Insider_Trading (Net Screen Shot)

8/4/2019 Insider_Trading (Net Screen Shot)

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Stock Compensation Meets SecuritiesLaws: Keeping Executives and EmployeesOut of Jail

Bruce Brumberg, [email protected]

Sue Morgan, Perkins Coie [email protected]

WorldatWork 48th Annual ConferenceMay 12, 2003 San Diego


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All the financial scandals involve securities lawviolations and sales of stock by insiders. The stock

sold, either from options or restricted share grants, orfounders stock, was often part of equity compensation.


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Topics to Keep Your Execs and

Employees Out of Trouble Insider Trading

Rule 10b5-1 Plans

Section 16 Sarbanes-Oxley Act:

CEO/CFO Certifications of SEC Filings;

Executive Loans; Pension Plan Blackouts;Non-Audit Services

Other CurrentIssues


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The investigations,stories and accusations

continue.


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Will ads for insider trading lawyers crowd outads for personal injury and medical malpractice

lawyers?


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What is insider trading?

You know material confidential information abouta public company (whether your company oranother company).

You trade on that information or tip others aboutit before the information is released publicly.

Insider Trading


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Insider Trading

Civil Penalties: any profit made or loss avoidedand penalty of up to three times this amount.Bar for serving as D&O of public company.

Individuals face up to 25 years in prison forsecurities fraud and fines of up to $1 million.Mail and wire fraud, tax evasion andobstruction of justice. Corporations face

penalties. Controlling persons liability for managers

New disgorgement penalty for restatements


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Insider Trading

Material information: news that canaffect a companys stock price,

for better or worseThis includes knowledge of:

takeover accounting problems dividend change blockbuster product earnings better or worse than

expected


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Insider Trading

MYTHsOnly a companys insiders or employees can commit insider

trading. Need to trade and be caught in the act.

TRUTHs The law applies to anyone who knows material nonpublic

information at the time of the trade or tip

Applies to trades of stock in customers, suppliers, clients

Tipping, even without the tipper trading, is illegal Most cases based on circumstantial evidence

These rules are separate from the Section 16 rules forsenior executives and directors


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Insider Trading

The ImClone case

What is the material nonpublic information and whendoes it become public?

Senior executives sell; CEOs family members sell

Martha Stewart: What did she know? When did sheknow it? Who gave her information?

What constituted obstruction of justice and falsestatements to government investigators?

Can brokers use information that senior executives arebuying or selling? Check your plan providers rules.


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Insider Trading

How does insider tradingapply to stock options?

Grant or exercise of stock options is not atrade

Cashless exercise/same-day sale raisesquestions of insider trading

Rules apply during post-termination exerciseperiod

Rules also apply to company stock in 401(k)


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Insider Trading

Insider trading harms the goals ofemployee ownership

Employee ownership culture encourages information-sharingand boasting about company.

Even well-intentioned actions can be illegal.

Destroys the financial link between employees andshareholders. Damages reputation of equity compensation.

Investors interpret insider trading investigation as sign thatcompany has undisclosed financial or accounting troubles.


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Insider Trading

Prevention Procedures

Blackout Periods vs. Quarterly TradingWindows

Pre-clearance for Senior Executives andDirectors. Rule 10b5-1 plans as defense.

Ongoing Education: Seminars, Videos (e.g.,Think Twice), Reminders, Press Clippings

Substantive prevention efforts, internalinvestigations and cooperation with SECand DOJ can reduce corporate liability


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For more detailsand questions oninsider trading,see Articles and

FAQs onmyStockOptions


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10b5-1 Plans What are Rule 10b5-1 trading plans?

How they help

How they work

FAQs

How you can help implement


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10b5-1 Plans How 10b5-1 plans help

Permit advance planning for orderly dispositionor to meet special needs

Sales can take place even when insiders areaware of material nonpublic information

Companies can manage public perception ofinsiders sales


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10b5-1 Plans How 10b5-1 plans work

Provide an affirmative defense against insidertrading claims if

When not aware of the inside information, theinsider must

Enter into a contract to sell (or purchase),

Instruct another person to sell for the insiders

account, or

Adopt a written plan for trading securities


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10b5-1 Plans The written trading plan must

Specify amount, price and date of sales,

Provide formula, algorithm or computerprogram for determining amounts, pricesand dates, or

Not permit the insider to exercise any

subsequent influence over how, when orwhether to effect the sales


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10b5-1 Plans Whose plan is it?

Agreement between insider and broker

Brokers usually supply form Company should review

To avoid controlling person liability


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10b5-1 Plans When should the plan be signed?

Generally, during a window period

When should sales start?

Hiatus before trading starts: two weeks,30 days, three months, after next earnings

release


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10b5-1 Plans What if your insider is always aware of

inside information?

SEC advice equivocal Rule says before becoming aware of the

information

Alternative: insider must not be aware of

inside information when plan commences Mechanisms: long hiatus before sales start

(six months); other officer signs off whentrading can begin


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10b5-1 Plans Should the plan be in writing?

Two of three affirmative defenses do not

require Best practice is to have written plan

Certainty of terms

Use as evidence in judicial proceedings

Summary judgment phase


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10b5-1 Plans Should the plan have a fixed term?

Not required

Best practice is to have fixed term Typically six months or one year

Two years at outside


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10b5-1 Plans What factors influence trading

instructions?

Impact on market Size of transactions

Multiple insiders

Two-day Section 16 reporting

Frequent sales, barrage of Forms 4 Ease of implementation

Keep it simple

Cashless option exercise issues


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10b5-1 Plans

What should cause the plan toautomatically suspend or terminate?

Insiders death, bankruptcy, termination ofinsider status, expiration of stock options

subject to plan

Announcement of merger, tender offer

Withdrawal of companys lack of objectionto plan


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10b5-1 Plans

When can insider terminate the plan?

Can be when aware of inside information

Does not violate Rule 10b5-1 because it isnot illegal not to trade (SEC informaladvice)

Issue of good faith if pattern or practice

Should be hiatus before start new plan


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10b5-1 Plans

When can insider modify the plan?

Only when not aware of inside information;

must wait for open window Can trades be made outside a plan?

Called parallel trading

Would not invalidate trading plan (SEC

informal advice)

On its own, trade must not violateRule 10b-5


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10b5-1 Plans

Should the company make a publicannouncement of the 10b5-1 plan or

program?

Press release

Form 8-K (SEC may require)

Form 10-Q

Company Web site


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10b5-1 Plans

What should be disclosed?

Existence of program (selling or buying)

Names of insiders Number of shares

Percentage of holdings (vested andunvested)

Duration, other terms

Whether insiders will trade outside plan


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10b5-1 Plans

Sample disclosureFour of the companys executive officers currently have in effect

Rule 10b5-1 sales plans for shares of the companys common stock.

In accordance with the requirements of Rule 10b5-1, the plans wereestablished at times when the officers were not aware of material

nonpublic information. The plans specify the trading periods, which

range from six months to one year, the numbers of shares to be sold

and the prices at which shares may be sold. If all conditions of the

plans are met, the aggregate number of shares that may be sold

under the plans would be ________, which would equal

approximately __% of the aggregate number of shares, includingrestricted shares and vested and unvested option shares, held by

the officers as of _______, 2002. The officers may amend the trading

plans and may sell additional shares of common stock outside of the

trading plans, provided they are not aware of material nonpublic

information at such time.


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10b5-1 Plans

What other laws impact plans?

Controlling person liability

Rule 144 Timing of filings

Attestation

Exclusive broker?

Section 16 Section 13(d)

State law


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10b5-1 Plans

How you can help implement plans

Designate 10b5-1 committee or compliance

officer Establish guidelines all plans must meet

Establish procedures for review andapproval

Vet plans of one or more brokers


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10b5-1 Plans

Process for approval

Committee reviews plan for compliancewith company's guidelines

Dialogue takes place between committee,broker and insider

Committee makes any requests for

changes and approves or rejects plan Committee works with broker

to generate required paperwork (e.g.,stock option exercise forms)


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10b5-1 Plans

Reporting transactions

Broker files Form 144

Pre-signed forms placed with broker Broker reports transaction details to

compliance officer--same day by phone,then confirmed by same-day fax or email

Compliance officer prepares Form 4 forinsider's signature--two-day filing unlessexact date not specified


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10b5-1 Plans

Sample guidelines

General plan requirements

Discretionary plans will not be permitted

Modification/voluntary termination of plan canonly take place during an open window

Company has discretion to terminate plan forcertain events

Automatic termination/suspension events

Plan intended to comply with Rule 10b5-1

Purpose, e.g., to permit orderly disposition oracquisition


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10b5-1 Plans

Insider representations that

Insider is not aware of material nonpublicinformation

Insider is entering into plan in good faith, andnot as part of a scheme to evade the purposeof the rule

Insider will not hedge against the trading plan

Insider will comply with Rule 144 and Sections16 and 13(d)

Insider will exercise no control over brokersactions


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10b5-1 Plans

Broker representations that

It will not seek instructions or advice frominsider

It will not deviate from the plan It will not execute if aware of material

nonpublic information

Company representations that

It has reviewed (or approved) trading plan

It has no objections to the plan

The plan does not violate the companys insidertrading policy


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Section 16

Provisions under securities laws andSEC rules that require SEC filings bysenior executives and directors for theircompany stock transactions, and alsomatching of trades within six-monthperiod

Forms 3, 4 & 5 Short-swing profit liability


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Section 16

Form 4

Filed two days after company stock transactions

Previously reported on Form 5: Option grants,

transactions with the company, including optionissuances, cancellations and repricings

Company procedures in place for assisting insiders withfilings

Interacting with outside stock plan service providers

and brokers Coming soon: Filings must be made on EDGAR and

simultaneously posted on your company's Web site

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Section 16

Issues Raised Late filings reported in proxy statement: New meaning

about corporate governance and compliance

Re-examine which officers are Section 16 officers: Nolonger prestigious. SEC definition includes president,CFO, chief accounting officers, VPs of principal businessunits and any person with significant policymakingfunction.

Changes in compensation design: Deferred comp; M&A

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Section 16

Short-Swing Profit Rules Senior officer and director who realize any profit from

the purchase and sale, or sale and purchase, of any

company shares within any period less than six monthsmust return this profit to the company

Extends to transactions made by your spouse and otherfamily members and to trusts set up for their benefit

Section 16(b) plaintiff's lawyers actively monitorsecurities trades for these violations because they sharein any profits paid back to your company

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Section 16

Danger: The six-month danger period runs both backwardand forward from the date of a transaction. Best matchapplies!

Down market example:

Sold stock on January 1 at $15. Stock executivepurchased two years ago. Stock drops to $5 over nextfour months. Buys stock on May 1 to show market that

confident in company future. We have a match! $10 per share profit on the May 1

purchase paid back to company. Window period andblackout rules no defense.

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Section 16

Option and Restricted Stock Grants

Grants of shares and stock options under employee

benefit plans will normally be exempt, assuming thatthe necessary shareholder or board approvals are givenin advance.

Any sale of shares is still matchable against any open

market purchase of shares within the six-month zone.Watch out for cashless exercise.

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Section 16

Example With Options

If you exercise a stock option and sell the stock

on January 1 when market price is $15, yourexercise is exempt from Section 16(b) matching.The sale of the stock is not. Thus, any gainsresulting from a match with a purchase sixmonths before this date or six months after will

be a short-swing profits violation. Purchase ofstock in November at $12 is matched for $3 pershare.

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Sarbanes-Oxley Act of 2002

CEO and CFO certifications

Ban on personal loans

Prohibition on trades during pension planblackout periods

Prior audit committee approval of non-audit

services

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CEO/CFO Certifications

Sarbanes Section 302: CEO/CFO of public companyrequired to submit a statement with certain filingscertifying that

Has reviewed the report

Based on CEO/CFOs knowledge, the report does not containany untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, inlight of the circumstances under which such statementswere made, not misleading with respect to the period

covered by the report

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CEO/CFO Certifications Along with other certifying officers

Are responsible for establishing and maintainingdisclosure controls and procedures

Have designed such disclosure controls and proceduresto ensure that material information is made known tothem, particularly during the period in which the periodicreport is being prepared

Have evaluated the effectiveness of the disclosurecontrols and procedures as of a date within 90 days prior

to the filing date of the report

Have presented in the report their conclusions about theeffectiveness of the disclosure controls and proceduresbased on the required evaluation as of that date

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Sarbanes Section 906: Requires CEO/CFO of publiccompany to submit a statement with certain filingscertifying that the filing fully complies with theExchange Act reporting requirements and fairly

presents in all material respects the companysfinancial condition and results of operations.

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What does this have to do with me?

Flow-down certification

Recent survey of large U.S. multinational companies

Two-thirds require subcertifications

Average of 18.6 additional executives

Including heads ofHR and Compensation

Participation in disclosure practices committee

Criminal penalties for CEO/CFO

HealthSouth first criminal certification case

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CEO/CFO not just certifying financial information

Most of proxy statement is incorporated byreference into PartIII of the Form 10-K

Executive compensation tables

Beneficial ownership table

Certain relationships and related transactions

Section 16 compliance Item 201(d) executive compensation plan information

table

Also financial statement equity compensation note

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Sample subcertification of proxy statement1. I understand that the Chief Executive Officer and Chief Financial

Officer of ABC Corp. will rely on this certificate, along with other

review procedures, in providing to the Securities and Exchange

Commission pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 and 302 of the Sarbanes-Oxley Act of 2002, a certification

in connection with ABC Corp.s annual report on Form 10-K, which

incorporates by reference certain sections of ABC Corp.s proxy

statement for its 2003 annual meeting.

2. I have reviewed the proxy statement.

3. Based on my knowledge, the proxy statement does not contain anyuntrue statement of a material fact or omit to state a material fact

necessary to make the statements made, in light of the circumstances

under which such statements were made, not misleading as of the

date on which the proxy statement was filed.

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Ban on Personal Loans Section 402: Bans personal loans to directors

and executive officers

Broker-assisted cashless exercises

Probably okay if

Regular T+3 settlement

Choice among approved brokers

Relocation

Residential loans probably not okay; alternatives:

Company buys and sells old residence, or

Company buys new house and rents to executive

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Ban on Personal Loans

Loan forgiveness

Partial loan forgiveness not okay if modification of agrandfathered arrangement

Total loan forgiveness may not be okay--depends onstatus of arrangement before forgiveness

Bonuses okay if not tied to repayment and otherwisejustifiable compensation as sign-on or retention bonuses

401(k) plan loans

Probably okay but inadvisable

DOL guidance: restrictions on pension plan loans toofficers of the plan sponsor do not violate ERISA loanrules (Field Assistance Bulletin 2003-1)

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Pension Plan Blackouts

New SEC Regulation BTR (Blackout TradingRestriction)

Prohibits directors and executive officers from trading during

pension plan blackout periods What is a blackout?

When at least 50% of participants in all individual accountplans cannot trade securities held in individual accounts formore than three consecutive business days

Exceptions for regularly scheduled blackout periodsincorporated into plan documents and disclosed toemployees and for merger transactions

Exemptions for DRIPs, certain 10b5-1 plan transactions, tax-qualified plan transactions other than discretionary

transactions, formula grants, gifts

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How does BTR affect insiders?

Restricts trading only of securities insiders acquired inconnection with their employment or service

Includes trades by family members

Insiders cannot acquire or dispose of securities acquired inconnection with employment or service as an insider

Includes receiving discretionary equity awards

Any profit realized by a director from a prohibitedtransaction is recoverable by the company

If company fails to act, shareholders can bring derivative action

Insiders also subject to civil injunctions, penalties and ceaseand desist proceedings, as well as possible criminal liability

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What do you have to do to implement BTR?

Include notification of regularly scheduled tradingsuspensions in plan documents

Notify plan participants at least 30 days in advance ofblackouts (per DOL regulations)

Applies to all individual account plans, regardless ofwhether hold company stock

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What do you have to do . . .

Notify insiders of blackouts at least five business days aftercompany receives notice from plan administrator

If no notice from plan administrator, notify insiders atleast 15 calendar days before start of blackout period

Limited relief possible

File notice with SEC on Form 8-K no later than date by whichnotice must be given to insiders

Requirements differ for foreign issuers Further information:

http://www.perkinscoie.com/resource/business/blackout.htm

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Non-Audit Services

Be aware when establishing perquisites forexecutives that the audit committee mustpre-approve, or establish policies and proceduresfor pre-approval of, non-audit services by the

companys auditing firm Includes provision of personal financial services to

executives by companys auditors

Sprint is a cautionary tale:

Two top executives were fired after their participation ina tax shelter for option exercise gains set up by thecompanys auditors left the executives with millions inpotential tax liability and a potential conflict with theauditors

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The new accounting board is expectedto issue more guidance and limits onconsulting and tax advice for audit

clients.

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Other CurrentIssues

NYSE/Nasdaq proposed rules will affect yourrelationship with the compensation committee

NYSE: compensation committee of independent

directors must Approve CEO compensation

Have sole authority to hire, fire and set feesof compensation consultants

Have written charter specifying purpose,duties and responsibilities

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Other CurrentIssues

Nasdaq: committee of independent directors ormajority of the independent directors must

approve CEO and executive officercompensation

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Other CurrentIssues

NYSE/Nasdaq proposed rules will affectavailability of equity and plan design

Shareholders must approve all equity

compensation plans

Also material amendments to plans

Discretionary broker voting on equity plans iseliminated

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Other CurrentIssues

Other things to watch out for: S-8 registrations must be effective before restricted stock

is granted

Expect new SEC guidance on Item 201(d) executive

compensation plan information table 906 certifications may be required for 11-Ks

Changes in accounting for equity compensation requireheightened awareness

New world of SFAS 123 accounting.

Impact on your Sarbanes-Oxley subcertifications forvaluation model used and its assumptions

Interpretations in state of flux

Liquidity accounting is variable

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References and FurtherReadingSarbanes-Oxley Acthttp://news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302.pdf

Securities and Exchange CommissionRegulatory Actionshttp://www.sec.gov/spotlight/sarbanes-oxley.htm

NYSE Corporate Governance Proposalshttp://www.nyse.com/abouthome.html?query=/about/report.html

NASDAQ Corporate Governance Proposalshttp://www.nasdaq.com/about/ProposedRuleChanges.stm

Perkins Coie LLPClient Updateshttp://www.perkinscoie.com/new.htm

myStockOptions.com--Insider trading, Section 16, Rule 144, 10b5-1content for executives and employees, along with tools and content onoptions, restricted stock and ESPPs

http://www.mystockoptions.com

Documents

Insider_Trading (Net Screen Shot)