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An important goal of many e-commerce and Internet companies is to conduct an initial public offering and have their stock publicly traded. While there are many advantages to a public offering of securities � such as the opportunity to raise significant amounts of capital for corporate operations � there are also important obligations and responsibilities that arise as a result of a company’s status as a publicly traded company. This article focuses on the obligations and responsibilities that apply to the individual officers, directors and primary shareholders of publicly traded companies. Counsel for e-commerce and Internet companies must ensure that all of the officers, directors and principal shareholders of a newly public company understand that there are numerous regulations that apply to them in their personal capacity. Many of these individuals will become subject to reporting and filing requirements for the first time, and consequently, it is easy to inadvertently fail to comply with the various rules. The restrictions that apply to officers, directors and principal shareholders of publicly traded companies can be broken down into two types: i) substantive restrictions on the purchase and sale of the company’s securities by such individuals, including restrictions on insider trading; and ii) reporting and filing requirements relating to the acquisition or disposition of the company’s securities by those individuals. First, let us examine the substantive restrictions on trading that these individuals must abide by. The proscriptions against insider trading are primarily designed to prevent corporate insiders, such as officers, directors and principal shareholders, from unfairly taking advantage of their access to material non-public information. Insider trading is prohibited by �10(b) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder and other statutes. Courts have come to different conclusions as to whether a corporate insider must use the non-public information as a basis for trading or whether the mere possession of material non-public information while trading is sufficient to constitute a violation of the insider trading rules. ( See United States v. Smith, 155 F.3d 1051 (9th Cir. 1998) and Securities and Exch. Comm’n v. Adler, 137 F.3d 1325 (11th Cir. 1998), which hold that the trader must use the material non-public information as a basis for trading). Also, insiders must not pass along “tips” to others concerning material information that the company has not disclosed to the public. Courts have defined material information as information that a reasonable investor would view as important in making a decision to buy or sell a security. A person who violates the prohibitions on insider trading can be required to disgorge any profits made from such purchases and sales and is also subject to other fines and penalties. Counsel for e-commerce and Internet companies should consider having the company adopt written policies and procedures to restrict communication of material non-public information and to monitor its distribution. SHORT-SWING PROFITS Corporate insiders are often surprised to learn that any profits earned by an officer, director or 10 percent shareholder as a result of a purchase and sale of the company’s stock within a six month period are recoverable by the company. This rule, known as the short-swing profit rule, is contained in �16 of the Exchange Act. This provision imposes a flat rule with respect to officers, directors and 10 percent shareholders, rendering them liable even if they did not trade on inside information or intend to profit based on such information. The short-swing profit rule is extremely broad and applies to all purchases and sales of securities, as long as both the purchase and the sale occur within six months of each other. The rule also applies to purchases and sales of derivative securities such as stock options. Officers, directors and 10 percent shareholders that profitably trade in their company’s securities within the six-month window are strictly liable and there is no need to show any intent to violate the law. It is incumbent upon a company’s counsel, therefore, to ensure that officers, directors and 10 percent shareholders are aware that they should not purchase and sell their company’s stock in the open market, or otherwise, within a six-month window. Rule 16a-1(f) defines an “officer” to include a company’s president, principal financial officer, principal accounting officer (or if there is no accounting officer, the controller) any vice-president of the company in charge of a principal business unit, division or function (such as sales, marketing or administration) and any other officer or person who performs similar policy-making functions. Officers, directors and 10 percent stockholders are also prohibited by �16(c) of the Exchange Act from making “short sales” of equity securities of their company. In other words, such persons cannot sell equity securities of the company if they do not already own the securities they intend to sell. This rule, in effect, prohibits officers, directors and 10 percent stockholders from profiting if their company’s stock price declines. RESTRICTED STOCK Counsel for e-commerce and Internet companies will often be requested to provide guidance to those shareholders that acquired a company’s stock prior to the public offering. Stock issued in a private transaction prior to an initial public offering is known as “restricted stock.” Holders of restricted stock should make resales of stock only in accordance with SEC Rule 144, which restricts the amount, manner of sale and timing of such resales. In addition, affiliates of the company will also be subject to the restrictions of Rule 144, which is fairly complex, when they desire to resell their company’s stock. Often, the company’s stock transfer agent will require an opinion letter from counsel stating that a particular shareholder’s sale of restricted stock is allowable under Rule 144. Because of the prevalence of stock options among e-commerce and Internet companies, counsel must also be familiar with SEC Rule 701, which applies to resales of common stock acquired before the public offering upon the exercise of stock options. Rule 701 enables non-affiliates to resell such shares without having to comply with most of the Rule 144 restrictions. However, sales under Rule 701 can only commence 90 days after the company becomes subject to the reporting requirements of the Exchange Act. The foregoing discussion covers the principal substantive restrictions on the securities trading of officers, directors and principal shareholders of public companies. Next, let us turn to the various reporting and filing obligations that are placed on these individuals. REPORTING OBLIGATIONS Section 16(a) of the Exchange Act sets up a comprehensive regulatory scheme where officers, directors and principal shareholders must publicly disclose their beneficial ownership of their company’ stock and any changes thereto. Each director, officer and greater than 10 percent stockholder of a publicly traded company must file with the SEC an Initial Statement of Beneficial Ownership of Securities on Form 3. If at a later time another person becomes an officer, director or greater than 10 percent shareholder, they too must file a Form 3. If there is a change in the ownership of an officer, director or 10 percent shareholder, that change must be reported on a Form 4, Changes in Beneficial Ownership of Securities, within 10 days after the calendar day after the month in which such change occurs. It is important to note that while most changes in beneficial ownership will be the result of purchases and sales of the company’s securities, other events might trigger the need to file a Form 4, such as giving shares as gifts. Also, the acquisition or disposition of a derivative security (such as an option) is treated and reported as an acquisition or disposition of the underlying stock. If an officer or director of the company ceases to serve in such capacity, he or she will be required to file a statement on Form 4 if he or she executes a transaction within six months of a transaction executed while he or she was an officer or director. All transactions must be reported on Form 4, except for small acquisitions not exceeding $10,000 and certain other exempted transactions involving options positions. A Form 5 must be filed within 45 days after the company’s fiscal year end by any person who was subject to �16 at any time during the fiscal year if that person engaged in transactions that were not previously reported. The Form 5 will disclose all transactions that constituted small acquisitions or were otherwise exempt from previous reporting. To help ensure compliance, counsel should advise a publicly traded company to appoint a person to receive and review a copy of each Form 3, 4 and 5 that is filed with the SEC. In addition, officers, directors and principal shareholders should be requested to forward copies of all Forms 3, 4 and 5 that are filed with the SEC to the designated person at the company. FURTHER DISCLOSURE In addition to the requirements of �16(a), certain stockholders of the company are subject to disclosure requirements under �13 of the Exchange Act, the purpose of which is to alert the public and the company to any significant ownership or trading of the company’s securities. Any person who acquires, directly or indirectly, the beneficial ownership of over five percent of a class of publicly traded equity securities must file a Schedule 13D, which requires disclosure of the purpose of the acquisition, the source of the funds for the acquisition of the securities and the level of ownership. Direct or indirect beneficial ownership includes securities held through corporations, trusts and partnerships and, usually, stock held by members of the stockholder’s immediate family. The �13D is filed with the SEC and sent to the issuer within 10 days after the acquisition of securities bringing the total amount of share ownership over the five percent threshold. It should be noted that when two or more people act as a group and collectively acquire over five percent of a class of a company’s stock, even if no individual member of the group owns over five percent, a Schedule 13D may have to be filed. As the foregoing discussion illustrates, there are numerous rules and regulations that apply personally to officers, directors and principal shareholders of publicly traded companies. To assist these individuals in complying with these important regulations, counsel should consider preparing clearly written guidelines to ensure that the individuals affected understand the various rules that apply to them. In addition, many e-commerce and Internet companies have adopted the salutary practice of providing regular written reminders to ensure that the various regulations are not mistakenly overlooked. Through these actions, e-commerce and Internet companies, as well as their officers, directors and shareholders, can best ensure that they are in full compliance with the numerous regulations that apply to them. Robert G. Heim, a former assistant regional director of the SEC, is a partner in New York’s Meyers & Heim LLP. Howard Meyers, a partner in the firm, assisted with the article.

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