SEC Proposes Rules for Insider Trading Prohibitions during Blackout Periods in Defined Contribution Plans

The Sarbanes-Oxley Act of 2002 (P.L. 107-24) bans certain corporate "insiders" from trading in their company's stock during a "blackout period" that prevents at least half of the people in the company's Section 401(k) plan or other defined contribution plans from trading in the employer stock held in their plan accounts.* Specifically, the insider trading provision prohibits corporate insiders from directly or indirectly purchasing, selling, acquiring or transferring any equity or derivative security of a publicly traded company that they acquired in connection with service or employment as a director or executive officer of that company.

The Securities and Exchange Commission (SEC) recently published proposed rules** under this provision of the Sarbanes-Oxley Act, which are scheduled to apply to blackout periods that begin on or after January 26, 2003. This Compliance Alert summarizes key aspects of the SEC's proposed rules.

Definitions
The proposed rules define the key concepts comprised in this new insider-trading ban. It is important to note that the rules are generally written to track the pre-existing SEC Section 16 insider trading rules and cover any transaction in which the covered insider (director or executive officer) has a pecuniary interest, including transactions by certain immediate family members.

• Blackout Period This is a period of more than three consecutive business days during which at least 50 percent of the participants in the company's U.S.-based defined contribution plans cannot trade in the employer securities held in their accounts. The head count includes participants in non-qualified as well as qualified plans maintained by any company in the issuer's controlled group, if they do or might offer employer stock as an investment. Thus, participants in plans with open brokerage windows through which they could use funds in their accounts to buy employer stock would be counted. There are two exceptions to the definition of blackout period: (1) a regularly scheduled period during which trading is prohibited, provided such period is included in the plan and disclosed to employees in a timely fashion and (2) a suspension imposed solely in connection with persons becoming or ceasing to be participants in a plan by reason of a corporate merger, acquisition, divestiture or similar transaction.
  
  
• Insiders The proposed regulation provides a detailed list of the persons who will be treated as insiders. In the main, for domestic issuers, they are the same group that is subject to the Section 16 insider trading restrictions (i.e., executive officers and directors). This simplifies the identification and notice requirements, as the company will already have identified that group, who are already on general notice that their trades in company stock are closely regulated.
  
  
• Equity Securities The term "equity security" is broadly defined to include: any stock or similar security, certificate of interest of participation in any profit sharing agreement, pre organization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for any equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust. In addition it will include options, futures, convertible equity securities and warrants relating to the issuance of an equity security of the issuer.
  
  Equities acquired in connection with the individual's service as a director or officer are subject to the restriction, including securities acquired before the Sarbanes-Oxley Act was passed or before the company went public. Under the proposed regulation, any employer stock purchased or sold by an insider during a blackout period will be treated as stock subject to the trading restriction, to the extent the person owns such securities. For example, if a company's chairman owns 1,000 shares, half of which were granted as a bonus for her service as chairman, and she sells 250 shares during the blackout period, they would be treated as having come from the bonus, regardless of how she actually acquired the particular shares that were transferred.
  
  
• Issuers The term "issuer" generally means a company whose equity securities are publicly traded in the U.S., including domestic issuers, foreign private issuers, banks and savings associations, small business issuers and, in some cases, registered investment companies. It also includes a company that has registered to sell its stock to the public, but has not yet done so.

Exceptions and Exemptions
The SEC's proposed rules would exempt the following transactions from the trading restriction:

• Acquisitions of equity securities under broadly based dividend or interest reinvestment plans, · Regularly scheduled purchases or sales of employer securities, pursuant to an automatic election, which satisfy the SEC Rule 10b5-1 affirmative defense conditions (i.e., an affirmative defense to a claim that the purchase or sale constitutes trading on the basis of material non-public information).
  
  
• Purchases or sales of equity securities under certain employee benefit plans (e.g., qualified §401(a) retirement plans, excess benefit plans and stock purchase plans), other than discretionary transactions, and
  
  
• Increases or decreases in equity holdings resulting from a stock split, stock dividend or pro rata rights distribution.