A shareholder has recently submitted letters to a number of public companies demanding that they seek to recover alleged short-swing profits under Section 16(b) of the Securities Exchange Act of 1934 from insiders who made non-exempt purchases of stock within six months of having shares withheld either (i) to satisfy tax liabilities upon the vesting of restricted stock, restricted stock units, or stock appreciation rights, or upon the exercise of employee stock options, or (ii) for payment of the exercise price of employee stock options. The withholding transactions generally were reported on Form 4s using transaction code “D” or “F,” indicating the dispositions were exempted from matching for purposes of Section 16(b) liability by SEC Rule 16b-3(e) because the withholding right was a term of the initial award as approved by the board or a committee of non-employee directors. The shareholder is taking the position that Rule 16b-3(e) does not exempt withholding unless both (i) the company has no discretion to accept or reject the withholding, and (ii) the withholding is “automatic” in that the insider must pay the tax or exercise price with shares and cannot elect to pay the tax or exercise price with cash instead. The shareholder is basing his claim primarily on the SEC’s Compliance and Disclosure Interpretation 123.16, dated May 23, 2007, which provides: “Approval of a grant that by its terms provides for automatic reloads would satisfy the specificity of approval requirements under Rule 16b-3(d) for the reload grants, unless the automatic reload feature permitted the reload grants to be withheld by the issuer on a discretionary basis. The same result applies under Rule 16b-3(e) where the automatic feature is a tax- or exercise-withholding right.” In at least two cases, the shareholder has filed suit pro se seeking recovery of the alleged short-swing profits.
Baker Botts disagrees with the shareholder’s analysis of the scope of the Rule 16b-3(e) exemption. Given the recent claims, however, it may be advisable for you to (i) reexamine your employee incentive award documentation to see how the shareholder’s theory could apply to your executives and (ii) warn insiders about the potential of a Section 16(b) claim if they make a non-exempt purchase of stock within six months of having shares withheld from them either to satisfy tax liabilities or for payment of the exercise price of employee stock options. We are, of course, available to consult with you about these issues.
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