We have been following the progress of a number of plaintiff shareholder suits alleging Exchange Act Section 16(b) short swing profits based on “discretionary” share withholding on equity awards. Just under a year ago we were happy to report the first district court dismissal of one of these claims, although that case is currently on appeal to the Fifth Circuit.
On January 26, 2018, a second such claim was thrown out via summary judgment, this time in the federal district court for the Northern District of Oklahoma (Olagues v. Muncrief, No. 17-CV-0153-CVE-JFJ).
Background: Withholding in Shares from Section 16 Insiders
Under Section 16(b) of the Exchange Act, a public company’s Section 16 insiders are required to disgorge to the company any “short swing profits” they realize from the purchase and sale (or sale and purchase) of the company’s equity securities within a six-month period, unless the applicable sale or purchase is exempt. Under Rule 16b-3(e), a company’s withholding of shares to satisfy taxes is exempt, provided the company’s Board of Directors or Compensation Committee approves the transaction in advance. The plaintiff claim is that Board or Compensation Committee approval of award terms authorizing share withholding is not sufficient to rely on the Rule 16b-3(e) exemption if the approved terms give the company or the Section 16 insider discretion as to whether shares are actually withheld.
Breaking Down the Case
In Olagues v. Muncrief, the company withheld shares to satisfy taxes upon vesting of RSUs and two executives purchased stock on the open market within six months of such vesting date. The plan under which the RSUs were granted permitted the company to satisfy tax withholding by a variety of methods, including withholding in shares. However, the RSU agreement required withholding of shares at the time of vesting of the RSUs, with the exception that the company was permitted (not required) to withhold shares to satisfy any FICA taxes arising prior to the scheduled vesting/payment of the RSUs.
Based on the discretion under the plan and with respect to FICA withholding under the agreement, the plaintiff claimed that the withholding of shares on the vesting of the RSUs was not exempt under Rule 16b-3(e), resulting in short-swing profits liability for the executives who purchased shares on the market within six months. The court rejected the claim, finding that the challenged withholding of taxes at vesting of the RSUs was non-discretionary under the award agreement. The court did not address (nor did it need to address) whether the company’s discretion to withhold shares prior to vesting to cover FICA taxes would have impacted the availability of the exemption.
Although it is encouraging to see the dismissal of a second of these claims, the court’s decision is not surprising because it is reasonably clear in this instance that the company did not have discretion regarding share withholding at vesting under the actual RSU terms (notwithstanding the various withholding methods set out in the plan). Therefore, the decision does not move us much further in obtaining definitive guidance that company (or insider) discretion around share withholding does not affect the Rule 16b-3(e) exemption. However, it is encouraging that the court expressed some skepticism as to whether short swing profits liability should ever arise out of an equity award withholding transaction.
We will continue to monitor these cases, but in the meantime, companies should continue to be cautious with the use of discretionary share withholding provisions in their equity award agreements with Section 16 insiders.