• Public companies may not make personal loans to their directors and executive officers;
• Plan administrators of individual account plans (for example, 401(k) plans) must give 30 days advance notice of any blackout period;
• Insiders cannot trade in company stock during certain blackout periods; and
• Increased penalties for ERISA violations.

Prohibition of Loans to Directors and Executives

In an amazing display of broadly drafted legislation, the Act prohibits publicly traded companies (and other issuers who are subject to the Securities Exchange Act of 1934) from extending credit, directly or indirectly, to their directors and executive officers, or merely arranging for the extension of credit. Prior to the Act, boards generally concerned themselves only with the business judgment rule in evaluating the legality of extending credit to directors and executive officers.

The breadth of the Act's provision would apparently prohibit most executive loan programs, including sign-on loans, salary advances, relocation loans, loans to exercise stock options and loans to purchase restricted stock.

There are a number of exceptions to the Act's prohibition against extending credit, but they are limited. One of the most important exceptions is that loans existing on July 30, 2002 may continue in effect, provided that they are not materially modified or renewed at any time. Certain other extensions of credit made in the ordinary course of the issuer's business are also permitted.

In interpreting the Act's provision, issuers should focus on the broad definition of "executive officer" under the securities laws, which will presumably govern. In general, an "executive officer" includes a president, certain vice presidents, and any other officer who performs a policy making function. Executive officers of subsidiaries are not generally deemed to be executive officers of the issuer unless they are involved in policy-making decisions for the issuer.

The prohibition on loans raises many issues that cannot be answered without additional guidance. For example, the Act does not address whether the prohibition on loans affects split dollar life insurance policies, whether a loan made after July 30, 2002 by a private company is grandfathered if the loan is still outstanding when the company becomes public, and whether the use of broker-assisted cashless exercises for stock options will be prohibited.

Until further guidance is issued, we advise clients to be conservative and carefully consider their existing loan programs and other extensions of credit to directors and executive officers.

The loan provisions are effective on the date of enactment of the Act, July 30, 2002.

Blackout Periods Require Notice

The Act requires plan administrators of individual account plans (such as 401(k) plans) to provide participants with at least 30 days advance notice of any blackout period. For this purpose, a "blackout period" is a period of more than 3 consecutive business days during which participants and beneficiaries are restricted from their normal right to direct plan investments, obtain plan loans, or obtain distributions. Limited exceptions to the 30-day advance notice requirement apply, such as in the case of unforeseeable circumstances or mergers and acquisitions.

The notice must include: (1) the reasons for the blackout period, (2) identification of the investments and other rights affected, (3) the expected beginning date and length of the blackout period, and (4) a statement that individuals should evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify assets credited to their accounts. The notice must be in writing or sent by electronic transmission, provided that such transmission is reasonably accessible to the participant.

The US Department of Labor is schedule to provide a model notice no later than January 1, 2003 and intends to publish interim rules by October 13, 2002.

The new blackout notice rules will become effective 180 days after the enactment of the Act, January 27, 2003.

No Insider Trades During Blackout Periods

The Act prohibits a director or executive officer from buying or selling company stock during a blackout period if that person acquired the stock in connection with his or her employment as a director or executive. If a prohibited sale occurs, the profit is recoverable by the issuer. For purposes of this insider trading requirement, "blackout period" means a period of more than 3 consecutive business days during which at least 50 percent of all plan participants under all individual account plans of the issuer are unable to buy or sell company stock held in an individual account plan. If directors and executive officers are subject to these restrictions, the issuer must give timely notice of the blackout period to such directors and officers, as well as the Securities and Exchange Commission.

It is important to note that the restrictions relating to insider trading only apply to blackout periods in individual account plans holding company stock. By contrast, the ERISA notice rules described above apply broadly to all individual account plans.

The new insider trading rules will become effective 180 days after the enactment of the Act, January 27, 2003.

Increased Sanctions for ERISA Violations

The Act increases the penalties for violating ERISA's reporting and disclosure requirements. Under the old law, an individual faced a fine of up to $5,000 and up to one year in prison for willfully violating ERISA's reporting and disclosure provisions. The Act increases these penalties to a fine of up to $100,000 and up to 10 years in prison. Although these penalties were increased presumably to enforce the blackout notices, they apply to all of ERISA's reporting and disclosure requirements