For decades, Foreign Private Issuers (“FPIs”) and their insiders have been exempt from the reporting requirements of Section 16 (“Section 16”) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) pursuant to Rule 3a12-3(b) under the Exchange Act. Recently, however, the U.S. government, through Congress and the SEC, has moved toward increasing oversight of FPIs accessing U.S. capital markets, signaling a move away from deference to home country rules. This trend is evidenced by the Holding Foreign Companies Accountable Act, mandatory Clawback Requirements and Share Repurchase Disclosure rules. Most recently, hidden within the ~2,000-page National Defense Authorization Act for Fiscal Year 2024 (“NDAA”) are consequential changes to Section 16, which – if passed unaltered – would subject directors, officers, and +10% shareholders (“insiders”) of FPIs to Section 16’s time-consuming and costly regime.
What is Section 16?
The purpose of Section 16 is to prevent the unfair use of information obtained by an insider through the insider’s relationship to the issuer. The rationale is that insiders have access to information about their companies not available to the general public and insiders could profit at the expense of less well-informed investors by trading on this information on a short-term basis. Section 16 imposes three substantive obligations on insiders: (1) Section 16(a) requires prompt disclosure of each insider’s holdings and transactions in the issuer’s equity securities; (2) Section 16(b) makes an insider’s profits from “short-swing” transactions subject to disgorgement to the company; and (3) Section 16(c) prohibits insiders from betting against the company through short-selling company securities. In imposing these obligations, Section 16 reporting requirements subject insiders to public (and occasionally SEC) scrutiny whenever they have significant changes in their beneficial ownership.
The proposed expansion of Section 16 will require FPIs to carefully consider who its “officers” are, a task they will also have to undertake for purposes of the recently introduced SEC’s mandatory Clawback rules. The officer analysis under the Exchange Act may be entirely different from the FPI’s home country “insider” analysis (e.g., under the U.K. or EU Market Abuse Regulations, the test is whether an individual is in fact in possession of inside information, whereas the Section 16 test turns on the role of the individual). This determination will have far reaching implications that may come as a surprise to officers of FPIs, including that the list of officers will become known to the public through Section 16’s reporting requirements.
The NDAA’s Expansion of Section 16
Section 6081 “Disclosures by Directors, Officers, and Principal Stockholders” of the NDAA is broken down into three parts. The first amends Section 16(a)(1) to include insiders of FPIs as persons required to file with the SEC reports on holdings and trades in the issuer’s securities. The second nullifies the portion of Rule 3a12-3(b) that exempts FPIs from Section 16. The third establishes that the SEC has 90 days after enactment to issue or amend regulations to comply with the amendment to Section 16.
The purported aim of the Senators supporting this rule change is to increase transparency for FPIs. As Senator Chris Van Hollen (D-MD) put it, “All companies operating on U.S. markets should have to play by the same rules. And when corporate insiders sell their stocks, investors and the American public have a right to know.”
Beneficial Ownership Reports
The proposed legislation would require insiders of FPIs, like those of domestic companies, to report holdings of and transactions in their company’s equity securities. These reports must be filed within two business days following a transaction and capture sell-to-cover transactions, grant of certain equity awards (e.g., stock options and restricted stock units), the exercise of stock options, the settlement of certain other derivative securities and open market purchases or sales, among other transactions. Timely and accurate reporting of such beneficial ownership changes can be burdensome, and failure to timely file these reports typically must be disclosed in an issuer’s annual report on Form 10-K and/or the annual proxy statement on Schedule 14A. While FPIs are currently not required to file annual reports on Form 10-K or annual proxy statements on Schedule 14A, it remains to be seen whether the SEC will update Form 20-F to require similar disclosure if FPI insiders, in fact, become subject to Section 16.
The proposed requirement is likely to present a significant administrative burden. For US companies, Section 16 compliance is a costly, time sensitive endeavor, and it is common for companies to take on the administrative expense and burden of filing on behalf of executives subject to Section 16 and directors. The significance of the burden will be especially acute for those FPIs that are already subject to similar disclosure requirements under their home country rules. For example, FPIs that are also listed in the U.K. and Europe would potentially need to comply with both the U.K. or EU Market Abuse Regulations’ requirements on public disclosure and regulatory notification of dealings by “persons discharging managerial responsibilities” as well as Section 16. While the impetus behind the two regimes and the principles of the requirements may be broadly similar, there are material differences that are likely to increase the compliance burden of such companies.
Disgorgement of Short-Swing Profits
If the proposed legislation is enacted, insiders of FPIs would, notably, be subject to Section 16(b), which imposes “short-swing” profit liability on insiders for the profits realized from any purchase and sale of their company’s registered equity securities within a six-month period, subject to several exemptions, including for board-approved equity compensation transactions with the company (for example, withholding of shares to cover taxes arising from equity awards). Profits or deemed profits from such transactions would be recoverable by the company or its shareholders, subject to a 60-day waiting period after the shareholders demand the company bring an action. Importantly, the SEC does not enforce this statute; rather, enforcement relies on a handful of attorneys constituting the plaintiffs’ bar. These claims are aggressively pursued due to the strict liability standard and method of computation for damages, which allows ‘matching’ between the lowest purchase price paid by the insider and highest sales prices received by the insider within the six-month period, regardless of whether any actual profits were realized under conventional computation methods. Already known as a “trap for the unwary,” Section 16(b) may soon further its reputation among FPI insiders if they become subject to its broad reach.
What’s to Come
The NDAA has not been signed into law, and FPIs still currently benefit from Section 16 exemption. The NDAA was passed by the U.S. Senate in July 2023 and now sits before the House of Representatives. As currently drafted, the NDAA would require the SEC to propose and adopt rules within 90 days of enactment. If this legislation is ultimately signed into law as drafted, it will serve to further blur the distinction between FPIs and domestic companies. The response of FPIs, which generally view the exemption from Section 16 as a key benefit to FPI status, may act as a bellwether for general confidence in, and reliance on, U.S. capital markets – will the juice still be worth the squeeze?