SEC Concerns With Delayed Reporting of ‘Bona Fide’ Gifts
Section 16(a) of the Securities Exchange Act of 1934, as amended, creates reporting obligations for insiders of public companies. For this purpose, “public companies” are those whose securities are registered under Section 12 of the Exchange Act, and “insiders” are officers, directors and beneficial owners of more than 10% of the equity securities of a public company.
Under Section 16(a), insiders of a public company are required to report their holdings and transactions in the equity securities of that company. The Section 16 filings are made on three forms:
- Form 3 for initial filings
- Form 4 for nonexempt acquisitions or dispositions of shares
- Form 5 for annual reports of transactions not previously reported
Most transactions are required to be reported on a Form 4. Before April 1, 2023, however, “bona fide” gifts were not required to be filed on a Form 4, although they could be voluntarily reported. Instead, insiders were able to report any bona fide gift on an annual basis on a Form 5, which is due within 45 days of the company’s fiscal year end. This filing schedule permitted insiders to potentially report these gifts more than a year after the date of the gift, depending on when it was made. The SEC noted that this delayed reporting of gifts could allow insiders to engage in “problematic practices,” such as making stock gifts while in possession of material nonpublic information or backdating stock gifts to maximize the associated tax benefits.
New Rule Effective April 1, 2023To address these concerns, the SEC adopted a new rule, effective April 1, 2023, requiring public company insiders who make a gift of the company’s stock to report that gift on Form 4 by the end of the second business day following the date of the transaction. So, for example, if an insider made the gift on a Monday, that insider would need to file Form 4 no later than 10 p.m. Eastern Time on Wednesday of the same week. The SEC believes that this new reporting deadline will help investors, other market participants and the SEC better evaluate the actions of insiders and the context in which gifts are being made. Further, while the SEC recognizes that the rule change might increase compliance costs for estate planning transactions, these increases are expected to be limited, as the majority of insiders already report gifts on Form 4.
Potential Insider Trading Violations When Making GiftsAn insider’s acquisition and disposition of equity securities pursuant to bona fide gifts remain exempt from the operation of the Section 16(b) short swing liability rules, which require insiders to disgorge profits from nonexempt transactions that take place within six months of each other. The SEC noted, however, that a gift of public company stock followed closely by the donee’s sale of that stock under conditions where the value at the time of donation and sale affects the tax or other benefits obtained by the donor, may raise the same policy concerns as more common forms of insider trading. Because the donor is in a position to benefit from the asset’s value at the time of donation and sale, the donor may be motivated to give at a time when the donor is aware of material nonpublic information and may expect the donee to sell before the disclosure of such information. The SEC also noted that a gift made with the knowledge that the donee will soon sell can be seen as, in effect, a sale for cash followed by a gift of the cash by the insider.
These comments suggest that the SEC may be considering greater regulatory action against those it suspects of making gifts while in possession of material nonpublic information. The SEC did clarify, however, that a gift made pursuant to a compliant 10b5-1(c)(1) plan would qualify for the affirmative defense provided in Rule 10b5-1(c)(1) under the Exchange Act. A 10b5-1(c)(1) plan is a trading plan that is adopted by an insider while not in possession of material nonpublic information, which allows trades to take place automatically (i.e., without the input of the insider) and, if structured correctly, provides an affirmative defense against liability under Section 10b-5 of the Exchange Act.
The SEC specifically rejected a suggestion that the SEC narrow the scope of the gift limitations on donations to charities, such as by applying it only to gifts made to charities affiliated with the insider. The SEC indicated that while, in some cases, a close affiliation between the donor and donee can make an abusive transaction easier to carry out, none of the potential concerns the SEC identified were limited to gifts to entities controlled by or affiliated with the donor.
Complying With the New Rules
Based on the new rules and commentary, donors who are insiders of public companies:
- Will need to report gifts on a Form 4 within two business days of making a gift of equity securities in the public company.
- Should consider making gifts only when they are not in possession of material nonpublic information or pursuant to a compliant 10b5-1(c)(1) trading plan if these gifts may be traded by the donee.
- Should consider adopting a 10b5-1(c)(1) trading plan if they wish to make donations when they may be in possession of material nonpublic information.