New SEC FAQs regarding S-K Item 403, Security ownership of certain beneficial owners and management

By Cydney Posner

The SEC has just issued new interpretations regarding Reg S-K, Item 403, Security ownership of certain beneficial owners and management. These interps replace the interps in the July 1997 Telephone Interps and March 1999 Supplement. Some of the interpretations are restated versions of previous interps.

Item 403(a) —Security ownership of certain beneficial owners

• A limited partnership holds restricted voting securities in a company that plans to make a public offering of its securities. The limited partnership agreement requires the limited partnership to distribute the restricted securities to its general and limited partners within 60 days following the public offering. Under Section 13(d), the beneficial ownership table contained in the company’s prospectus must include beneficial ownership of the distributed shares that will be held by the general and limited partners whose holdings will be in excess of five percent (or if any of these persons is a director or NEO) following the distribution.
• Issuers are not required to consider Form 13-F reports of "investment discretion" in determining the identity of five percent beneficial owners under Item 403(a): the concept of "investment discretion" is not the same as "beneficial ownership," and investment managers subject to Form 13-F reporting would also have to file Schedule 13D or Schedule 13G if their interests in the securities constituted beneficial ownership. However, issuers should keep in mind that Item 403 allows issuers to rely on Schedules 13D and 13G, but that reliance cannot be exclusive if the issuers have knowledge of any five percent beneficial owners who have not filed Schedules 13D or 13G or if the issuers have reason to believe that the information was not complete or accurate or that a statement or amendment that should have been filed was not.

Item 403(b) —Security ownership of management

• Item 403(b), by its terms, requires the disclosure of shareholdings of all directors named in the registrant’s proxy statement, including directors’ qualifying shares, even if the terms of some directors will not continue beyond the annual meeting.
• With regard to phantom stock units held in a nonqualified deferred compensation plan, if the units could be settled in stock at the holder’s election (so that if the holder were terminated currently he or she would get the underlying stock without the need to satisfy any additional vesting requirements), the registrant should report the total number of shares and percent of class beneficially owned, including the shares and percent of class beneficially owned due to the potential exercise of rights acquired under the phantom stock units. This result obtains because the holder has the right to acquire the underlying stock within 60 days (Rule 13d-3). In addition to including the shares underlying the units in the total number of shares and percent of class beneficially owned, the phantom stock units should be footnoted to distinguish them from stock owned outright. In contrast, if the phantom stock units can be settled in stock only at the company’s discretion, they should not be reported in the total number of shares and percent of class beneficially owned because the holder does not have a right to acquire the underlying stock within 60 days. Similarly, if the phantom stock units can be settled solely in cash, they should not be reported because the holder has no right to acquire the underlying stock.
• If an NEO has died since the beginning of the registrant’s last fiscal year, he or she need not be included in the Item 403(b) ownership table.
• The Item 403(b) requirement to indicate, by footnote or otherwise, the amount of shares that are pledged as security applies to a "negative pledge" of the company’s stock by a director, nominee or NEO. (A "negative pledge" is a covenant granted by a borrower to a lender in which a promise is made not to convey the shares to a third party or to otherwise encumber them. Assuming a default by the borrower, the "negative pledge" would not transfer title by operation of law, but would instead require a foreclosure.) Shares subject to a "negative pledge" may be subject to material risk or contingencies that do not apply to other shares beneficially owned by these persons, and these shares are pledged as security by operation of the negative pledge covenant.
• The tax consequences under Section 409A of the Internal Revenue Code that apply if a "key employee" receives a stock distribution within six months after leaving the company do not affect the analysis as to whether the person has a right to acquire the stock within 60 days under Rule 13d-3(d)(1). Section 409A results in a negative economic consequence, but is not a prohibition upon receipt of the shares.

Item 403(c) —Changes in control

• The requirement in Item 403(c) to disclose "any arrangement . . . including any pledge . . . which may at a subsequent date result in a change in control of the registrant" would not ordinarily apply to a "negative pledge" of the company’s stock by a principal shareholder. However, the registrant should consider whether any circumstances, such as insolvency of the borrower or takeover activity with respect to the registrant, would render a change in control arising from such an arrangement foreseeable and, therefore, disclosable under Item 403(c).

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