April 4, 2013
SEC No Action on SOX 402
Sometimes a blurb on an equity compensation “happening” crosses our desks, and it’s hard to know whether it’s the start of a new trend, or just an isolated occurrence. This was the case when I recently came across an SEC no-action letter on Sarbanes-Oxley 402 (the provision of the Act that covers loans to officers and directors). I hesitated to blog about it, but then decided that it could be a useful and interesting clarification in an area where the SEC has long remained silent. I realized I wasn’t alone, because Broc Romanek expressed the same sentiments in a recent CorporateCounsel.net blog.
Innovation Breeds a No-Action Letter
As far as I can tell, the circumstances leading to the no-action letter represent a one-off scenario. However, the interesting part to me was the creative approach to equity compensation that was the intent behind the request to the SEC. The company involved, RingsEnd Partners LLC, created a program for restricted stock award shares that they believed would encourage executives to hold on to award shares that they might otherwise consider selling upon vest (when taxes are typically due). As more fully described in the detailed version of the incoming letter to the SEC, participation would be voluntary, and those electing participation in the program would allow their shares to be initially taxed at grant (I’m guessing via agreement from the participant to make an 83(b) election). Underlying shares from new awards would be transferred to a trust at the time of grant. The trust would then go to a bank to obtain a loan to pay the taxes on the shares (based on the spread at the award date). The shares would be held by the trust as collateral for the loan. Once vested, no additional taxes would be due (any appreciation would later be taxed at sale), and a portion of the shares would be sold to cover the loan amount from the bank. The remaining shares (and any residual cash proceeds) would then be released to the participant. With shares free and clear, and no further amounts due until sale, RingsEnd Partners believes that participating executives will be encouraged to hold the shares, further aligning with shareholder interests. The company would have no participation in the program, other than “ministerial” tasks. Believing their arrangement would not violate SOX 402’s provisions regarding making loans to officers and directors, they sought a no-action letter from the SEC.
The Legal Details
The firm leading the charge to the SEC on behalf of the company was BakerHostetler, and they released their own summary of the events that led to the no-action letter. This is one of those times when they can articulate it much better than I can, so I will extract some of the pertinent sections:
In BakerHostetler’s Feb. 28 letter to the SEC staff, Messrs. Oxley, Gallagher and Reich sought guidance on Section 402 with regard to an innovative equity-based incentive compensation (EBIC) program that their client, financial services firm RingsEnd Partners LLC, developed with global financial institution BNP Paribas. The EBIC program contemplates that participating employees will receive company stock as incentive compensation and thereafter transfer those shares to an independently managed Delaware statutory trust. The trust could then obtain term loans from an independent banking institution, using some or all of the shares transferred to the trust as collateral. The letter notes that, in the absence of interpretive guidance on SOX 402, public companies have been reluctant to permit directors and officers to participate in the proposed program.
BakerHostetler contended that an issuer allowing its employees to participate in the EBIC program would not be extending or maintaining credit, or arranging for the extension of credit, in the form of a personal loan to employees subject to SOX 402. The lawyers noted that although a company would “need to perform certain ministerial tasks in order to allow its employees to participate in the EBIC program,” the company would “neither encourage nor discourage employee participation,” nor would the company “directly or indirectly make or guarantee the loans, or provide any extension of credit or other financial support” to the trust, its trustee, or trust beneficiaries (the employees). BakerHostetler argued that the legislative history suggests that under the final version of SOX 402, the phrase prohibiting a company from “arrang{ing} for the extension of credit” should be read no more broadly than prohibiting the company from providing a “loan guarantee or similar arrangement,” language found in earlier versions of SOX 402.
In the new guidance issued by the SEC, the agency’s staff wrote that an issuer that permits its directors and officers to participate in the plan “would not be deemed thereby, directly or indirectly, to be extending or maintaining credit, in the form of a personal loan to or for such individuals for purposes of Section 13(k) of the Securities Exchange Act of 1934” {SOX Section 402}. The SEC also wrote that an issuer that undertakes certain ministerial or administrative activities to permit its directors and officers to participate in the EBIC Program would similarly not be deemed, directly or indirectly, to be extending … or arranging for the extension of credit in the form of a personal loan to or for such individuals within the meaning of SOX 402.
Is this just a one-off scenario? Or, will this no-action letter spark a trend of creative arrangements that allow for funding of equity compensation awards in a manner that won’t evoke action from the SEC for a SOX 402 violation? Only time will tell, but it was certainly interesting to intercept.
-Jennifer