What Reporting Is Required for Former Section 16 Insiders?

An officer is resigning and will no longer be subject to Section 16. But do her Section 16 reporting obligations end on her last day as an officer? Sometimes. Here’s a breakdown of how the rules work.

Exempt Transactions Are Not Reportable

Transactions that are exempt from the Section 16 short-swing profits recovery provisions and that occur after a former officer or director has ceased to be subject to Section 16 are not reportable. Because the majority of officer and director transactions are exempt, this likely covers most transactions by former insiders.

What About Transactions That Occur Upon Termination of Employment?

When officers terminate employment, they will typically forfeit their equity awards. Directors also may sometimes forfeit equity awards upon stepping down from the board. In many cases, the forfeiture occurs simultaneously with the officer’s termination or the director’s resignation. Because these transactions technically occur at the same time that the officer or director ceases to be subject to Section 16, rather than after cessation of Section 16 status, could these transactions be reportable? In most cases, the answer is no, even these transactions are not reportable.

Forfeitures of derivative securities for no consideration are never reportable, even if they occur while the holder is still subject to Section 16. Thus, forfeitures of stock options, RSUs, and PSUs upon cessation of Section 16 status are not reportable transactions.

Even If the RSUs Were Reported as Nonderivative Securities?

Yep, for RSUs, this is true even if the RSU grant was reported as an acquisition of common stock in Table I. The fact that the arrangement was reported as common stock doesn’t make it a nonderivative security; it’s still a derivative security and, thus, forfeiture of the RSU is still exempt from reporting (but, if former insiders have any future common stock transactions that must be reported, their common stock holdings should be updated to reflect the RSU forfeiture).  

What About Forfeitures of Restricted Stock?

Forfeitures of nonderivative securities, including restricted stock, are reportable as dispositions back to the company. In most cases, however, the disposition will be exempt from the short-swing profits recovery provisions, and, as noted above, exempt transactions that occur after cessation of Section 16 insider status are not reportable. The timing of the forfeiture is critical, however.

If the restricted stock is forfeited while the individual is still subject to Section 16, it is reportable. Does a forfeiture that occurs “upon” termination of service occur while the individual is still subject to Section 16? The conservative approach is to go ahead and report the forfeiture. For those who are comfortable with a more aggressive approach, it may be reasonable to argue that, because the forfeiture is triggered by the termination of service, the termination occurs first, the individual is no longer subject to Section 16 at the time the forfeiture occurs, and, thus, the forfeiture is not reportable.

In Romeo & Dye’s Forms & Filing Handbook, Model Form 136, the authors note that an easy fix to this dilemma is for equity plans and award agreements to specify that forfeiture occurs “immediately after” (rather than “upon”) termination of service. Granting RSUs instead of restricted stock also fixes this problem (and a bunch of other problems, as well). 

Are Any Transactions Reportable for Former Insiders?

Yes, nonexempt transactions (e.g., open market purchases and sales) that occur after cessation of Section 16 insider status can sometimes be reportable, but only if all of the following conditions are met:

• The post-insider transaction is not exempt from the short-swing profits recovery provisions
• The post-insider transaction occurs within six months of a transaction that occurred while the individual was still subject to Section 16
• The pre-cessation transaction is also not exempt from the short-swing profits recovery provisions
• The pre-cessation transaction is in the opposite direction of the post-insider transaction (e.g., the post-insider transaction is a sale and the pre-cessation transaction is a purchase)

If all the above conditions are met, the post-insider transaction is reportable. This is also a situation where any profits on the two transactions will be recoverable under the short-swing profits recovery rule.

How About an Example?

You got it! Let’s say that an officer resigns on August 18, 2021. In the six months prior to her resignation, she had the following transactions:

• An open market purchase on April 20, 2021
• An open market sale on June 10, 2021

(Yes, these two transactions would have triggered the short-swing profits recovery provisions. This might have made her unhappy and probably means we need to tighten up our pre-clearance procedures, but it doesn’t change the post-insider reporting requirements.)

The officer will have to report the following post-termination transactions:

• Any nonexempt sales that she executes before October 20, 2021 (six months after her last nonexempt purchase)
• Any nonexempt purchases that she executes before December 10, 2021 (six months after her last nonexempt sale)

Stay Tuned!

I still have more to say on this topic. Next week I will cover exit filings, administrative considerations, Rule 144, and other follow-up items.