom Stock Reporting. Note 3 to Rule 16b-3 provides generally that the approval conditions of Rules 16b-3(d)(1), 16b-3(d)(2) and 16b-3(e) require the approval of each specific transaction. However, Note 3 states that initial approval of a plan in its entirety will be sufficiently specific where the terms of each transaction are fixed in advance. The Note also provides that where the terms of a subsequent transaction are provided for in a transaction as initially approved, the subsequent transaction will not require further specific approval. The Division is of the view that the specific approval standards of Note 3 to Rule 16b-3 and the reporting requirements of Section 16(a) will be satisfied as described below:
The election to participate in such a plan is not an event subject to Section 16. Initial approval of the plan will satisfy the approval requirements of Rules 16b-3(d) and (e) to exempt (a) the acquisition of phantom stock units (including the crediting of dividends in additional phantom stock units) and (b) the subsequent payout on the fixed date elected by the participant or automatically pursuant to the terms of the plan, as described above.
However, dispositions resulting from the participant's subsequent election to change the fixed payout date or installment schedule, or to elect installment payments in lieu of a lump sum, would not be exempted by initial approval of the plan. Instead, such dispositions would require further specific approval in order to be exempted by Rule 16b-3(e).
Further, where a payout of the phantom stock units is a Discretionary Transaction, as defined by Rule 16b-3(b)(1), the transaction will need to satisfy the conditions of Rule 16b-3(f) in order to be exempt. In cases where the payout is neither a Discretionary Transaction nor exempted pursuant to initial plan approval as provided above, approval of the individual payout transaction will be necessary to satisfy the standards of Rule 16b-3(e) and Note 3 to Rule 16b-3.
However, where the units are settled automatically on a one-for-one basis in stock, the acquisition of the units alternatively may be reported on Form 5 the same way as an acquisition of restricted stock, i.e., as the acquisition of the underlying shares on Table I. Cf. Lincoln National Corporation (Mar. 20, 1992) Q.3.
5. Domestic Relations Orders. Rule 16a-12 exempts an acquisition or disposition of any equity security pursuant to a domestic relations order. The exemption is not limited to transfers of securities acquired under employee benefit plans that satisfy the standards of a "qualified domestic relations order," as defined under the Internal Revenue Code.
Because these positions are based on the representations made to the Division in your letter, it should be noted that any different facts or conditions might require a different conclusion.
Anne M. Krauskopf
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