The Securities and Exchange Commission has proposed rules for the prohibition of insider trading during pension fund blackout periods imposed by Section 306(a) of the Sarbanes-Oxley Act of 2002. Section 306(a) generally prohibits directors and executive officers of SEC reporting companies (including foreign private issuers) from buying or selling their company's equity securities at times when plan participants are precluded from doing so under a company pension plan, such as a 401(k) plan, profit-sharing plan, stock bonus plan or non-qualified deferred compensation plan.

As proposed by the SEC, new Regulation BTR (for "Blackout Trading Restriction") would clarify the scope and operation of the Section 306(a) trading prohibition, set forth exceptions and clarify the remedies for violations. Regulation BTR would also specify the content and delivery requirements for the notice that a company must provide in advance of a blackout period to its directors and executive officers and to the SEC on Form 8-K. (See SEC Release No. 34-46778, which you can access at http://www.sec.gov/rules/proposed/34-46778.htm.) The comment period on proposed Regulation BTR ends December 16, 2002. Regardless of whether the SEC issues final rules, the trading prohibition of Section 306(a) becomes effective on January 26, 2003.

In addition to the SEC's proposal, the Department of Labor has recently adopted interim final regulations under Section 306(b) of the Sarbanes-Oxley Act requiring plan administrators to notify plan participants at least 30 days in advance of the blackout period, subject to certain exceptions. The DOL rules become effective for any blackout period beginning on or after January 26, 2003.

Pension plan blackouts may occur for a variety of administrative reasons-such as changes in record keepers, trustees or investment funds. SEC reporting companies will need to identify plans covered by the new rules and work closely with their HR departments and plan record keepers and trustees to ensure they receive sufficient notice of any blackout to avoid violations.

Definition of "Blackout Period"

U.S. reporting companies
For purposes of the trading prohibition, a "blackout period" for a U.S. reporting company occurs when at least 50% of the participants in all of the company's "individual account plans" are subject to a temporary suspension imposed by the company or a fiduciary of more than three consecutive business days that prevents the participants from purchasing or selling the company's equity securities held in a plan. For purposes of Regulation BTR, an "individual account plan" means a plan in which participants hold or could hold equity securities of the company that meets the definition of "individual account plan" under Section 3(34) of ERISA, as well as any non-qualified deferred compensation plan that reflects the elements of Section 3(34). This would include 401(k) plans, profit-sharing and savings plans, stock bonus plans, money purchase pension plans and non-qualified deferred compensation plans that have a company stock fund, that provide for an open brokerage window through which participants may purchase any public company stock or that match contributions in company stock.

Foreign private issuers
Regulation BTR would define a "blackout period" for foreign private issuers to occur when (1) plan participants located in the U.S. and subject to a blackout comprise 50% or more of all participants located in the U.S. and (2) plan participants in the U.S. subject to a blackout represent more than 15% of all plan participants worldwide.

Exclusions from definition
Under Regulation BTR, a "blackout period" would not include:

  • Regularly scheduled suspensions that are described in the plan documents and disclosed to an employee before, or within 30 days after, enrolling in the plan; and

  • Suspensions for the principal purpose of enabling employees of an acquired or divested business to become or cease to be plan participants following the acquisition or divestiture.

As a result, some common plan blackouts would not restrict trading by directors and executive officers, so long as such periods are properly noticed to plan participants.

Scope of Trading Prohibition
The Section 306(a) trading prohibition applies only to equity securities (including options and other derivative securities as defined in SEC rules under Section 16 of the Securities Exchange Act of 1934) acquired by the director or executive officer in connection with his or her service to the company. Equity securities acquired on the open market, for example, would technically be excluded from the trading restriction. Directors and executive officers should not rely on this exclusion, however, since proposed Regulation BTR treats securities owned by directors and executive officers as fungible for purposes of the Section 306(a) trading prohibition. As a result, if a director or executive officer owns any securities acquired "in connection with service or employment," these securities will be deemed to be sold first if he or she sells during a blackout period.

Regulation BTR defines equity securities acquired "in connection with service or employment as a director or executive officer" to include those acquired:

  • Under a compensatory plan or arrangement (whether or not set forth in any formal plan document) of the reporting company or one of its affiliates, at a time when the individual was a director or executive officer;

  • As a result of certain transactions or business relationships between the individual and the company;

  • As director's qualifying shares or to satisfy a company's minimum securities ownership guidelines for directors or executive officers; or

  • As an inducement to become a director or executive officer with the company or one of its affiliates.

The proposed rules would also apply to direct and indirect acquisitions and dispositions of equity securities where a director or executive officer had a pecuniary interest in the transaction. The term "pecuniary interest" would have the same meaning as under the Section 16 rules, such that acquisitions and dispositions made by family members and related entities would be attributed to the director or executive officer.

Transactions Exempt from Trading Prohibition
Section 306(a) permits the SEC to exempt certain transactions in equity securities from the trading prohibition. Proposed Regulation BTR would exempt:

  • Acquisitions under broad-based and non-discriminatory dividend or interest reinvestment plans;

  • Purchases or sales under Rule 10b5-1(c) trading plans (as long as the related election was not made or modified during the blackout period or at the time the director or executive officer was aware of the impending blackout);

  • Purchases or sales of equity securities pursuant to certain tax-qualified employee benefit plans, such as a qualified employee stock purchase plan, other than discretionary transactions (as defined in the Section 16 rules); and

  • Stock splits, stock dividends or pro rata rights distributions.

Remedies
Under Section 306(a) and Regulation BTR as proposed, a company, or a securityholder on behalf of the company, could bring an action (within two years of the violation) for disgorgement of profits realized by a director or executive officer in violation of the trading prohibition. The proposed rules would provide guidance on how the computation of profits would be made in a private action, and solicits comment on alternative approaches. In addition, individuals violating the proposed rules would be subject to action by the SEC, including civil injunctive actions, penalties and cease and desist proceedings, as well as possible criminal liability.

Notice of Blackout Periods
Proposed Regulation BTR and the DOL's interim final regulations specify the content and timing of the notice companies and plan administrators are required to provide as follows:

Notice to directors and executive officers
Companies would be required to provide notice to directors and executive officers 15 calendar days before commencement of the blackout period describing: (1) the reasons for the blackout; (2) the plan transactions to be suspended or affected; (3) the class of equity securities subject to the blackout; (4) the beginning and ending dates of the blackout period; and (5) contact information for the person designated to respond to related inquiries.

Notice to the SEC
Although not mandated by the Sarbanes-Oxley Act, proposed Regulation BTR would require companies to notify the SEC by means of a newly created Form 8-K filing obligation, with the same content required in the notice to directors and executive officers.

Notice to plan participants
The DOL interim final regulations require plan administrators to notify plan participants in writing at least 30 but not more than 60 calendar days before the blackout period (which term is broader in scope under the DOL rules than under Regulation BTR). The required content is similar to the notice to directors and executive officers, except that if investments are affected by the blackout, the notice must also advise participants to evaluate whether their investments are appropriate in light of their inability to direct or diversify assets during the blackout period.

Considerations for Foreign Private Issuers

In addition to the distinct definition of "blackout period" for foreign private issuers, the SEC identified other considerations for or differences in applying the proposed rules to these companies, including:

  • Proposing that equity securities covered by the trading prohibition include depositary shares evidenced by American Depositary Receipts;

  • Proposing changes to Forms 20-F and 40-F and Rules 13a-11(b) and 15d-11(b) of the Exchange Act to reflect the new notice requirements and encouraging foreign private issuers to file the required notices on a current basis on Form 6-K; and

  • Soliciting comment on whether foreign private issuers should be exempt from the private right of action under Section 306(a).

Conclusion

SEC reporting companies should identify plans covered by the new rules and develop communications and compliance plans to avoid violations related to any blackout period that may arise. Please contact the Dorsey & Whitney attorney with whom you work if you have any questions regarding the proposed rules or if you require any assistance preparing comments for submission to the SEC.

November 15, 2002