United States: Pensions Blackout Periods - SEC and DOL Proposed Rules
January 2003

This article summarizes regulatory guidance recently issued under Section 306(a) and 306(b) of the Sarbanes-Oxley Act (the "Act") with respect to blackout periods under individual account retirement plans

Section 306(a) of the Act prohibits insiders from trading in their company’s equity securities acquired in connection with service as a director or executive officer during a retirement plan blackout period.

Section 306(a) also requires that, in any case where a director or executive officer is subject to trading restrictions in connection with a blackout period, the issuer must notify the directors, officers, and the SEC of such blackout period.

Section 306(b) of the Act also amended ERISA to add a new provision that requires administrators of "individual account plans" to provide notice to affected participants and beneficiaries in advance of the commencement of any blackout period.

Regulation BTR. The SEC’s proposed rules, so-called "Regulation Blackout Trading Restriction" or "Regulation BTR," clarify Section 306(a) of the Act, which prohibits directors and executive officers from directly or indirectly purchasing, selling, or otherwise transferring an equity security of the company during a blackout period under a company pension plan.

Application to Directors and Executive Officers. Regulation BTR provides that Section 306(a) applies to the directors and executive officers of domestic issuers, foreign private issuers, banks and savings associations, small business issuers, and, in rare instances, to registered investment companies. (The SEC has specifically requested comment on the impact of Regulation BTR on foreign private issuers.)

The statutory trading prohibition and the provisions of Regulation BTR no longer apply to an individual who ceases to be a director or executive officer of an issuer.

Definition of "Blackout Period." For purposes of the SEC rules, the term "blackout period" is defined 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 an issuer held in an individual account plan maintained by the issuer (or a member of its "controlled group" under the Internal Revenue Code (the "Code")) is temporarily suspended by the issuer or by a fiduciary of the plan with respect to at least 50 percent of the participants or beneficiaries under all individual account plans maintained by the issuer or any member of the issuer’s controlled group. For foreign private issuers, a blackout period occurs when plan participants located in the U.S. subject to the blackout comprise 50 percent or more of all participants located in the U.S. and plan participants in the U.S. subject to the blackout represent more than 15 percent of all plan participants worldwide. Because individual account plans that are pension plans are not common in many foreign jurisdictions, the 15 percent test applicable to foreign private issuers will often be met whenever the 50 percent test is met.

A "blackout period" does not include:

• a regularly scheduled period in which the participants and beneficiaries may not purchase, sell, or otherwise acquire or transfer an interest in any equity security of the issuer if such period is (1) incorporated into the individual account plan, and (2) disclosed to employees before, or within 30 days after, they become participants under the individual account plan or as a subsequent amendment to the plan; and
• any suspension that is imposed solely in connection with persons becoming participants or beneficiaries, or ceasing to be participants or beneficiaries, in an individual account plan by reason of a corporate merger, acquisition, divestiture, or similar transaction involving the plan or plan sponsor of an acquired or divested entity.

Definition of "Equity Security." Regulation BTR also defines the term "equity security" broadly to include any equity security and any derivative security relating to the issuer (including security-based swap agreements, standardized options, and securities futures and ADRs).

"Acquired in Connection with Service or Employment." The scope of the trading prohibition is limited to equity securities acquired in connection with the director’s or executive officer’s service or employment as a director or executive officer. Regulation BTR clarifies that the broad language of the statute would include any equity securities acquired through grants and awards under employee stock option, restricted stock, and other common equity compensation plans and would encompass any plan, contract, authorization, or arrangement that results in the acquisition of issuer securities in exchange for the performance of services for, or employment with, an issuer. Securities acquired outside of an individual’s service as a director or executive officer (including securities acquired while such individual was an employee but not an executive officer) would not technically be covered. As a practical matter, however, directors and executive officers would need to refrain from making any trades during blackout periods because the proposed rules establish an irrebuttable presumption that any equity securities sold or otherwise transferred by a director or executive officer during a blackout period were acquired in connection with service or employment as a director or executive officer to the extent that the director or executive officer holds such securities, without regard to the actual source of the securities disposed.

Further, under Section 306(a) and Regulation BTR, an acquisition or disposition of equity securities would be considered an acquisition or disposition by a director or executive officer if the director or executive officer has a pecuniary interest in the transaction. The term "pecuniary interest" is interpreted in a manner consistent with the rules and interpretations that have developed under Section 16 of the Exchange Act. Accordingly, a purchase or sale or other acquisition or transfer of equity securities by immediate family members sharing the same household, a partnership, corporation, limited liability company, or trust could be attributable to a director or executive officer for purposes of the trading prohibition.

Exemptions. The proposed rules exempt from the prohibition on trading the following transactions involving equity securities:

• acquisitions of equity securities under dividend or interest reinvestment plans;
• 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);
• purchases or sales of equity securities pursuant to certain "tax conditioned" plans (such as Section 401(k) plans), other than discretionary transactions; and
• stock splits, stock dividends, and rights granted to all shareholders.

Under the proposed Regulation BTR, stock option grants and exercises are not excluded, and these transactions would be prohibited during a pension blackout.

Penalties for Noncompliance. Where a director or executive officer realizes a profit from a prohibited transaction during a blackout period, an issuer, or a security holder of the issuer on its behalf, may bring an action to recover the profit (irrespective of the director or executive officer’s motive or intention). Because of the complexity in calculating realized profits, the SEC did not propose a specific approach to calculating realized profits. Instead, the SEC solicited comment on various possible approaches.

A violation of the statutory trading prohibition of Section 306(a) is also subject to SEC enforcement action. SEC enforcement can include possible civil injunctive actions, cease-and-desist proceedings, civil penalties, and all other remedies available to the SEC to redress violations of the Exchange Act. Under appropriate circumstances, a director or executive officer could also be subject to possible criminal liability.

Notice Requirements. The proposed rules would require an issuer to notify affected directors and executive officers at least 15 calendar days in advance of commencement of the blackout period. When commencement of the blackout period is due to events that were unforeseeable, or to circumstances that were beyond the control of the issuer, a 15-day advance notice requirement would be excused if the issuer makes a written determination that the circumstances preclude compliance with the requirement.

In addition, the company must file a notice of the blackout on Form 8-K within two business days of the plan administrator giving notice of the blackout or, if earlier, actual knowledge of the blackout. Foreign private issuers must file the notices to directors and executive officers during the previous year as exhibits to Form 20-F or 40-F (unless the notice was previously filed on Form 6-K, which is encouraged by the SEC).

Broad Sweep. Following the Act for the most part (with an occasional embellishment), the DOL rules require advance written notice for every blackout period (defined broadly) under every individual account plan (as defined in Section 3(34) of ERISA), other than a "one-participant retirement plan."

Definition of "Blackout Period." For purposes of the DOL rules, a blackout period is any period for which the ability of plan participants or beneficiaries, which is otherwise available under the plan, (i) to direct or diversify their account assets, (ii) to obtain loans from the plan, or (iii) to obtain distributions from the plan, is temporarily suspended, limited, or restricted for more than three consecutive business days.

The "otherwise available" and "temporarily suspended, limited, or restricted" elements of the rules are important. These elements draw attention to what these notice provisions do not do: (i) they do not require an individual account plan to permit participants to direct or diversify their account assets or to obtain loans, and (ii) they do not apply if either of such rights are permanently eliminated, limited, or restricted. Thus, the notice requirement is triggered only if an existing right of the type described in the DOL rules is temporarily suspended, limited, or restricted.

Suspensions, limitations, or restrictions that occur by reason of the application of the securities laws, or pursuant to a qualified domestic relations order, also are not treated as blackout periods.

Individual Account Plans Covered. The DOL notice rules apply to every individual account plan described in Section 3(34) of ERISA, except for one-participant plans. Thus, covered plans clearly include (except for one-participant plans) all tax-qualified individual account retirement plans (e.g., 401(k) plans, ESOPs, profit sharing plans, and money purchase pension plans) of all employers (publicly or privately held). Non-qualified ERISA plans that provide for an individual account (e.g., "excess" 401(k) plans and other deferred compensation arrangements) also appear to be covered. However, it is unclear whether a notice would be required if temporary restrictions were placed on deemed investment preferences under a typical non-qualified plan, because such plans do not hold actual assets (i.e., ERISA requires that such plans be "unfunded" in order to avoid the application of ERISA’s minimum vesting, funding, and other substantive requirements).

The notice requirements are triggered by any temporary restriction on participant-directed investment rights under, or any rights to obtain loans or distributions from, any covered plan.

The Notice – General Requirements. The DOL rules require that the notice (1) explain the reasons for the blackout period, (2) describe the rights affected by the blackout period (including identifying the plan investments, if any, subject to the blackout period), (3) specify the expected beginning and ending dates of the blackout period, (4) with respect to investments affected by a blackout period, advise participants and beneficiaries to evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify investments during the blackout period (this content requirement does not apply to the issuer notice described below), and (5) provide the name, address, and telephone number of the person responsible for answering questions during the blackout period.

The notice is required to be given by the plan administrator. The notice must be in writing consistent with the DOL’s general disclosure regulations, including regulations dealing with the use of electronic media.

The notice must be provided to all participants and beneficiaries of the plan, and to the issuer of employer securities (if any) held by the plan and subject to the blackout period. The purpose of the notice to the issuer of employer securities is to permit the issuer to notify its executive officers of the blackout period, for purposes of the SEC-administered blackout period rules summarized above.

The DOL supplied model language for certain parts of the notice. Generally, however, compliance with the notice content requirements depends on the facts and circumstances of the particular blackout period and plan.

The Notice – Timing. The DOL rules require that the notice be provided not less than 30 calendar days, nor more than 60 calendar days, before the last date on which the plan’s participants or beneficiaries will have the right to take the restricted action.

The DOL rules provide an exemption from the 30-day advance notice requirement if (i) deferral of the blackout period to permit 30-days' notice would cause a breach of ERISA’s fiduciary duties, (ii) unforeseeable circumstances beyond the control of the plan administrator prevent compliance with the 30-day notice requirement, or (iii) the blackout period applies only to participants or beneficiaries solely in connection with their becoming, or ceasing to be, participants or beneficiaries of the plan as a result of a merger, acquisition, divestiture, or similar transaction involving the plan or plan sponsor. In the case of (i) and (ii), a fiduciary of the plan must reasonably determine, in writing, that one of the exemptions applies. If an exemption applies, notice must be provided as soon as reasonably possible, unless notice in advance of the expiration of the blackout period is impracticable.

The SEC and DOL rules will become effective January 26, 2003. The notice requirement under Regulation BTR would apply to blackout periods commencing on or after January 26, 2003. For blackout periods that occur between January 26, 2003 and February 10, 2003, notice should be furnished as soon as reasonably practicable.

For the 30-day period following January 26, 2003, good faith compliance with the statute is required under the DOL rules.

Penalties for Noncompliance. The DOL can assess a penalty of up to $100 per day per participant, for the period from the date of the plan administrator’s failure to provide the notice to the end of the blackout period. In determining the amount of the penalty, the DOL will consider the degree and willfulness of the failure. A plan administrator can request a reduction or complete waiver of the penalty by demonstrating reasonable cause for the failure.