Questions and Answers about Section 16 (b) of the Securities Exchange Act of 1934.

Question 1.

What is the purpose of Section 16 (b) of the 1934  act?

Answer:

  Verbatim from the Act itself is below:

" the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer"

But what exactly does the sentence above mean?

It means that the purpose of Section 16 (b) is to prevent an officer, director or a 10% beneficial owner of equity shares of the issuer from buying and selling shares when they have an advantage over the opposite party due to their inside information.

The person opposite the insider can be members of the public or the issuer itself.

Question 2.

Does the SEC enforce Section 16 (b)?

Answer:

No, the enforcement is left up to the issuer or a shareholder if the issuer refuses to enforce it.

Question 3.

What constitutes a violation of Section 16 (b) of the 1934 Act?

Answer

A violation consists of a purchase and a sale (or sale and a purchase) of issuer equity securities within less than 6 months, by the officer, director, or greater than 10 % owner and a profit results. It is a strict liability statute. No showing of knowledge or intent is required for there to be a violation of Section 16 (b).

Question 4.

Are any transactions exempt from 16 (b)?

Answer is yes, but only the SEC, through its Rules and Regulations can exempt certain transactions.

Question 5.

Can the SEC exempt any type transactions it wants?

Answer is No. The only type of transactions that are exempt are ones that are not comprehended within the purpose of Section 16 (b). That purpose is the purpose stated in the answer to Question 1.

Question 6

Can the SEC exempt transactions by an officer or director made with the issuer of the company?

Answer is:

The SEC does exempts some transactions between the officer or director with the issuer. But those exemptions have limitations and have requirements to be satisfied to achieve an exemption. Most of the transactions between the issuer and the insider that are exempt are grants of ESOs, RS, RSU from the issuer to executives.

There are some transactions where the insider disposes shares to the issuer, where the insider claims that the transactions are exempt but are often not exempt. The only time that the dispositions to the issuer are exempt from section 16 (b) is when the transaction is not comprehended within the purpose of the section 16 (b) and the transaction meets "gatekeeping requirements" for exemptions.

Question 7.

What are some of the requirements, whereby the SEC can exempt transactions between the officer or directors and the issuer.

A) The specific transaction must be approved by the Board of Directors or the Compensation Committee in advance of the transaction.

B) The transaction must satisfy certain "gate keeping requirements" as stated by the American Bar Association and the New York Bar Association adopted by the SEC.

C) The transaction must be not comprehended within the purpose of Section 16 (b).

D) The issuer must be on equal footing with the issuer with regard to having equal "inside information". 

E) And the officer or director with negative inside information and has a choice of paying cash or delivering shares can not be  exempted for disposing of shares when the issuer has no discretion to accept or to not accept the disposition.

Question 8

Do the companies enforce Section 16 (b) against officers and directors, when the officer or director disposes of shares to the issuer in violation of Section 16 (b)?

Rarely does it happen since the equity compensation plans are designed to allow maximum wealth extraction from the issuer by the officers and directors.

Most Securities law firms represent the Issuers and or the executives and do not represent shareholders who are trying to enforce Section 16 (b). And executives at the issuer decide whether the issuer pursues the executives for recovery of the profits made in violation of Section 16 (b).

The Company/issuer executives have a fiduciary duty to the shareholders to enforce section 16 (b) against fellow executives, who violate section 16 (b). But very few enforcements are brought by officers against executives for Section 16 (b) violations.

More to come