Stock Compensation Meets Securities Laws: Keeping Executives and Employees Out of Jail

Bruce Brumberg, Editor Sue Morgan, Perkins Coie LLP WorldatWork 48th Annual Conference May 12, 2003 San Diego


All the financial scandals involve securities law violations and sales of stock by insiders. The stock sold, either from options or restricted share grants, or founders stock, was often part of equity compensation.


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 Current Issues

stories and accusations continue. .4 The investigations.

5 Will ads for insider trading lawyers crowd out ads for personal injury and medical malpractice lawyers? .

 .6 Insider Trading What is insider trading?  You know material confidential information about a public company (whether your company or another company). You trade on that information or tip others about it before the information is released publicly.

Mail and wire fraud. Controlling person¶s liability for managers New disgorgement penalty for restatements .7 Insider Trading     Civil Penalties: any profit made or loss avoided and penalty of up to three times this amount. tax evasion and obstruction of justice. Individuals face up to 25 years in prison for securities fraud and fines of up to $1 million. Bar for serving as D&O of public company. Corporations face penalties.

8 Insider Trading Material information: news that can affect a company s stock price. for better or worse This includes knowledge of: takeover accounting problems dividend change blockbuster product earnings better or worse than expected .

9 Insider Trading MYTHs Only a company s insiders or employees can commit insider trading. Need to trade and be caught in the act. clients Tipping. even without the tipper trading. is illegal Most cases based on circumstantial evidence These rules are separate from the Section 16 rules for senior executives and directors . 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.

10 .

    . CEO s family members sell Martha Stewart: What did she know? When did she know it? Who gave her information? What constituted obstruction of justice and false statements to government investigators? Can brokers use information that senior executives are buying or selling? Check your plan provider s rules.11 Insider Trading The ImClone case  What is the material nonpublic information and when does it become public? Senior executives sell.

12 Insider Trading How does insider trading apply to stock options?     Grant or exercise of stock options is not a trade Cashless exercise/same-day sale raises questions of insider trading Rules apply during post-termination exercise period Rules also apply to company stock in 401(k) .

Destroys the financial link between employees and shareholders. Even well-intentioned actions can be illegal. Investors interpret insider trading investigation as sign that company has undisclosed financial or accounting troubles.    . Damages reputation of equity compensation.13 Insider Trading Insider trading harms the goals of employee ownership  Employee ownership culture encourages information-sharing and boasting about company.

Videos (e. Reminders. Press Clippings Substantive prevention efforts. Rule 10b5-1 plans as defense. Think Twice ).. internal investigations and cooperation with SEC and DOJ can reduce corporate liability . Quarterly Trading Windows Pre-clearance for Senior Executives and Directors.14 Insider Trading     Prevention Procedures Blackout Periods vs. Ongoing Education: Seminars.g.

see Articles and FAQs on myStockOptions .15 For more details and questions on insider trading.

16 10b5-1 Plans  What are Rule 10b5-1 trading plans?     How they help How they work FAQs How you can help implement .

17 10b5-1 Plans  How 10b5-1 plans help    Permit advance planning for orderly disposition or to meet special needs Sales can take place even when insiders are aware of material nonpublic information Companies can manage public perception of insiders sales .

 Instruct another person to sell for the insider s account. the insider must  Enter into a contract to sell (or purchase).18 10b5-1 Plans  How 10b5-1 plans work   Provide an affirmative defense against insider trading claims if When not aware of the inside information. or  Adopt a written plan for trading securities .

algorithm or computer program for determining amounts.  Provide formula. or  Not permit the insider to exercise any subsequent influence over how. prices and dates. when or whether to effect the sales .19 10b5-1 Plans  The written trading plan must  Specify amount. price and date of sales.

20 10b5-1 Plans  Whose plan is it?  Agreement between insider and broker  Brokers usually supply form  Company should review  To avoid controlling person liability .

during a window period When should sales start?  Hiatus before trading starts: two weeks. after next earnings release  . 30 days.21 10b5-1 Plans  When should the plan be signed?  Generally. three months.

22 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 when trading can begin .

23 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 .

24 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 .

25 10b5-1 Plans  What factors influence trading instructions?  Impact on market   Size of transactions Multiple insiders Frequent sales. barrage of Forms 4 Keep it simple  Two-day Section 16 reporting   Ease of implementation   Cashless option exercise issues .

tender offer  Withdrawal of company s lack of objection to plan .26 10b5-1 Plans  What should cause the plan to automatically suspend or terminate?  Insider s death. expiration of stock options subject to plan  Announcement of merger. bankruptcy. termination of insider status.

27 10b5-1 Plans  When can insider terminate the plan?  Can be when aware of inside information  Does not violate Rule 10b5-1 because it is not illegal not to trade (SEC informal advice)  Issue of good faith if pattern or practice  Should be hiatus before start new plan .

28 10b5-1 Plans   When can insider modify the plan?  Only when not aware of inside information. trade must not violate Rule 10b-5 . 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.

29 10b5-1 Plans  Should the company make a public announcement of the 10b5-1 plan or program?  Press release  Form 8-K (SEC may require)  Form 10-Q  Company Web site .

other terms  Whether insiders will trade outside plan .30 10b5-1 Plans  What should be disclosed?  Existence of program (selling or buying)  Names of insiders  Number of shares  Percentage of holdings (vested and unvested)  Duration.

2002. the plans were established at times when the officers were not aware of material nonpublic information.31 10b5-1 Plans  Sample disclosure Four of the company¶s executive officers currently have in effect Rule 10b5-1 sales plans for shares of the company¶s common stock. the aggregate number of shares that may be sold under the plans would be ________. The officers may amend the trading plans and may sell additional shares of common stock outside of the trading plans. In accordance with the requirements of Rule 10b5-1. If all conditions of the plans are met. which range from six months to one year. . the numbers of shares to be sold and the prices at which shares may be sold. provided they are not aware of material nonpublic information at such time. which would equal approximately __% of the aggregate number of shares. The plans specify the trading periods. including restricted shares and vested and unvested option shares. held by the officers as of _______.

32 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 .

33 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 and approval  Vet plans of one or more brokers .

broker and insider  Committee makes any requests for changes and approves or rejects plan  Committee works with broker to generate required paperwork (e. stock option exercise forms) .g..34 10b5-1 Plans  Process for approval  Committee reviews plan for compliance with company's guidelines  Dialogue takes place between committee.

35 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 for insider's signature--two-day filing unless exact date not specified .

g.36 10b5-1 Plans  Sample guidelines  General plan requirements       Discretionary plans will not be permitted Modification/voluntary termination of plan can only take place during an open window Company has discretion to terminate plan for certain events Automatic termination/suspension events Plan intended to comply with Rule 10b5-1 Purpose. e.. to permit orderly disposition or acquisition .

37 10b5-1 Plans  Insider representations that      Insider is not aware of material nonpublic information Insider is entering into plan in good faith. and not as part of a scheme to evade the purpose of the rule Insider will not hedge against the trading plan Insider will comply with Rule 144 and Sections 16 and 13(d) Insider will exercise no control over broker s actions .

38 10b5-1 Plans  Broker representations that    It will not seek instructions or advice from insider It will not deviate from the plan It will not execute if aware of material nonpublic information It has reviewed (or approved) trading plan It has no objections to the plan The plan does not violate the company s insider trading policy  Company representations that    .

4 & 5 Short-swing profit liability . and also matching of trades within six-month period Forms 3.39 Section 16    Provisions under securities laws and SEC rules that require SEC filings by senior executives and directors for their company stock transactions.

transactions with the company. cancellations and repricings Company procedures in place for assisting insiders with filings 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 .40 Section 16 Form 4      Filed two days after company stock transactions Previously reported on Form 5: Option grants. including option issuances.

Changes in compensation design: Deferred comp. chief accounting officers. VPs of principal business units and any person with significant policymaking function.41 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: No longer prestigious. CFO. M&A   . SEC definition includes president.

or sale and purchase. of any company shares within any period less than six months must return this profit to the company Extends to transactions made by your spouse and other family members and to trusts set up for their benefit Section 16(b) plaintiff's lawyers actively monitor securities trades for these violations because they share in any profits paid back to your company .42 Section 16 Short-Swing Profit Rules    Senior officer and director who realize any profit from the purchase and sale.

We have a match! $10 per share profit on the May 1 purchase paid back to company. Stock drops to $5 over next four months. Stock executive purchased two years ago. Best match applies! Down market example:   Sold stock on January 1 at $15.43 Section 16 Danger: The six-month danger period runs both backward and forward from the date of a transaction. . Buys stock on May 1 to show market that confident in company future. Window period and blackout rules no defense.

Any sale of shares is still matchable against any open market purchase of shares within the six-month zone.  . assuming that the necessary shareholder or board approvals are given in advance. Watch out for cashless exercise.44 Section 16 Option and Restricted Stock Grants  Grants of shares and stock options under employee benefit plans will normally be exempt.

your exercise is exempt from Section 16(b) matching. . Purchase of stock in November at $12 is matched for $3 per share. The sale of the stock is not. Thus.45 Section 16 Example With Options If you exercise a stock option and sell the stock on January 1 when market price is $15. any gains resulting from a match with a purchase six months before this date or six months after will be a short-swing profits violation.

46 Sarbanes-Oxley Act of 2002    CEO and CFO certifications Ban on personal loans Prohibition on trades during pension plan blackout periods Prior audit committee approval of non-audit services  .

in light of the circumstances under which such statements were made.47 CEO/CFO Certifications  Sarbanes Section 302: CEO/CFO of public company required to submit a statement with certain filings certifying that   Has reviewed the report Based on CEO/CFO s knowledge. not misleading with respect to the period covered by the report . the report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made.

particularly during the period in which the periodic report is being prepared Have evaluated the effectiveness of the disclosure controls 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 the effectiveness of the disclosure controls and procedures based on the required evaluation as of that date    .48 CEO/CFO Certifications  Along with other certifying officers  Are responsible for establishing and maintaining disclosure controls and procedures Have designed such disclosure controls and procedures to ensure that material information is made known to them.

49 CEO/CFO Certifications  Sarbanes Section 906: Requires CEO/CFO of public company to submit a statement with certain filings certifying that the filing fully complies with the Exchange Act reporting requirements and fairly presents in all material respects the company s financial condition and results of operations. .


CEO/CFO Certifications 

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 of HR and Compensation    

Participation in disclosure practices committee Criminal penalties for CEO/CFO 

HealthSouth first criminal certification case


CEO/CFO Certifications 

CEO/CFO not just certifying financial information Most of proxy statement is incorporated by reference into Part III 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


CEO/CFO Certifications 

Sample subcertification of proxy statement

1. 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 any untrue 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.

or Company buys new house and rents to executive .53 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.

54 Ban on Personal Loans  Loan forgiveness  Partial loan forgiveness not okay if modification of a grandfathered arrangement Total loan forgiveness may not be okay--depends on status of arrangement before forgiveness Bonuses okay if not tied to repayment and otherwise justifiable compensation as sign-on or retention bonuses    401(k) plan loans   Probably okay but inadvisable DOL guidance: restrictions on pension plan loans to officers of the plan sponsor do not violate ERISA loan rules (Field Assistance Bulletin 2003-1) .

formula grants. gifts . certain 10b5-1 plan transactions. taxqualified plan transactions other than discretionary transactions.55 Pension Plan Blackouts  New SEC Regulation BTR (Blackout Trading Restriction)  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 account plans cannot trade securities held in individual accounts for more than three consecutive business days  Exceptions for regularly scheduled blackout periods incorporated into plan documents and disclosed to employees and for merger transactions Exemptions for DRIPs.

56 Pension Plan Blackouts  How does BTR affect insiders?  Restricts trading only of securities insiders acquired in connection with their employment or service  Includes trades by family members  Insiders cannot acquire or dispose of securities acquired in connection with employment or service as an insider  Includes receiving discretionary equity awards  Any profit realized by a director from a prohibited transaction is recoverable by the company  If company fails to act. as well as possible criminal liability . shareholders can bring derivative action  Insiders also subject to civil injunctions. penalties and cease and desist proceedings.

regardless of whether hold company stock .57 Pension Plan Blackouts  What do you have to do to implement BTR?   Include notification of regularly scheduled trading suspensions in plan documents Notify plan participants at least 30 days in advance of blackouts (per DOL regulations)  Applies to all individual account plans.

com/resource/business/blackout.58 Pension Plan Blackouts  What do you have to do .htm . notify insiders at least 15 calendar days before start of blackout period  Limited relief possible File notice with SEC on Form 8-K no later than date by which notice must be given to insiders Requirements differ for foreign issuers Further information:  http://www. .     Notify insiders of blackouts at least five business days after company receives notice from plan administrator  If no notice from plan administrator.perkinscoie. .

non-audit services by the company s auditing firm  Includes provision of personal financial services to executives by company s auditors Sprint is a cautionary tale:   Two top executives were fired after their participation in a tax shelter for option exercise gains set up by the company s auditors left the executives with millions in potential tax liability and a potential conflict with the auditors .59 Non-Audit Services  Be aware when establishing perquisites for executives that the audit committee must pre-approve. or establish policies and procedures for pre-approval of.

60 The new accounting board is expected to issue more guidance and limits on consulting and tax advice for audit clients. .

duties and responsibilities . fire and set fees of compensation consultants  Have written charter specifying purpose.61 Other Current Issues  NYSE/Nasdaq proposed rules will affect your relationship with the compensation committee  NYSE: compensation committee of independent directors must  Approve CEO compensation  Have sole authority to hire.

62 Other Current Issues  Nasdaq: committee of independent directors or majority of the independent directors must approve CEO and executive officer compensation .

63 Other Current Issues  NYSE/Nasdaq proposed rules will affect availability of equity and plan design   Shareholders must approve all equity compensation plans  Also material amendments to plans Discretionary broker voting on equity plans is eliminated .

 Impact on your Sarbanes-Oxley subcertifications for valuation model used and its assumptions  Interpretations in state of flux  Liquidity accounting is variable .64 Other Current Issues  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 require heightened awareness  New world of SFAS 123 accounting. trading. restricted stock and ESPPs http://www. along with tools and content on .html NASDAQ Corporate Governance Proposals Rule Securities and Exchange Commission Regulatory Actions http://www.perkinscoie.65 References and Further Reading Sarbanes-Oxley Act http://news. Section 10b5-1 content for executives and employees.stm Perkins Coie LLP Client Updates http://www.html?query=/about/report.htm NYSE Corporate Governance Proposals

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