[15355]
November 14, 2002
TO: PENSION COMMITTEE No. 44-02
PENSION OPERATIONS ADVISORY COMMITTEE No. 73-02
RE: SEC PROPOSED RULES ON INSIDER TRADES DURING PENSION BLACKOUT
PERIODS
The Securities and Exchange Commission has proposed rules that implement section
306(a) of the Sarbanes-Oxley Act of 2002 (the “Act”), which prohibits directors and officers of
issuers from trading equity securities of the issuer during pension blackout periods.1 As
discussed below, these proposed rules could have implications for certain investment
companies that compensate their directors with their shares, as well as fund companies that
provide recordkeeping and other plan services to retirement plans that permit investment in
employer securities.2
The blackout trading restrictions in section 306(a) become effective on January 26, 2003.
Comments on the SEC’s proposed rules are due 30 days after publication in the Federal
Register. The SEC is seeking comment on numerous aspects of the proposed rules.
ACTION REQUESTED: To the extent that you have any comments or issues with
regard to the SEC’s proposed rules, please provide them to the undersigned by Monday,
November 25, 2002. I can be reached by phone (202-326-5837) or email (tkim@ici.org).
I. General Rule
Proposed Regulation BTR — Blackout Trading Restriction3 would prohibit any director
or executive officer of an issuer of any equity security (other than an exempt security), directly
1 SEC Release 34-46778, IC-25795 (November 6, 2002) (“Release”). A copy of the Release is available on the SEC’s
website at http://www.sec.gov/rules/proposed/34-46778.htm.
2 The Department of Labor recently issued regulatory guidance under section 306(b) of the Act, which requires
administrators of individual account plans to notify affected participants and beneficiaries 30 days in advance of any
blackout period. See Institute Memorandum to Pension Members No. 50-02, dated October 23, 2002. The Act
directed the SEC, in consultation with the Department of Labor, to issue rules that clarify the application of the
statutory trading restriction of section 306(a) and to prevent the evasion thereof.
3 17 C.F.R. 245.100-104.
2
or indirectly, from purchasing, selling or otherwise acquiring or transferring any equity
security of the issuer (other than an exempt security) during any blackout period with respect to
such equity security, if such director or executive officer acquires or previously acquired such
equity security in connection with his or her service or employment as a director or executive
officer. The proposed rules also would require an issuer to provide a timely notice to its
directors, executive officers and the SEC of the commencement of a blackout period.
Additionally, remedies for violations of the statutory trading prohibition are set forth in the
proposed rules.
Various elements of the proposed rules are discussed in greater detail below.
II. Blackout Period Definition
The proposed rules would define “blackout period” to mean any period of more than
three consecutive business days during which the ability to purchase, sell or otherwise acquire
or transfer an interest in any equity security of such issuer held in an individual account plan is
temporarily suspended by the issuer or by a fiduciary of the plan. The suspension must apply
to at least 50% of the participants or beneficiaries under all individual account plans maintained
by the issuer that permit participants or beneficiaries located in any state to acquire or hold
equity securities of the issuer. 4
Definition of Individual Account Plan. The term “individual account plan” is defined
by reference to ERISA section 3(34),5 which generally includes section 401(k) plans, profit
sharing and savings plans, stock bonus plans, and money purchase plans. The proposed rules
also would include in this definition non-qualified deferred compensation arrangements “that
reflect the elements described in the [ERISA] definition.”
50% Test. For purposes of the 50% test, the proposed rules would clarify that individual
account plans “maintained by the issuer” would include only such plans in which participants
or beneficiaries held or could hold equity securities of the issuer, whether or not the plan
actually contained equity securities of the issuer at the time of the calculation. Such plans
would include individual account plans that (1) permit participants or beneficiaries to invest
their plan contributions in the equity securities of the issuer; (2) provide an “open brokerage
window” that permits participants or beneficiaries to invest in the equity securities of any
publicly-traded company, including the issuer; (3) match employee contributions with equity
securities of the issuer; or (4) reallocate forfeitures that included equity securities of the issuer to
the remaining plan participants.6
4 The definition of blackout period under section 306(a) differs from that in section 306(b). Specifically, the
Department of Labor’s guidance, which tracks the statutory language of section 306(b), defines the term “blackout
period” as any period of more than 3 consecutive business days for which any ability of participants and
beneficiaries, which is otherwise available under the terms of the plan, to direct or diversify the assets credited to
their accounts, or to obtain loans or distributions from the plan, is temporarily suspended, limited, or restricted.
5 The term “individual account plan” or “defined contribution plan” is defined as “a pension plan which provides for
an individual account for each participant and for benefits based solely upon the amount contributed to the
participant’s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other
participants which may be allocated to such participant’s account.” ERISA section 3(34). One-participant retirement
plans, however, would be excluded from the definition for purposes of the proposed rules.
6 The proposed rules provide examples illustrating the application of the 50% test.
3
Additionally, for purposes of the 50% test, all such plans of the issuer must be
aggregated with plans of its affiliates, as determined under the “controlled group” rules of
Internal Revenue Code section 414(b), (c), (m) and (o).
Exceptions to Blackout Period Definition. Section 306(a) of the Act and the proposed
rules exclude two types of suspensions from the definition of blackout period: (1) a regularly
scheduled period in which participants and beneficiaries are restricted, if the period is (a)
incorporated into the individual account plan, and (b) timely disclosed to employees before
they become participants under the individual account plan or as a subsequent amendment to
the plan; and (2) any suspension that is imposed solely in connection with persons becoming
participants or beneficiaries, or ceasing to be participants or beneficiaries, by reason of a
corporate merger, acquisition, divestiture or similar transaction involving the plan or plan
sponsor.7
Under the first exception, a blackout period would be considered to be incorporated in
the plan if a description of the regularly scheduled blackout period, including the plan
transaction to be suspended during or otherwise affected by the blackout and its frequency and
duration, is included in the documents or instruments under which the plan operates. The
disclosure of the blackout period (in such documents or instruments) would be timely if the
employee is provided the disclosure at any time prior to, or within 30 days after, the employee
formally enrolls in the plan, or, in the case of a subsequent amendment to the plan, within 30
days after the adoption of the amendment. The notice may be in any graphic form that is
reasonably accessible to the intended recipient.
Under the second exception, a suspension would not constitute a blackout period if its
principal purpose is to enable individuals to become participants or beneficiaries in the plan, or
to terminate participation in the plan, even though the blackout also is used to effect other
administrative actions that are incidental. This exception would be available only with regard
to participants or beneficiaries of the acquired or divested entity.
III. Issuers Subject to Trading Prohibition
Definition of Issuer. The proposed rules generally would apply to directors and
executive officers of domestic issuers, foreign private issuers, banks and savings associations,
small business issuers, and in certain instances, registered investment companies. Specifically,
the term “issuer” would mean an issuer defined in section 3 of the Securities Exchange Act of
1934 (“Exchange Act”), the securities of which are registered under section 12 of the Exchange
Act or that is required to file reports under section 15(d) of the Exchange Act, or that files or has
filed a registration statement that has not yet become effective under the Securities Act of 1933
(“Securities Act”).
Application to Registered Investment Companies. The proposed rules provide that
7 The exclusions from the blackout period definition under section 306(b) of the Act and the Department of Labor’s
interim rules are suspensions, limitations, or restrictions that (1) occur by reason of the application of the securities
laws; (2) are a change to the plan that provides for a regularly scheduled suspension, limitation or restriction that is
disclosed through any summary of material modifications, any materials describing specific investment alternatives,
or any changes thereto; or (3) apply only to 1 or more individuals, each of whom is the participant, an alternate
payee, or any other beneficiary, pursuant to a qualified domestic relations order.
4
section 306(a) of the Act applies to directors and executive officers of registered investment
companies that otherwise meet the definition of the term “issuer.” The Release notes that
investment companies typically do not have employees because they are externally managed,
with investment advisory and other services provided by affiliated and unaffiliated parties
pursuant to contracts with the investment company. Without employees, investment
companies typically do not maintain employee pension plans, and as a practical matter, there
would generally be no blackout periods triggering the statutory trading prohibition.
The Release provides, however, that there could be some cases (for example, internally
managed closed-end investment companies and investment companies that compensate their
directors with their shares) where the statutory trading prohibition could apply in practice. In
light of such situations, the proposed rules would require registered investment companies to
notify the SEC of the commencement of a blackout period. Specifically, investment companies
would have to file Form 8-K8 for the sole purpose of meeting any notice obligation that might
arise under the proposed rules. The Release states that the principal purpose of providing
notice to the SEC is to ensure that an issuer’s security holders can monitor compliance with the
blackout period rules.
Notably, the SEC has specifically asked for comment on whether investment companies
should be excluded from the proposed rules (and the rationale for the exclusion) and whether
there are feasible alternatives to the Form 8-K filing requirement that would minimize the
reporting burdens on registered investment companies. The SEC is also seeking comment on
the utility to investors of the reports to the SEC in relation to the costs to registered investment
companies and their affiliated persons of providing those reports.
Equity Securities of Issuer. Section 306(a) of the Act applies to any equity security of an
issuer (other than an exempted security). The proposed rules would define “equity security of
the issuer” by reference to section 3(a)(11) of the Exchange Act and Exchange Act rule 3a11-1;
this term would include any equity security or derivative security relating to an issuer, whether
or not issued by that issuer.9 Thus, the proposed rules would apply to any equity security that
relates to an equity security of the director or executive officer’s company, even if the security is
issued by a third party.
IV. Directors and Executive Officers Subject to Trading Prohibition
Section 306(a) of the Act imposes the trading restriction on directors and executive
officers of issuers. The proposed rules define the term “director” by reference to section 3(a)(7)
of the Exchange Act.10 The proposed rules clarify that an individual’s title would not be
dispositive as to his or her status as a director; an individual may be a director without holding
the title if that person functions as a director. The term “executive officer” is defined by
8 Form 8-K is the "current report" used to report the occurrence of any material events or corporate changes which are
of importance to investors or security holders and previously have not been reported by the registrant.
9 Examples of such securities would include security-based swap agreements, standardized options, security futures
on equity securities and security futures on narrow-based security indexes.
10 This provision defines “director” as “any director of a corporation or any person performing similar functions with
respect to any organization, whether incorporated or unincorporated.”
5
reference to the definition of “officer” in Exchange Act Rule 16a-1(f).11 The proposed rules also
would clarify that the blackout trading prohibition would not apply to an individual who
ceases to be a director or executive officer of an issuer.
V. Notice to Officers, Directors and the SEC
The proposed rules would require the issuer of the equity security to timely notify each
director, executive officer and the SEC of a blackout period with respect to any equity security.
Notice to Directors and Executive Officers. The notice must include the following
information: (1) the reason or reasons for the blackout period; (2) a description of the plan
transactions to be suspended during, or otherwise affected by, the blackout period; (3) a
description of the class of equity securities subject to the blackout period; (4) the actual or
expected beginning and ending dates of the blackout period; and (5) the name, address and
telephone number of the person designated by the issuer to respond to inquiries about the
blackout period, or, in the absence of such a designation, the issuer’s human resources director
or person performing equivalent functions.
The proposed rules would require that the notice be provided to directors and executive
officers at least 15 calendar days in advance of commencement of the blackout period. The notice
may be in any graphic form that is reasonably accessible to the intended recipient.
Additionally, the notice would be considered provided as of the date of mailing, if mailed by
first class mail, or as of the date of electronic transmission, if transmitted electronically.
An exception from the 15-day advance notice requirement is provided where the
blackout period is due to events that were unforeseeable or circumstances that were beyond the
reasonable control of the issuer, and the issuer reasonably so determines in writing (dated and
signed by an authorized representative of the issuer). Where this exception applies, the notice
and a copy of the written determination must be provided to all affected directors and executive
officers as soon as reasonably practicable before the blackout period commences.
Notice to the SEC. As previously discussed, the proposed rules would require that
notice to the SEC be provided on Form 8-K. The content of the report in Form 8-K would be the
same as that of the notice to directors and executive officers. The Form would be required to be
filed 2 business days after the earlier of (1) the receipt of notice of a blackout from the plan
administrator,12 or (2) actual knowledge of the blackout period by the person designated by the
issuer to oversee the issuer’s pension plans, or in the absence of such a designation, the issuer’s
human resources director, or a person performing equivalent functions.13
11 The Release notes that this broader term is used, rather than the term “executive officer” as defined in Exchange Act
Rule 3b-7, because of the former term’s focus on the policy-making functions of the individual.
12 The Department of Labor’s interim rules under section 306(b) of the Act would require a plan administrator to
provide a notice (similar to that furnished to affected participants and beneficiaries) to the issuer of any employer
securities held by the plan and subject to the blackout period.
13 The Release states that this proposed amendment to Form 8-K would supersede the SEC’s proposal to add an item
requiring disclosure of any known event that would have the effect of materially limiting, restricting or prohibiting
participants in an employee benefit, retirement or stock ownership plan from acquiring, disposing or converting their
holdings, other than a periodic or other limitation, restriction or prohibition based on presumed or actual knowledge
6
Effective Date and Transition Period for Notices. Under the proposed rules, the notice
requirement would apply to blackout periods commencing on or after January 26, 2003. For
blackout periods occurring between January 26, 2003 and February 10, 2003 (i.e., 15 days after
the effective date), issuers must furnish notices as soon as reasonably possible.14
VI. Transactions Subject to Trading Prohibition
Nexus to Service or Employment as Director or Executive Officer. The statutory trading
restriction is limited to equity securities that a director or executive officer acquires in
connection with his or her service or employment. Under the proposed rules, the term
“acquired in connection with service or employment” includes equity securities acquired by a
director or executive officer:
• At a time when the individual was a director or executive officer of the issuer, under a
compensatory plan, contract, authorization or arrangement, including, but not limited
to, plans relating to options, warrants or rights, pension, retirement or deferred
compensation or bonus, incentive or profit-sharing (whether or not set forth in any
formal plan document), including a compensatory plan, contract, authorization or
arrangement with a parent, subsidiary or affiliate of the issuer;
• At a time when the individual was a director or executive officer of the issuer, as a result
of any transaction or business relationship that is described in paragraph (a) or (b) of
Item 404 of Regulation S-K to the extent that the individual has a pecuniary interest in
the equity securities;
• As directors’ qualifying shares or other securities that the individual must hold to meet
an issuer’s minimum ownership requirements for directors or executive officers; or
• Prior to becoming or while a director or executive officer of the issuer if the equity
security was acquired as an inducement to service or employment with the issuer or a
parent, subsidiary or affiliate of the issuer or as a result of a merger, consolidation or
other acquisition transaction involving the issuer.
Service or Employment Presumption. The proposed rules would establish an
irrebuttable presumption that any equity securities sold or otherwise transferred during a
blackout period were acquired in connection with service or employment as a director or
executive officer — without regard to the actual source of the securities disposed — to the
extent that the director or executive officer holds such securities.15 However, in a given blackout
period, equity securities held by a director or executive officer that were acquired in connection
of or access to material non-public information, if that plan is broadly available to the issuer’s employees. See Release
No. 33-8106 (June 17, 2002) (Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date).
14 A similar transition rule is provided in the Department of Labor’s guidance under section 306(b) of the Act with
regard to blackout notices required to be furnished to affected participants and beneficiaries. See Institute
Memorandum to Pension Members No. 50-02, dated October 23, 2002.
15 The Release notes that the purpose of the irrebuttable presumption is to “simplify identification and eliminate
tracing the source of equity securities involved in a disposition transaction and to prevent possible evasion of the
statute.”
7
with his or her service or employment could only count against a single disposition transaction
during that blackout period.16
Indirect Interests. Section 306(a) of the Act applies to indirect, as well as direct,
purchases, sales or other acquisitions or transfers of equity securities of an issuer. The proposed
rules, therefore, would provide that to the extent that a director or executive officer has a
“pecuniary interest” in the equity security, an acquisition or disposition of an equity security of
the issuer during a blackout period would be deemed to be a transaction involving an equity
security “acquired in connection with service or employment as a director or executive officer.”
The proposed rules would apply the definition of “pecuniary interest” in section 16 of
the Exchange Act.17 Accordingly, a purchase, sale or other acquisition or transfer of equity
securities by immediate family members sharing the same household, partnership, corporation,
limited liability company or trust would be attributable to a director or executive officer.
Exempt Transactions. The proposed rules exempt the following types of transactions
from the statutory trading prohibition: (1) purchases or sales of equity securities pursuant to
qualified plans, excess benefit plans or stock purchase plans — other than discretionary
transactions18; (2) acquisitions of equity securities under dividend or interest reinvestment
plans; (3) purchases or sales of equity securities pursuant to a contract, instruction or written
plan that satisfies the affirmative defense conditions of Exchange Act Rule 10b5-1(c); and (4)
increases or decreases in the number of equity securities held as a result of a stock split or stock
dividend applying equally to all equity securities of that class, including a stock dividend in
which equity securities of a different issuer are distributed, and acquisitions of rights, such as
shareholder or pre-emptive rights, pursuant to a pro rata grant to all holders of the same class
of equity securities registered under section 12 of the Exchange Act.
VII. Remedies
The proposed rules set forth two remedial schemes for violations of the statutory trading
restriction. First, the SEC may institute enforcement actions and sanctions under the Exchange
Act pursuant to which a director or executive officer could be subject to possible civil injunctive
actions, cease-and-desist proceedings, civil penalties and other remedies available to the SEC to
redress violations of the Exchange Act.
16 The Release provides an example illustrating this rule: If an executive officer owned 1,000 shares of the issuer’s
common stock, 250 of which were acquired as a result of the exercise of an employee stock option, a sale of 250 shares
of common stock during a blackout period would be presumed to be a sale of the option shares — regardless of the
actual source of the shares sold — and therefore subject to the statutory trading prohibition. A subsequent sale of 250
shares during the same blackout period, however, would not trigger the trading restriction because the option shares
would have been deemed to have been sold in the first transaction.
17 See Exchange Act Rule 100(l).
18 Exchange Act rule 16b-3(b)(1) defines the term “discretionary transaction” as a transaction pursuant to an employee
benefit plan that (1) is at the volition of a plan participant; (2) is not made in connection with the participant’s death,
disability, retirement or termination of employment; (3) is not required to be made available to a plan participant
pursuant to a provision of the Internal Revenue Code; and (4) results in either an intra-plan transfer involving an
issuer equity securities fund, or a cash distribution funded by a volitional disposition of an issuer equity security.
8
Second, the issuer may institute an action to recover a director or executive officer’s
realized profits from a violation of the statutory trading restriction. If the issuer fails or refuses
to bring an action within 60 days after the date of a request or fails to diligently pursue the
action thereafter, the owner of any equity security of the issuer may bring an action on behalf of
the issuer. The Release provides that all holders of the equity securities of the issuer, including
plan participants and beneficiaries who hold equity securities of the issuer in their individual
account plans as of the date of the transaction at issue, would have standing to bring such an
action.
Thomas T. Kim
Associate Counsel