SEC Issues SOX 402 Guidance

Michael Oxley is of counsel at Baker & Hostetler LLP, and is former Congressman and Chairman of the House Financial Services Committee. Mr. Oxley co-authored the landmark Sarbanes-Oxley Act of 2002. The following post is based on a BakerHostetler memorandum by Mr. Oxley, Andrew W. Reich, and Thomas S. Gallagher.

The SEC staff for the first time issued interpretive guidance regarding Section 402 of the Sarbanes-Oxley Act of 2002 (SOX). To date, in the absence of authoritative guidance, issuers have largely steered clear of activities arguably within the ambit of SOX 402’s prohibition on personal loans to officers and directors. The staff’s new letter provides a measure of clarity regarding SOX 402’s scope.

SOX 402, codified as Section 13(k) of the Securities Exchange Act of 1934, makes it unlawful for an issuer “directly or indirectly … to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan” to any of its directors or executive officers. Violations of SOX 402 can subject issuers to civil and criminal penalties under Sections 21B and 32(a) of the Exchange Act.

On February 28, 2013, financial services firm RingsEnd Partners, LLC sought guidance from the SEC’s Division of Corporation Finance regarding a proposed equity-based incentive compensation (EBIC) program that RingsEnd had developed in collaboration with the global bank BNP Paribas. Under the EBIC program, participating employees would place shares of stock awarded under a compensation program into a trust, which would use the shares as collateral for a loan from an independent lender. The trust would use the proceeds of the loan to purchase additional shares, and subsequently sell enough shares to pay back the loan and transfer remaining shares to the participating employees. As described in RingsEnd’s letter to the staff, the EBIC structure would result in favorable tax treatment for the employees and incentivize them to hold awarded shares for the long term.

In its March 4, 2013, interpretive guidance letter, the SEC staff confirmed that an issuer that permits its directors and executive officers to participate in the EBIC program would not be deemed thereby to be extending credit or arranging for the extension of credit, for purposes of SOX 402. The staff further confirmed that an issuer would also not be deemed to be extending or arranging for the extension of credit, under SOX 402, if it undertakes certain ministerial or administrative activities so as to enable its directors and executive officers to participate in the EBIC program.

As the SEC staff’s first published guidance on SOX 402, this letter breaks new ground. However, the guidance is expressly limited to the particular facts and representations presented in RingsEnd’s letter. Issuers and boards would be well-advised to proceed cautiously before reading the staff’s issuance as giving a green light to other programs or activities that may be deemed to fall within SOX 402’s scope.

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