11.13.2002
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Updates
Section 306(a) of the Sarbanes-Oxley Act of 2002 prohibits insider trading during pension fund blackout periods. During an open meeting on October 30, 2002, the SEC discussed proposed rules clarifying the scope and operation of the statutory trading restrictions. The SEC then posted the proposed rules on its Web site on November 7, 2002, and will accept comments for 30 days following publication of the proposed rules in the Federal Register.
Who Is Restricted?
In general, the blackout period trading prohibition applies to directors and executive officers of all reporting companies, including domestic issuers, foreign private issuers, banks and savings associations, small business issuers and, in rare instances, registered investment companies. The term "director" under the proposed rules has the same meaning as set forth in Section 3(a)(7) of the Exchange Act, and includes "any director of a corporation or any person performing similar functions with respect to any organization, whether incorporated or unincorporated."The term "executive officer" under the proposed rules has the same meaning as the term "officer" as defined in Exchange Act Rule 16a-1(f), and includes an issuer's president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice-president of an issuer in charge of a principal business unit, division or function and any other officer or person who performs a policy-making function for an issuer.
What Securities Are Restricted?
The restriction applies only to equity securities of a company that its directors and executive officers acquire in connection with their service or employment as a director or executive officer. For example, equity securities acquired under a plan, contract, authorization or arrangement while the individual was an employee, but not a director or executive officer, are technically excluded from the trading prohibition.
Derivative securities relating to an equity security of a company, whether or not issued by the company, are also restricted. This includes instruments such as options, futures, instruments convertible into equity securities and warrants, as long as they relate to an equity security of an issuer.
What Types of Transactions Are Restricted?
The Section 306(a) trading prohibition is limited to transactions (purchases, sales or other means of acquisition or transfer) involving equity securities acquired in connection with service or employment as a director or executive officer. Indirect transactions, such as transactions by family members, partnerships, corporations, limited liability companies and trusts, are also restricted if the director or executive officer has a pecuniary interest in the equity securities.
The following types of transactions are exempt from the restriction and are still allowed:
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acquisitions of equity securities under dividend or interest reinvestment plans;
- purchases or sales of equity securities that meet the "Affirmative Defenses" conditions of Exchange Act Rule 10b5-1(c);
- purchases or sales of equity securities pursuant to certain employee benefit plans (other than discretionary transactions); and
- acquisitions or dispositions of equity securities resulting from stock splits, dividends or pro rata rights distributions.
When Is the Trading Restriction for a "Blackout Period"?
The Section 306(a) trading restriction is triggered only if a blackout period:
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lasts more than three consecutive business days; and
- temporarily suspends the ability of at least 50% of the participants or beneficiaries under all individual account plans maintained by the company to conduct transactions in company securities held in an account plan.
For purposes of the 50% calculation, the individual account plans maintained by an issuer include only individual account plans in which participants or beneficiaries held or could hold equity securities of the issuer, whether or not the account plan actually contained equity securities of the issuer at the time of calculation.
Section 306(a) expressly excludes the following two categories of blackout periods from the trading restriction:
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a regularly scheduled blackout period in which participants may not engage in transactions of the equity securities if such period is incorporated into the individual account plan and timely disclosed to employees before they become participants (or as a subsequent amendment to the plan); or
- any suspension imposed solely in connection with persons becoming participants, or ceasing to be participants, by reason of a corporate merger, acquisition or similar transaction.
Timely disclosure means prior to or within 30 calendar days of an employee becoming a participant, or within 30 calendar days of the adoption of the amendment. In the case of a blackout period imposed in connection with a merger, acquisition or similar transaction, the trading prohibition is not triggered if the principal purpose of the blackout period is to enable individuals to become participants (or to terminate participation in a plan), even if the blackout period is also used to effect other administrative actions.
Required Notices
An issuer of equity securities must provide notice of a blackout period to the director or executive officer, as well as to the SEC. An issuer's notice is timely if provided at least 15 calendar days in advance of commencement of the blackout period, and is deemed "provided" as of the date of mailing, or electronic transmission, of the notice.
The simultaneous notice to the SEC is designed to ensure that security holders have notice of the blackout period as well. Issuers provide the SEC notice by filing a Form 8-K upon the earlier of receipt of notice of the blackout period from the plan administrator, or actual knowledge of the blackout period by the person overseeing the issuer's pension plans. Note that plan administrators who fail to provide proper notice to issuers can face civil penalties of up to $100 per day per participant.
Section 306 takes effect on January 26, 2003. The notice requirement applies to blackout periods commencing on or after January 26, 2003. For blackout periods occurring between January 26, 2003, and February 10, 2003 (15 days after), issuers should furnish notice as soon as reasonably practicable.
Remedies
Violations of the Section 306(a) statutory trading prohibition can result in possible SEC enforcement action. In addition, a company itself, or a security holder on behalf of a company, may bring a private action to recover any profits realized by a director or executive officer from a prohibited transaction during a blackout period.
Note that the Department of Labor has recently adopted interim final regulations to implement Section 306(b) of the Act, the provisions of which generally require plan administrators of 401(k) and other individual account plans to notify participants and beneficiaries at least 30 days in advance of an ERISA blackout period (defined more broadly than the insider trading blackout period under Section 306(a) of the Act).
Related Article
An article by Perkins Coie partner Kurt Linsenmayer, entitled "Sarbanes-Oxley: DOL Issues Interim Final Regulations on Blackout Notices and Civil Penalties," appeared in the October 24, 2002 issue of the EBIA WEEKLY, a national newsletter published by the Employee Benefits Institute of America LLC. This article summarizes the U.S. Department of Labor's new interim final regulations for purposes of the 30-day notice requirement of Section 306(b) of the Sarbanes-Oxley Act. This notice must be provided in advance of an ERISA blackout period by the administrator of a covered pension plan to each of the plan's participants and beneficiaries. If the plan holds any company equity securities affected by the ERISA blackout period, the issuer of such securities must also be notified. You may access the article via the following link: http://www.ebia.com/weekly/articles/2002/401k021024DOL.jsp.
Contact Kurt Linsenmayer in our Seattle Office (206.359.3458) if you would like additional information regarding the Department's interim final regulations.
Text of the Rules
As this Update is intended only as a summary of the rules, you are encouraged to review the full text of the SEC proposed rules at http://www.sec.gov/rules/proposed/34-46778.htm. You can find further discussion of other recent laws and regulations of interest to public companies on our website.
