In the world of comp lawyers, this is the time of year when every day’s to do list includes a review of one or more (sometimes, many more) equity award agreements in need of an annual update. In view of recent events in the world of plaintiff shareholders, one of the areas we’re homing in on this year is the award agreement’s tax withholding provision and its level of discretion around whether or not shares will be withheld for taxes.

This focus on our part arises because a plaintiff shareholder has recently sent a demand letter to and/or filed a complaint against a few unlucky companies, alleging that the exemption from Exchange Act Section 16(b) short-swing profit liability for the disposition of shares to the issuer in a withholding transaction applies only if the transaction was approved in advance by the Board or Comp Committee (so far, so true), and that the exemption is lost if any other party has discretion as to whether such withholding in shares occurs (this is where it gets shaky).

The Risk Factor

From a legal perspective, there should not be a real risk of losing the Section 16(b) exemption for a share withholding transaction unless the “company” has discretion not to withhold in shares. This risk arises out of an SEC Compliance and Disclosure Interpretation in May 2007, where the SEC determined that Board or Comp Committee approval of the terms of an equity award that provides for automatic reload grants or an automatic right to withhold shares to satisfy taxes or the exercise price is sufficiently specific to meet the requirements of the exemption in Rule 16b-3(e), as long as the award terms do not allow the issuer to exercise discretion as to whether reload grants would be made or shares would be withheld.

We are not aware of any SEC guidance stating that a Section 16 insider’s discretion as to whether shares are withheld impacts the availability of the exemption and we do not think any claim that it does has legal merit. But until the recent claims in this area run their course and prove unsuccessful (we hope), the presence of insider discretion in an award agreement could pose a risk that your company will be targeted.

The Bottom Line

The bottom line is that where a publicly filed award agreement has withholding provisions that allow the “company” or even the “participant” to decide whether shares will be withheld for taxes, there is a risk that a plaintiff shareholder will be able to claim that a share withholding transaction is not exempt from 16(b) and, as a result, there is a violation of the short-swing profits rule if there is a matchable opposite way transaction within six months of the share withholding. In this regard, recall that all of these transactions for a Section 16 insider will be reportable on a Form 4 and new software programs make it easy for plaintiffs to trawl through filings and analyze potentially matchable transactions.

To avoid your company being targeted, do like we’re doing and add a review of your equity award tax withholding provisions to your to do list for Spring 2017.


Sinead Kelly is a partner in Baker McKenzie’s Compensation practice in San Francisco. She advises on U.S. executive compensation and global equity and has practiced in the compensation field since 2005. In her practice, Sinead counsels U.S. and non-U.S. public and private companies on all aspects of equity and executive compensation plans and arrangements, including plan design, drafting, administration and governance. In this regard, Sinead advises on and assists companies with compliance with U.S. federal and state securities and tax laws relating to compensation arrangements, as well as with preparing SEC disclosures, complying with stock exchange rules and addressing non-U.S. tax and regulatory requirements. She has been repeatedly recognized by Legal 500 as a leading lawyer for Executive Compensation and Employee Benefits.