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US District Court Holds That Discretionary Tax Withholding is Exempt Under 16b-3

Several companies have received shareholder letters seeking to recover short-swing profits from insiders under Section 16(b) of the Securities Exchange Act of 1934, alleging that such insiders made non-exempt purchases of stock within six months of having shares withheld either for payment of the exercise price of employee stock options or to satisfy tax liabilities upon the vesting of restricted stock units (resulting in deemed dispositions of those shares). In each case, the shareholder has claimed that the Rule 16b-3(e) exemption (for transactions between an issuer and its officers and directors) is only available for such dispositions when the withholding is automatic, without an election by the insider or the company. On April 26, the United States District Court for the Southern District of Texas granted a motion to dismiss in JD. Jordan v. Robert Flexton, et al., No.4:16-CV03316, holding that dispositions of restricted stock units to cover tax withholding are compensation related transactions designed to be exempt under Section 16b-3(e) of the Securities Exchange Act of 1934.

This ruling is significant because it rejects the argument that Rule 16b-3 exempts withholding transactions only if “automatic.” In this case the court allowed reliance on the exemption, when the company (Dynegy, Inc.) made the decision to withhold shares, not the insider. Note that, to rely upon this exemption, the tax withholding right must have been approved by the board of directors of the issuer, or a committee of the board of directors that is composed solely of two or more “non-employee directors” (typically, the compensation committee).

The full text of the order is available here.

©2019 Katten Muchin Rosenman LLP


About this Author

Farzad F. Damania, Capital markets and securities lawyer, Katten Law Firm

Farzad F. Damania focuses his practice on capital markets and securities law, mergers and acquisitions, and general corporate law. He is regularly engaged on capital markets transactions, including initial public offerings, follow-on offerings, tender offers, and high yield debt transactions as well as direct investments by private equity acquirers, sellers and co-investors. He also represents public companies on corporate governance issues, securities law compliance and stock exchange regulations.

Farzad counsels US public companies and foreign...