The NASPP Blog

Back in December I reported on a shareholder who was sending demand letters to companies alleging that share withholding transactions aren’t exempt from Section 16(b) unless the transaction is automatic, i.e., insiders have no choice in how to pay their taxes (“Shareholder Challenging 16(b) Status of Share Withholding“). I have a few updates on this development.

The Bad News

Back in December, it was just one shareholder but now there at least two more shareholders that are issuing demand letters like this. Also, we’ve now progressed beyond demand letters, with several companies now in litigation over this.

Both Good and Bad News

As noted in the March 2017 issue of Section 16 Updates, the shareholders have submitted demand letters to around 70 companies. One bit of good news is that in most cases, the amount of the alleged short-swing profits has been small, so payments to the shareholders have also been small.

But this is also bad news because it means that most companies would prefer to settle rather than pursuing costly litigation, which is necessary to get clarification on this matter from the courts.  As noted in Section 16 Updates:

A clear ruling on the issue is much needed, given the chilling effect that the shareholders’ demand letters have had on the grant and exercise of elective stock withholding rights and the burden that re-approvals have imposed on compensation committees.

The Good News

On May 8, there was a ruling in favor of the defendant in one of the cases that has been litigated (Jordan v. Flexton), which Alan Dye describes in his blog on Section16.net (“Court Holds that Discretionary Tax Withholding Exempted by Rule 16b-3“). Here is Alan’s summary of the decision:

The court dismissed the complaint for failure to state a claim, holding in a one-page order that “the transactions in question are compensation related and are designed to be exempt under” Rule 16b-3(e). While a lengthier discussion of the issue might have been more helpful in resolving other pending cases, the court’s holding is nevertheless important because it clearly rejects the plaintiff’s argument that Rule 16b-3 exempts withholding transactions only if they are “automatic.” Moreover, the court allowed reliance on the exemption even where the decision to withhold shares was made by the issuer (i.e., employees) rather than the insider or the compensation committee. The case therefore provides reason to believe that courts will reach a similar result regarding all forms of stock withholding so long as withholding was authorized by the compensation committee as part of the initial equity award.

I’m sure this is a topic that Alan will be discussing in his session “Section 16 & Insider Considerations in Today’s Market” at the 25th Annual NASPP Conference—don’t miss it!

– Barbara