Section 16 Requirements
Section 16 Requirements- Under Section 16, every person who is an insider must file an initial statement on Form 3 within 10 days of the event triggering such filing and file continuing changes on Form 4 within two business days following such change. Transactions required to be reported on Form 4 include acquisitions and disposition of securities including the purchases and sales of securities, exercises and conversions of options, warrants and other derivative securities, and grants or awards of securities from the Company. An annual report on Form 5 is used to report changes and information that should have been, but were not included in prior Forms 3 or 4.
As mentioned in the last Lawcast, Section 16 is intended to prevent unfair use of inside information and discourage speculative trading by insiders by requiring them to report holdings and transactions in a reporting company’s securities and by requiring them to pay over to the reporting company any “profits” realized from any purchase and sale (or any sale and purchase) of the reporting company securities within a six-month period.
Section 16, also precludes insiders from making short sales of the reporting company’s securities. In addition to the individual reporting requirement, the SEC requires that the reporting company itself disclose in its annual proxy statement the names of insiders who have failed to make required Section 16 filings on a timely basis, and to disclose if there have been violations both on the cover of its annual report Form 10-K by checking a box and narratively on this inside of the report.
The first gating question for a Section 16 analysis is who is an insider and therefore subject to the Section 16 short swing and short sale trading prohibitions, and its reporting obligations. On the top line an insider is an officer, director or 10% or greater shareholder.
However, not all officers are Section 16 filers. A Section 16 filer for sure include the principal or chief executive officer, principal financial and accounting officer and any officer in charge of a business unit, division or function. Beyond that the key determination is the level of control and ability to perform significant policymaking functions for the reporting company. The SEC recognizes that reporting companies may give titles to individuals that include terms like “vice president of…” or “director of…” which individuals are not in a high-level control position. These individuals are not considered Section 16 filers.
As with other SEC rules and regulations, 10% ownership is based on beneficial ownership and not the legal title or record ownership. Beneficial ownership is determined by the person’s ability to control the voting power of the securities, investment decisions related to the securities (whether to buy or sell), and monetary interests in the securities. A monetary interest is the direct or indirect ability to profit from purchases or sales of securities. An insider is considered to have a beneficial ownership interest of securities held by their immediate family sharing the same household. Immediate family members include grandparents, grandchildren, siblings and in-laws, as well as your spouse, children and parents.
In the next Lawcast in this series I will continue with specifics under Section 16. However, even for the most experienced practitioner, the rules under Section 16 are complex and contain a number of “gray” areas and potential traps for the unwary. Insiders should consult with counsel before engaging in any transactions in the company’s securities, particularly transactions involving “derivative” securities such as options or warrants.