Form 4 Has 20 Transaction Codes. None Say "Section 351 ETF Swap"

The Executive Stock Dilemma

On August 20, Alex Karp sold about $86 million of Palantir stock.

Roughly $70 million of it went to tax withholding on restricted stock units that had just vested, executed under a trading plan adopted months earlier, which does not make for an interesting headline.

So, the headline was that the ‘Palantir CEO sold $86 million of stock.’

That headline is why there is a conversation happening in the office of every wealth advisor who serves executives at Mag 7 and other public hyperscalers.

The client has eight figures of vested company stock, a cost basis of approximately nothing, and would like to own something else.

Maybe the multiple looks rich.

Maybe it is imprudent to have the salary, the bonus, and the entire portfolio riding on one ticker symbol.

Two things stand in the way, taxes, and SEC Form 4 for an Insider Transaction Filing.

The advisor suggests a 351 exchange. Great idea.

It is not a sale, it is a tax-deferred swap of stock for newly issued ETF shares, which handles the tax bill.

But what about filing a Form 4?

Good question.

Again, it is not a sale, so perhaps no filing and no headline, that sends the wrong signal to the market effecting your net worth.

But the executive no longer controls the shares afterward, and that turns out to matter quite a lot.

This Is Not About Unvested Equity

We are talking about vested stock sitting in a brokerage account and shares from exercised options.

An unvested RSU is not stock.

It is a promise from an employer to hand over stock later, assuming the executive is still there.

It does not exist at DTC, so it cannot be delivered to a fund’s custodian, and no fund administrator can strike an opening NAV off contractual expectations.

What a 351 Exchange Is

Section 351 lets you contribute property to a corporation in exchange for its stock without recognizing gain.

An ETF is a corporation for this purpose, one whose business happens to be holding a diversified portfolio of stocks.

Bring a diversified portfolio, receive shares in a fund that holds a diversified portfolio, and carry over your cost basis. It is now the fastest growing way to seed an ETF.

The catch for most corporate executives and founders is that diversification requirement.

According to Michael Prendergast, SVP, ETF Senior Product Specialist, Ultimus Fund Solutions, “the rules themselves are not complicated.

No more than 25% in any one stock, no more than 50% in the top five.

If the corporate insider can come up with enough other stock that meets the ETF’s investment strategy and the IRS diversification requirements, the transaction can happen.”

The executive did not “sell.” No sale, no Form 4, no headline. Right?

Section 16, Where It Breaks

A savvy financial advisor might know about Rule 16a-13, which exempts a transaction that changes only the form of beneficial ownership without changing financial interest.

Moving shares into a family trust, for instance.

However, a 351 exchange is more than a change in form of beneficial ownership.

In a section 351 exchange, the executive gives up their pecuniary interest in the stock.

They become shareholders in the ETF, which is professionally managed by the fund’s investment adviser.

As a shareholder, they are not a client of the ETF’s adviser and have no ability to direct the investments of the ETF, the fund’s portfolio managers make the trading decisions.

The executive also has no ownership rights in individual portfolio securities held by the ETF, including any stock that they transferred via the 351 exchange.,” according to Kate Fuentes, Founder and CEO, Ascent Governance & Advisory.

Somebody thought of this before.

The SEC’s Division of Corporation Finance has had an interpretation on the books since 2007, C&DI 221.02, addressing a director who proposed transferring shares of the director’s own company into a newly created, foreign domiciled mutual fund.

The fund’s equity investments would be limited to that one issuer’s stock.

The SEC staff’s answer runs one sentence. Rule 16a-13 would not be available for the director’s transfer. So, the Form 4 gets filed.

But Which Box to Check for a Section 351 Transfer

Under which code is a fair question, because Form 4 offers twenty transaction codes and not one of them describes a tax-deferred swap.

Code S is a sale, which is the thing that did not happen, for tax reasons.

Code K is for the derivative kind of swap, which is the wrong kind of swap unless you are Bill Hwang.

That leaves Code J, other acquisition or disposition, which requires a footnote. And all the market sees is a large block of stock leaving the executive’s control.

The market does not read footnotes, does not care about prudent diversification, and has no opinion on tax deferral strategy.

So, the filing sends the signal the whole exercise was meant to avoid.

At least the taxes were deferred.

What This Actually Means

The wealth advisor’s pitch is simple. Swap your pile of tech stock, and some other stuff, into a brand new ETF, walk away diversified, and hear the IRS say ‘not a sale, no tax today.’

Wonderful.

Then the SEC says ‘not so fast.’ Form 4, with twenty distinct boxes, none of which say “I magically transformed my shares into an ETF, please do not write an article about me,” still has to get filled out.

Though judging by Alex Karp and every other tech executive dumping shares into this bull market, the headlines do not seem to affect the share price anyway.

About Matthew Bucklin

Matthew Bucklin is a finance professional and entrepreneur. He is the Founder of ExchangiFi, a capital markets platform that enables ETF issuers to raise seed capital through Section 351 tax-deferred exchanges.

Previously, Matt launched Valley Cove Capital, a search fund focused on small business acquisition and growth, co-founded Sense Relief, a digital therapeutics company, Credible, a speech coaching app, and founded The Quit Company, a smoking cessation products platform. He began his career in asset management with MDRxFinancial and W.P. Stewart.

Matt holds an MBA from the Yale School of Management and a BA in Economics and Mathematics from Colby College. He is based in West Palm Beach, and serves as President of the Yale Club of the Palm Beaches and mentors with the Yale Entrepreneurial Society and Colby Halloran Lab.

Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.