1. Who cannot receive personal loans from a company?
Executive officers and directors - and their spouses, minor children, trusts, and similar entities. An "executive officer" is not covered under the Sarbanes-Oxley Act. Most practitioners believe the definition encompasses the same persons identified in the Form 10-K as executive officers - who typically also are Section 16 insiders. Since "indirect" personal loans also are prohibited, loans to spouses, minor children, trusts and similar arrangements are suspect and should not be made.
2. What is a "personal loan"?
It is unclear - as the Sarbanes-Oxley Act does not define the term and there is no definition of the term in the Securities Exchange Act of 1934. The new law prohibits the extension or maintenance of credit; arranging of credit or renewal of credit. In the absence of guidance from the SEC or other regulators, many practitioners have been conservative in how to interpret this term - and there have been differences of opinion among many practitioners. Some practitioners have noted that this new law is novel and indicative of a greater attempt to federalize state corporate law.
3. Can executive officers or directors still use brokers to conduct cashless exercises of stock options?
This is unclear - and probably the most controversial aspect of this Sarbanes-Oxley Act provision due to its potential widespread impact. Many companies allow executive officers and directors to exercise their options through "broker-assisted cashless exercises." This allows the officer to exercise an option and sell the underlying shares at approximately the same time - and use the proceeds from the sale to pay the exercise price and any withholding taxes. These companies have made agreements with brokers to provide this service for its officers and directors.
Depending on the precise facts of the agreement between the company and the broker, these cashless exercise agreements involve either a temporary financing of the officer's exercises by the company - or an "arranging" for credit by the company with the broker on behalf of the officers or directors. Companies typically either advance shares to the broker with a value equal to the exercise price (which the broker sells to pay the exercise price) - or promise to deliver shares to the broker after the broker uses its own shares to sell to pay the exercise price.
There are other permutations of these types of arrangements in which the company arguably extends - or "arranges" - credit to the officers and directors for a short period of time (between the time of the option exercise and the time of the underlying stock sale).
Since new Section 13(k) prohibits companies from "arranging" for the extension of credit, the question is whether the company's involvement with the broker is sufficient for these agreements to be considered "arranged" credit that is prohibited under the new law.
Practitioners differ widely in their opinions until further guidance is obtained from regulators. Some believe that the Sarbanes-Oxley Act was never intended to apply to cashless exercises as they are not susceptible to the type of abuses that led to Congress acting - this view is growing in popularity . Others recommend the suspension of cashless exercises through these programs for executive officers and directors.
Some practitioners point out that officers can make their own arrangements with brokers to exercise their options and sell the underlying stock. These entail the officer or director tendering their own shares to pay the exercise price. Under these circumstances, the officer or director should not recognize any gain for selling the underlying shares. However, these arrangements could result in adverse accounting treatment for the company.
Note that even cash exercises can be problematic - as the company may be deemed to be extending credit between the time of the exercise (and withholding taxes are paid by the company) and the time that the officer receives a paycheck reflecting the deduction for the withholding.
4. Can companies still pay advances to executive officers for upcoming credit card obligations or other expenses?
It is unclear. Although Section 13(k)(2) provides exemptions from the prohibition on personal loans for extension of credit under charge cards or under an open end credit plan - these exemptions are qualified to require that the credit be made in the "ordinary course" of the company's consumer credit business.
Some practitioners believe this qualification is confusing and casts the availability to rely on the exemption into doubt - pending further guidance from a regulator. On the other hand, some practitioners believe that bona fide travel advances or use of company credit cards for business purposes should not be considered "personal loans" - so long as they are made in the ordinary course and promptly repaid.
If companies decide to bear the risk and make advances, some practitioners advise that there should be clear policies restricting the use of advances and credit cards for business purposes.
5. Can companies still guarantee loans to executive officers from a third-party?
No. Most practitioners believe this would be an "indirect" extension of credit from the company to an executive officer under most circumstances.
6. Can executive officers obtain loans in 401(k) and other broad-based employee loan programs?
It is uncertain. The "market terms" requirement for loans that are exempt from the prohibition on loans requires that the loans be no more favorable than what is offered to the "general public." Since most 401(k) and other broad-based employee loan programs offer terms that are more beneficial than that offered to the public, executive officers may not be able to obtain loans under these plans.
On the other hand, it should be noted that these loans are permissible from an insured depository institution to its insiders under an exemption under the Sarbanes-Oxley Act for these types of loans.
7. Can executive officers obtain loans in connection with grants of restricted stock?
No. Some companies grant restricted stock under terms that require the grantees to receive a loan from the company for all - or a portion - of the purchase price of the stock. After a certain threshold is met (either corporate performance targets or employment until a certain date), the loan is partially or completely forgiven.
8. Can companies still use indemnification arrangements under which an executive officer's or director's litigation expenses are paid in advance?
It is unclear - for many of the reasons set forth above regarding advances for other expenses. On the other hand, some practitioners note that the analysis in making these arrangements does not involve any consideration of whether the insider is creditworthy. Others provide more detailed rationales for the inapplicability of Section 402 to indemnification arrangements.
