Key takeaways
- Buried within the Senate version of the National Defense Authorization Act for Fiscal Year 2024 is a proposal to amend Section 16(a)(1) of the Securities Exchange Act to make insiders of foreign private issuers (FPIs) subject to Section 16
- Should the proposed amendment become law, FPIs will lose their prior Section 16 exemption and insiders of FPIs will be required to comply with both the reporting requirement and the short-swing profit recapture provision of Section 16
- This bill is not yet law, and these bills can change a lot between the proposed and final versions
The National Defense Authorization Act
The National Defense Authorization Act (NDAA) typically is not the type of legislation one would expect to have major implications for the regulation of non-US companies listing their securities on US stock exchanges. However, buried within the Senate's version of the National Defense Authorization Act for Fiscal Year 2024, which the Senate passed on July 27, 2023, is Section 6081, relating to Section 16 of the Securities Exchange Act of 1934 (Exchange Act). This section reads:
SEC. 6081. DISCLOSURES BY DIRECTORS, OFFICERS, AND PRINCIPAL
STOCKHOLDERS.
(a) In General.--Section 16(a)(1) of the Securities Exchange Act of
1934 (15 U.S.C. 78p(a)(1)) is amended by inserting ``(including any
such security of a foreign private issuer, as that term is defined in
section 240.3b-4 of title 17, Code of Federal Regulations, or any
successor regulation)'' after ``pursuant to section 12''.
(b) Effect on Regulation.--If any provision of section 240.3a12-
3(b) of title 17, Code of Federal Regulations, or any successor
regulation, is inconsistent with the amendment made by subsection (a),
that provision of such section 240.3a12-3(b) (or such successor) shall
have no force or effect.
(c) Issuance or Amendment of Regulations.--Not later than 90 days
after the date of enactment of this Act, the Securities and Exchange
Commission shall issue final regulations (or amend existing regulations
of the Commission) to carry out the amendment made by subsection (a).
The House of Representatives' version of the NDAA, which was passed on July 14, 2023, does not include any corresponding language regarding Section 16 of the Exchange Act. With the NDAA having passed (albeit different versions) in both the House and Senate, the two chambers of Congress are now in the process of resolving the differences between their respective versions of the bill. Procedurally, this requires that each version of the NDAA approved by each of the Senate and House must now be reconciled, and then approved by each chamber before a final version is sent to the President to be signed into law. As of September 27, 2023, a motion that the House instruct conferees failed, so it is not yet clear whether – or if – the final version of the NDAA will address Section 16 of the Exchange Act.
If the final version of the NDAA includes the provision currently proposed in the Senate version, Section 16(a)(1) of the Exchange Act would be amended such that officers, directors and beneficial owners of more than 10% of any registered class of securities of a company (insiders) of FPIs would lose their exemption from – and make them subject to – the insider trading prohibitions of Section 16. Further, any rule made by the US Securities and Exchange Commission (SEC) exempting FPIs from Section 16 would be rendered null and void.
Section 16
Section 16(a) of the Exchange Act requires insiders of public companies with securities listed on a US exchange to file reports with the SEC relating to their beneficial ownership of the company's securities. When a company first becomes public (whether through a traditional initial public offering, direct listing, or de-SPAC merger) or when a company loses FPI status, insiders are required to file a Form 3 by the effective date of the initial public offering or the first day as a domestic filer. After this time period, any new insider must file a Form 3 within 10 calendar days of becoming an insider. Insiders are also required to publicly report changes in their beneficial ownership of a company's securities. This is typically done on Form 4, which is required each time an insider conducts a non-exempt acquisition or disposition of securities of the company held by the insider. Subject to certain narrow exceptions, the filing deadline for a Form 4 is within two business days following execution of the transaction.
In addition to the reporting requirements under Section 16(a), Section 16(b) requires insiders to forfeit all profits realized from a purchase and sale, or sale and purchase, of registered securities of a company within a six-month period. This is known as "short-swing profit liability." Section 16(b) enables an issuer or its shareholders to sue the insider, requiring the insider to return the profits from such transactions back to the issuer. Section 16(b) creates a strict liability cause of action, meaning insiders can be sued and forced to return profits regardless of whether they intended to profit and regardless of whether the insider possessed any insider information about the company.
Foreign Private Issuers
FPIs are currently exempt from Section 16 pursuant to Rule 3a12-3 of the Exchange Act. As such, insiders of FPIs are exempt from filing Forms 3, 4 and 5, and are not subject to the short-swing profit recapture rule to which insiders of domestic companies are subject. Should the proposed amendment become law, FPIs will lose this exemption, and insiders of FPIs will be required to comply with both the reporting requirement and the short-swing profit recapture provision of Section 16. This could create a substantial new compliance burden for FPIs, notwithstanding the burden for FPIs that are dual-listed and already subject to insider reporting requirements and regimes in their respective home countries.
This potential change to the treatment of FPIs by the SEC comes on the heels of several other rules approved by the SEC that impact the reporting and disclosure requirements of FPIs, including new rules relating to the clawback of incentive compensation from executive officers, share repurchase reporting, and cybersecurity disclosures. In October 2022, the SEC adopted a new rule governing the recovery of erroneously awarded incentive compensation from executive officers, from which FPIs are not exempt. In May 2023, the SEC adopted a proposal intended to modernize and improve disclosure of company stock repurchases, which includes a requirement that FPIs report daily quantitative repurchase data at the end of every quarter on a new Form F-SR, due 45 days after the end of the FPI's fiscal quarter (though an FPI can incorporate by reference any home country disclosures furnished on Form 6-K that satisfy the Form F-SR requirements). Lastly, in August 2023, the SEC adopted cybersecurity disclosure requirements for public companies, including requirements that FPIs file a Form 6-K should it experience a "material cybersecurity incident" and new Item 16K to annual reports on Form 20-F requiring cybersecurity disclosures similar to those required of domestic issuers under Item 106 of Regulation S-K.
For more details on the recent SEC rulemakings that have implications for FPIs, see the publications related to clawbacks, share repurchases, and cybersecurity.
What's Next?
Hold tight. The provision that would repeal the Section 16 exemption for FPIs is not yet law, and both the House and Senate will have to resolve their differences – on the entire bill, which is more than 2,000 pages – before the bill reaches the President for signature. If eventually enacted, the SEC will have to first propose, then adopt, rules to repeal the Section 16 exemption granted to FPIs within 90 days of enactment.
For FPIs with securities listed on a US exchange, or that have plans to list on a US exchange, we do not believe changes to their Section 16 compliance programs need to be made at this time. Bills like these can change a lot between proposal and final passage. Cooley lawyers will be monitoring any developments of this bill as it works its way through parliamentary procedure in Congress, and we will provide updates when available.
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