Accelerated Form 4 Reporting Requirements Under the Sarbanes-Oxley Act of 2002

Article by Michael L Zuppone, Kurt E Scheuerman and Chad C Conwell

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Act"),¹ which enacted a number of reforms regarding the oversight of public auditors, improving corporate governance and requiring greater executive responsibility and accountability. Among these reforms, Section 403 of the Act amends Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act") to shorten the deadline to two business days for corporate insiders to report changes in their beneficial ownership of securities. Section 403 of the Act required the Securities and Exchange Commission (the "SEC") to adopt implementing regulations by August 29, 2002.

On August 27, 2002, the SEC adopted amendments to its rules promulgated under Section 16(a) implementing the accelerated reporting time-frame imposed by the Act.² The two business day reporting timeframe mandated by the Act reflects a significant acceleration of the reporting deadline that prevailed under the prior rules. The prior Section 16(a) reporting rules imposed a deadline for reporting changes in beneficial ownership of ten days after the end of the month in which the change in ownership occurred. The prior rules permitted certain changes in beneficial ownership to be reported on Form 5 within forty-five days after the end of the company’s fiscal year, and had exempted certain changes in beneficial ownership from the reporting requirements entirely.

The Act did not change the class of persons who are required to file reports on Form 4. Section 16 of the Exchange Act continues to apply to directors and executive officers of public companies with equity securities registered under Section 12 of the Exchange Act (i.e., common stock listed on a stock exchange or Nasdaq) and to any person who beneficially owns more than 10 percent of such equity securities.³ These persons are collectively referred to in this Alert as "insiders."

The following are examples of some common transactions that will be reportable on Form 4 within two business days. This list is illustrative only and is not intended to be exhaustive:

• open market purchases and sales;
• stock option exercises (including cashless exercises);
• stock option grants;
• conversions of derivative securities;
• vesting of performance options not considered "derivative securities" reportable at the time of grant;
• purchases pursuant to deferred compensation arrangements;
• purchases pursuant to excess benefit plans; and
• voluntary purchases under dividend reinvestment plans.

The two business days are counted from the date of the execution of the sale or purchase, not the settlement date. The date of the execution of the transaction does not count as one of the days. For example, if an insider’s broker executes a sale of the company’s securities on a Monday, the Form 4 would be due on Wednesday.

No. As discussed below, the new rules provide that certain changes in beneficial ownership are reportable on Form 4 within a timeframe not to exceed five business days, certain changes continue to be reportable on Form 5 within 45 days after the company’s fiscal year, and certain changes continue to be non-reportable.

The Act provides that the SEC may establish by rule a later deadline upon a finding that the two-day period is not feasible. In this regard, Rule 16a-3(g) adopted by the SEC permits the following two types of transactions to be reported within a timeframe not to exceed five business days after the date of execution of the transaction.

• If a transaction occurs pursuant to a contract, instruction (such as a limit order) or written plan for the purchase or sale of securities that satisfies the affirmative defense conditions of Exchange Act Rule 10b5-1(c) (such as transactions pursuant to employee benefit plans and dividend or interest reinvestment plans that are not otherwise exempt from Section 16 reporting) where the insider does not select the date of execution, then the transaction will be deemed to have been executed on the date the insider receives notification of the transaction from the executing broker, dealer or plan administrator.
• If the transaction is a "discretionary transaction" pursuant to an employee benefit plan where the insider did not select the date of execution, then the transaction will be deemed to have been executed on the date the insider receives notification of the transaction from the plan administrator. A "discretionary transaction" is defined as a transaction which involves an intra-plan transfer of previously invested assets into or out of a plan issuer securities fund, or a cash-out from a plan issuer securities fund.

With these types of transactions, the insider is still obligated to report on Form 4 within two business days following the deemed date of execution. In either case, however, regardless of whether the insider has actually received the notice of the execution of the transaction, the transaction will be deemed to have occurred on the third business day following the actual execution date.

The following are illustrative examples of some common transactions that will continue to be reportable on Form 5 within 45 days after the end of the company’s fiscal year:

• small acquisitions from persons other than the company which are, in the aggregate, less than $10,000; and
• bona fide gifts of securities.

The following transactions will continue to be exempt from Section 16 reporting altogether:

• changes in form of beneficial ownership;
• transactions pursuant to certain domestic relations orders;
• certain automatic acquisitions pursuant to dividend or interest reinvestment plans;
• expirations of stock options;
• stock splits and stock dividends; and
• transactions pursuant to certain employee benefit plans, such as 401(k) plans and employee stock purchase plans.

Nevertheless, an insider must disclose on each Form 4 filed by the insider the aggregate number of shares beneficially held immediately after the transaction being reported. An insider must monitor all its changes in beneficial ownership (even if eligible for deferred reporting on Form 5 or otherwise exempt from reporting) in order to ensure that this aggregate number is accurately reported. An insider may rely on the latest plan statement received by the insider in reporting holdings pursuant to 401(k) and other exempt employee benefit plans.

The accelerated Form 4 reporting requirements apply to transactions that occurred on or after August 29, 2002.

Transactions that were mandatory Form 4 reportable transactions that took place before August 29, 2002 need to be reported on a Form 4 within 10 days after the end of the month (i.e., by September 10, 2002). Transactions that were eligible for deferred reporting prior to the Act (e.g., option grants or other Section 16b-3 exempt transactions with the company) may still be reported on a Form 5 within 45 days after the end of the company’s fiscal year.

The Act did not make any changes to these restrictions. Insiders continue to be subject to the same sanctions and trading limitations under Section 16(b) (subjecting short-swing profits to statutory disgorgement) and Section 16(c) (prohibiting short sales by insiders).

No. Insiders of foreign private issuers continue to be exempt from Section 16.

Q: Did the Act accelerate the deadline for filing initial reports of beneficial ownership on Form 3?

No. Initial reports on Form 3 must still be filed by every insider within 10 days of becoming an insider. However, the insider’s two day Form 4 reporting obligation begins immediately upon becoming an insider. In other words, if an insider engages in a reportable transaction within the first eight days after becoming an insider, a Form 4 could be due before the insider’s Form 3 is due. For example, if a director or executive officer is granted stock options upon election or appointment, the insider would be required to file a Form 4 within two days of the option grant date, even though the Form 3 would not be due until 10 days after the insider was appointed. In this situation, the SEC encourages insiders to file the Form 3 concurrently with the filing of this first Form 4.

There is no provision for an extension of the filing deadlines, and the SEC can take enforcement action against chronic violators of the filing requirements. In addition, each company is required to report the number of late filings of reports under Section 16 by its insiders in the company’s proxy statement for its annual meeting and to identify the insiders who made the late filings.

To be timely, a Form 4 must be received by the SEC by the end of the second business day. If a Form 4 is filed electronically via EDGAR it must be received by the SEC by 5:30 p.m. Eastern time on the second business day following the transaction. If it is filed on paper, it must be received at the SEC’s offices by the end of the second business day following the transaction. Conformed and facsimile signatures are acceptable. Therefore, an insider may fax or e-mail the insider’s Form 4 with a conformed signature to someone in Washington D.C. for physical delivery to the SEC by the end of the second business day.

At the present time, insiders may continue to file their Form 4 either on paper or electronically through EDGAR. If an insider desires to file its Form 4 electronically via EDGAR and has not previously done so, the insider will need to obtain EDGAR filing codes by completing and filing a Form ID with the SEC. The Act mandates that Section 16 reports be filed electronically within one year, and the SEC has announced that it will undertake the necessary changes to EDGAR to require mandatory electronic filing by July 30, 2003. In addition, once mandatory filing is implemented, each company will be required to post the Section 16 filings made by its insiders on its publicly available website.

Yes. On August 29, 2002, the SEC published a new Form 4 to reflect the new reporting requirements. Paul Hastings has developed a new electronic Form 4 which conforms to this update.

Public companies should implement a Section 16 compliance program (or update their existing Section 16 compliance program) applicable to executive officers and directors (and, as appropriate, other insiders), which consists of:

• implementing a comprehensive pre-clearance procedure that prohibits all insiders from engaging in any transaction involving the company’s securities without first obtaining pre-clearance of the transaction from the company;
• sending a memorandum to insiders explaining the reporting requirements and the company’s compliance program and policies;
• taking over responsibility for preparing Form 4 reports on behalf of insiders;
• having insiders execute a power of attorney to enable the company to prepare and file the Forms 4 on a timely basis;
• advising insiders of the need to carefully track securities which they beneficially own directly as well as those deemed beneficially owned indirectly (e.g., securities held by members of the insider’s immediate family who share the same household);
• considering implementing electronic EDGAR filing of Form 4 reports; and
• sending insiders periodic preventive reminders and alerts during the course of the year.

© 2002 Paul, Hastings, Janofsky & Walker LLP