Section 16 of the Securities Exchange Act of 1934 (SEA) sets out the regulatory filing obligations facing senior personnel and individuals with a significant beneficial ownership stake in public companies.
The SEA refers to those required to act under the Section 16 rules as “insiders.” For the purposes of the legislation, insiders are the directors and officers of a company, as well as people who own stock to a level that gives them ownership of more than 10% of the business.
In addition, the terms of the SEA extend the net wider, regarding “beneficial ownership” as not being limited merely to those with a direct equity interest in the company. For example, an individual living in a shared household where an immediate family member is required to file relevant documentation under Section 16 will also be subject to those rules and requirements, even if they themselves own no stock in that business.
The Section 16 reporting obligations kick in once a company in the process of going public finalizes its Form S-1 registration statement. Under Securities and Exchange Commission (SEC) regulations, the registration statement represents a key landmark on the Initial Public Offering (IPO) journey, with its approval marking the moment that a company receives the green light to offer securities to the general public, with any subsequent follow-on offers also requiring that an S-1 be formally lodged with the SEC.
Anyone deemed to be an insider must file specific forms with the SEC outlining their equity interests in the company. These forms require individuals to not just provide detail on their interests at that moment in time, but also how their position may have changed over time, in line with past transactions.
When subject to the requirements of Section 16, affected individuals are obliged to file SEC Forms 3, 4, and 5 when applicable, with the purpose being to ensure that investors get to see the equity stake of company insiders, with at least some of those insiders set to be the key decision-makers in the business.
This is the initial document that will be filed by a person required to adhere to the terms of Section 16. When an individual is deemed to be an insider, they are then obliged to complete and file this form within 10 days. Alternatively, it must be filed no later than the effective date of an S-1 registration statement in the context of an IPO. The form requires individuals to set out their ownership stake in the company.
In most circumstances, when an insider executes a transaction (subsequent to filing Form 3), they will need to provide the relevant details to the SEC and do so by completing and lodging Form 4. Among the details to be included will the number of shares bought or sold and the price per share. Other transactions involving, for example, options, warrants, and convertible securities must also be reported. Also important to note is that Form 4 must be returned within two business days following any relevant transaction. The overall logic of these requirements is, again, to ensure that investors have an up-to-date picture of the equity-related activities of insiders.
This form will usually be filed no later than 45 days after the end of a company’s fiscal year. Depending upon the events of a given year, individuals subject to Section 16 may have no need to submit a Form 5 for that time period. It is only required when transactions exempt from Form 4 reporting requirements have been conducted or in the event that transactions that should have been reported were not reported in the required timeframe. For example, some transactions below a value of $10,000 do not trigger the Form 4 obligations, so those trades will then be reported at the end of the year in a Form 5 return.
Remember, the purpose of the exercise is to ensure that investors and prospective investors have access to insider ownership information. The SEC has reported that the investor community can find this information useful, the logic of this position being that the buying and selling of company stock by insiders may offer insight into how senior figures view the performance and/or prospects of the company.
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