It is not uncommon for a corporation to have net operating losses ("NOLs")¹ that may be carried forward from year-to-year, and may be used to offset the corporation’s taxable income in future years. A corporation’s ability to utilize its NOLs to offset future taxable income may be significantly limited if the corporation experiences an “ownership change” as defined in Code §382 and the Treasury Regulations.² While it is important for all corporations to keep close tabs on their stockholder base, it is uniquely important for a corporation with NOLs to do so because if a stockholder or group of stockholders accumulate a position in the corporation’s stock, then too much of an accumulation could potentially jeopardize the corporation’s ability to utilize its NOLs. In this article, we provide a brief explanation of Code §382, and an overview of methods and tools that a corporation can use to monitor stockholder stock accumulation. As will become apparent as you read on, although this article is intended to be a practical resource for monitoring ownership changes, it requires some discussion of the technical aspects of both the Code and the Exchange Act.³ If you prefer to leave the nuances of the Code to your professional advisors, then you may prefer to skip over Part I of this article and just read Part II, which focuses on methods and tools for monitoring changes to a corporation’s stockholder base.

I. Code §382 and Ownership Changes
Code §382 was enacted with the policy objective to prevent ‘trafficking’ in NOLs. In general, an ownership change will occur when the percentage of the corporation’s ownership (measured by value) by one or more “5-percent shareholders” (as defined in the Code) has increased by more than 50 percentage points over the lowest percentage owned by such stockholders at any time during the prior three years ending on the date of an “owner shift” event or an “equity structure shift” event (in each instance, generally calculated on a rolling basis). In general, a 5-percent shareholder is a stockholder who owns, directly or constructively, 5% or more of the stock of the corporation.

An owner shift is a change in the percentage of stock owned in the corporation by a stockholder who is a 5-percent shareholder before or after that change. An owner shift typically involves a stock acquisition, but can result from a redemption of another stockholder’s shares. As contemplated in Treas. Reg. §1.382-2T(e)(1)(i), an owner shift includes, among others:

• a purchase or disposition of stock by a party who is a 5-percent shareholder before such acquisition or disposition;
• a purchase of stock by a party who, as a result of such purchase, becomes a 5-percent shareholder (regardless of the size of the final purchase(s) that caused the 5% threshold to be exceeded);
• a redemption, recapitalization, or buyback of shares of the corporation's stock that directly or indirectly affects the percentage of stock owned by (i) a 5-percent shareholder, (ii) someone who becomes a 5-percent shareholder as a result of such redemption, recapitalization, or buyback, and/or (iii) groups of stockholders who are not themselves “5-percent shareholders”;
• an issuance of stock that affects the percentage of stock owned by a 5-percent shareholder (including someone who becomes a 5-percent shareholder as a result of such issuance); and
• an equity structure shift (discussed below) that affects the percentage of stock owned by a 5-percent shareholder (including someone who becomes a 5-percent shareholder as a result of such shift).

An equity structure shift generally includes an acquisitive reorganization of a corporation, such as through a merger of a target corporation with NOLs (sometimes referred to as the “loss corporation”) into an acquiring corporation.

An entity that experiences an ownership change under Code §382 generally will be subject to an annual limitation on its ability to use NOLs that arose prior to the ownership change to offset income arising after the ownership change. The limitation is generally equal to the product of (i) the equity value of the corporation immediately before the ownership change, multiplied by (ii) the long-term, tax-exempt rate posted monthly by the Internal Revenue Service, subject to certain adjustments.

The rules of Code §382 are highly complex and a detailed discussion is beyond the scope of this article. Rather, the purpose of this article is to provide certain key guideposts that can be used to monitor any significant changes that may trigger an issue, or be a precursor to an issue, under Code §382 and therefore merit further detailed analysis by the corporation’s professional advisors. Some of the factors and special rules that must be considered in determining whether a Code §382 ownership change has occurred (or is expected to occur) include the following:

• The group of stockholders who each own less than 5% of the outstanding stock are generally (but not always) grouped together and treated as a separate “5-percent shareholder” (referred to as a “public group”) for purposes of Code §382. Transactions in the public markets among stockholders who are members of a public group are generally (but not always) excluded from the Code §382 calculation.
• There are several rules regarding the aggregation and segregation of stockholders who otherwise do not qualify as “5-percent shareholders.”
• For purposes of Code §382, ownership of stock is generally attributed to the economic owner (referred to in this article as the “Tax Owner”, i.e., the party who would have rights to dividends and sales proceeds), without regard to ownership by nominees, trusts, corporations, partnerships, or other entities.
• In comparison, and as discussed below, for securities filing purposes, ownership of stock is generally attributed to the party who has voting or disposition power over the stock (referred to in this article as the “Securities Owner”). Examples of a Securities Owner include pooled investment vehicles, such as mutual funds and hedge funds, investment advisor accounts or similar vehicles.
  • When stock is attributed to a Securities Owner in a securities filing, that does not mean that the inquiry can stop for Code §382 purposes. Depending on the facts, the corporation may have to seek additional information from the Securities Owner with respect to the Tax Owner(s) of the stock treated, in the securities filing, as owned by the Securities Owner.
  • To the extent the corporation has actual knowledge of stock ownership on any testing date by any person who would qualify as a 5-percent shareholder, then the corporation must take such ownership into account, regardless of any securities filing that includes or omits information to the contrary.
• Certain constructive ownership rules, which generally attribute ownership of stock owned by estates, trusts, corporations, partnerships, or other entities to the ultimate indirect individual owner thereof, or to related individuals, are applied in determining the level of stock ownership of a particular stockholder.
• Special rules can result in the treatment of options, warrants, or other similar interests as having been exercised if such treatment would result in an ownership change.

For the purpose of determining whether there has been an ownership change, the change in ownership as a result of purchases by “5-percent shareholders” will be aggregated with certain changes in ownership that occurred over the three-year period ending on the date of such purchases.⁴ If the corporation were to experience an ownership change, it is possible that all or a portion of the corporation’s NOLs would expire before the corporation would be able to use them to offset future taxable income.

While it is always important for a public corporation to monitor changes in its stockholder base, such monitoring is uniquely important for a corporation that has NOLs so that it can continuously evaluate potential risks to its ability to utilize its NOLs in the future.

II. Stockholder Obligations to Report Ownership Changes

Under certain circumstances, stockholders of public corporations are required to report ownership of, and changes in, their publicly traded securities. Although stock ownership for securities filing purposes under the Exchange Act may not necessarily confirm stock ownership for purposes of determining an owner shift within the meaning of Code §382, monitoring such filings, by such means as discussed in Appendix A to this article, is helpful in determining whether a stockholder is accumulating additional shares of a corporation’s stock in a manner that might jeopardize the corporation’s ability to utilize its NOLs. Generally, these reporting obligations arise under (i) Section 13 of the Exchange Act, which is generally applicable to persons that own, or exercise investment discretion over accounts that own, publicly traded or exchange-listed equity securities, and (ii) Section 16(a) of the Exchange Act, which are applicable to persons considered to be “insiders” of public corporations.

Under Section 13 of the Exchange Act, beneficial ownership reports made to the Securities and Exchange Commission (“SEC”) are filed on Schedule 13D, Schedule 13G, Form 13F, and Form 13H. Form 13H filings with the SEC are confidential and exempt from public disclosure. As such, this article will only discuss Schedule 13Ds, Schedule 13Gs, and Form 13Fs as tools to monitor stockholder accumulation. Any stockholder that, directly or indirectly, beneficially owns, in the aggregate, more than 5% of a class of a public corporation’s equity securities, has a Schedule 13D or Schedule 13G reporting obligation with respect to such corporation. In addition, any securities firm that manages discretionary accounts that, in the aggregate, hold equity securities of a public corporation trading on a national securities exchange with an aggregate fair market value of $100 million or more will have a Form 13F reporting obligation. Section 16(a) of the Exchange Act requires that directors and officers of a public corporation, as well as persons who beneficially own more than 10% of any class of equity security of a public corporation, file reports with the SEC on Forms 3, 4, and 5.

A. Schedules 13D and 13G Reporting Requirements
Sections 13(d) and 13(g) of the Exchange Act require any person or group of persons who directly or indirectly acquire or have beneficial ownership of more than 5% of a class of a public corporation’s equity securities to report such beneficial ownership on Schedule 13D or Schedule 13G, as appropriate. Under Rule 13d-3, a person is deemed to have “beneficial ownership” of a security if that person has the power, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, (i) to vote or direct the voting of a security, or (ii) to dispose of or direct the disposition of a security.

While Schedule 13G is the more abbreviated version of the two schedules, both Schedule 13D and Schedule 13G require the following information: (i) background information about the reporting persons, including the name, address, and citizenship or place of organization of each reporting person, (ii) the amount of the securities beneficially owned and aggregate beneficial ownership percentage, (iii) whether the person has sole or shared voting and investment power with respect to the securities, and (iv) whether any other person is known to have the right to receive or the power to direct the receipt of dividends from, or the proceeds from the sale of, the securities and, if such interest relates to more than 5% of the class of securities, the identity of such person.

While there are other reasons why a Schedule 13G filing may be available in lieu of a Schedule 13D filing, in general, Schedule 13G filings are available only to passive investors. For these purposes, a stockholder is a “passive investor” if it beneficially owns more than 5% but less than 20% of a class of a corporation’s equity securities and the stockholder does not hold such securities with an activist intent.

Initial Schedule 13Ds must be filed within five business days after a stockholder’s direct or indirect acquisition of beneficial ownership of more than 5% of a corporation’s equity securities.⁵ Subject to certain exceptions which allow certain stockholders to defer their initial filing on Schedule 13G until 45 days after the end of the calendar year in which the person exceeds the 5% threshold, initial Schedule 13Gs also must be filed within 10 days after a stockholder’s direct or indirect acquisition of beneficial ownership of more than 5% of a class of a corporation’s equity securities.⁶

A Schedule 13G filer that no longer satisfies the conditions for Schedule 13G eligibility must switch to reporting on a Schedule 13D. This could occur if (i) a stockholder changes its investment intent from being one of a passive stockholder to an activist stockholder, or (ii) a passive stockholder acquires 20% or more of a class of a corporation’s equity securities. In either case, a Schedule 13D filing must be made within five business days after the event that caused the stockholder to no longer satisfy the necessary conditions.

A stockholder must file an amendment to its Schedule 13D when there has been any material change to the information in a Schedule 13D previously filed within two business days after the date of such change. A stockholder’s acquisition or disposition of 1% or more of a class of a corporation’s equity securities, including as a result of a corporation’s repurchase of its securities, constitutes a material change. Smaller percentage changes may be considered material depending on the circumstances.

Under recently revised Schedule 13G filing deadlines, amendments must be filed within 45 days after the end of each calendar quarter if there has been any material change to the information reported in such Schedule 13G. No annual amendment is required if there has been no change since the previously filed Schedule 13G or if the only change results from a change in the person’s ownership percentage as a result of a change in the aggregate number of the corporation's shares outstanding (e.g., due to a corporation’s share repurchases).

B. Form 13F Reporting Requirements
Under Rule 13f-1 of the Exchange Act, a Form 13F is required to be filed by institutional investment managers (referred to in this article as a “reporting manager”) that exercise investment discretion over one or more accounts holding equity securities that (i) are admitted for trading on a national securities exchange, and (ii) have an aggregate fair market value as of the last trading day of any month during a calendar year equal to at least $100 million. Reporting managers must report the amount and value of the securities held in their discretionary accounts in the aggregate and on an issuer-by-issuer basis (i.e., they must identify how many shares of stock of each applicable public corporation they hold). However, unlike Schedule 13D and Schedule 13G, Form 13F does not require disclosure of whether any other person is known to have the right to receive or the power to direct the receipt of dividends from, or the proceeds from the sale of, the securities. Form 13Fs must be filed (i) within 45 days after the last day of each calendar year in which a reporting manager meets the $100 million threshold, and (ii) within 45 days after the last day of each of the first three calendar quarters of the following calendar year.

C. Section 16 Reporting Requirements
Section 16 of the Exchange Act and related rules require certain filings to be made by insiders of public corporations (sometimes referred to as “Section 16 filers”). For purposes of Section 16, an “insider” is (i) a director of the public corporation, (ii) a designated officer of the public corporation, or (iii) a person who beneficially owns more than 10% of any class of equity securities of a public corporation.

Section 16 filers are required to report their direct and indirect beneficial ownership of a corporation’s equity securities and any transactions in such securities, and to disgorge any “short-swing profits.” A discussion of short-swing profits is beyond the scope of this article. Contrary to how “beneficial ownership” is evaluated for purposes of Schedules 13D and 13G (i.e., voting and dispositive power), for Section 16 reporting purposes (other than for the limited purpose of determining whether a person is a 10% holder), a person is deemed to have “beneficial ownership” over a security if the person has the opportunity to profit, directly or indirectly, from a purchase, sale, or other transaction in securities (sometimes referred to as a “pecuniary interest”). This interest can arise by virtue of any of the following: (i) equity securities held by family members in the same household as the insider, (ii) a security-based swap involving the equity securities, (iii) the right to acquire equity securities through the exercise or conversion of any other derivative security (whether or not exercisable within 60 days), and (iv) a general partner’s proportionate interest in the equity securities held by a partnership.

The reports that an insider will file with the SEC under Section 16 are:

Form 3 – Initial Statement of Beneficial Ownership of Securities. Form 3 must be filed within 10 days after any individual or entity first becomes an insider. Form 3 includes the details of any equity securities of the public corporation that the insider beneficially owns at the time of becoming an insider. Changes to an insider’s position are disclosed on Form 4 or Form 5.

Form 4 – Statement of Changes of Beneficial Ownership of Securities. A Section 16 filer must report on Form 4 any change that occurs with respect to the owner's beneficial ownership interest in a public corporation’s equity securities. These changes can be as a result of (i) any open market or private purchase or sale, or bona fide gift of any equity or convertible securities; (ii) a stock option grant; (iii) the conversion of a derivative security; (iv) the acquisition or vesting of any restricted stock or restricted stock units; (v) a merger, exchange offer, or a tender offer; or (vi) any purchase, sale or exercise of any option, warrant, or right. Form 4s must be filed no later than the second business day following the day on which the reportable transaction took place.

Form 5 – Annual Statement of Beneficial Ownership of Securities. A Section 16 filer must file a Form 5 to report any equity securities and transactions that were not previously reported on a Form 3, 4 or 5. These include securities and transactions that should have been reported during the year but were not, and certain transactions that were not required to be reported on Form 4, which are now extremely limited.

III. Conclusion

Corporations that have NOLs need to be particularly cautious to monitor shifts in their stockholder base to ensure the preservation of these valuable tax assets. If it becomes apparent that a stockholder (or group of stockholders) is undertaking an accumulation strategy and is approaching an applicable threshold that may result in, or may have resulted in, (i) such stockholder being treated as a 5-percent shareholder, (ii) an ownership change for Code §382 purposes, or (iii) any other change in such person’s ownership percentage that may impact the corporation’s ability to utilize its NOLs, then there are several potential steps a corporation may consider taking. Those steps will depend, in large part, on whether the corporation believes a stockholder or group of stockholders is accumulating shares with activist or passive intent, and various anti-takeover measures a corporation may have in place under its governing documents. Whatever the case may be, when a corporation’s NOLs may be at risk, it is important to engage counsel and assess appropriate responses and measures that a corporation could take to attempt to preserve these valuable tax assets.

Footnotes

1. In this article, references to "NOLs" include (i) net operating losses generated in the current year, and (ii) net operating losses generated in a prior year that are carried forward to the current year (often referred to as “NOL carryforwards”). Although beyond the scope of this article, there may be differences between NOLs and NOL carryforwards.

2. In this article, references to the “Code” or a “Code §” are to the Internal Revenue Code of 1986, as amended; and references to the “Treasury Regulations” or a “Treas. Reg. §” are to the Treasury Regulations promulgated thereunder.

3. In this article, references to the “Exchange Act” are to the Securities Exchange Act of 1934, as amended.

4. The increase must be more than 50 percentage points, not more than 50%. This is an important distinction and is illustrated in the following examples:

Ex. #1. A and B each own 40% of the outstanding stock of “Corporation.” The remaining 20% of Corporation is held by unrelated individuals, none of whom is a 5-percent shareholder. C, who owns no stock in Corporation, purchases all of A’s and B’s stock. This results in an ownership change because C’s interest has increased from 0% to 80% during the testing period.

Ex. #2. Corporation has 200 shares of outstanding common stock, owned by A, B, and C as follows: A (100 shares), B (50 shares), and C (50 shares). In Year 1, A sells 60 shares to B, resulting in ownership as follows: A (40 shares), B (110 shares), and C (50 shares). In Year 2, A purchases all of C’s shares, resulting in ownership as follows: A (90 shares), B (110 shares), C (0 shares). In this case, A’s percentage ownership increases from 40 shares (its lowest during the testing phase) to 90 shares. Even though A suffers a net decrease (i.e., from owning 100 shares constituting 50% of the shares, to owning 90 shares constituting 45% of the shares) A must still be considered a 5-percent shareholder for these purposes because A’s ownership percentage increased from 20% (when it owned only 40 shares) to 45% (when it owned 90 shares at the end of the testing date).

Importantly, although A and B have jointly increased their aggregate ownership in Corporation by only 25 percentage points (i.e., from 75% (comprised of 40 and 110 shares, respectively) to 100% (comprised of 90 and 110 shares, respectively) the total of their separate increases, compared to their respective lowest ownership percentages at any time during the testing period is 55 percentage points – i.e., 25% for A (from 40 shares comprising a 20% ownership percentage, to 90 shares comprising a 45% ownership percentage; calculated as 45% - 20% = 25%), plus 30% for B (from 50 shares comprising a 25% ownership percentage, to 110 shares, comprising a 55% ownership percentage; calculated as 55% - 25% = 30%).

As such, in this Ex. #2, an ownership change has occurred during the testing period.

Interestingly, if A did not acquire C’s shares, or otherwise increase A’s percentage ownership, then A’s interest would have been disregarded for purposes of determining an ownership change. Instead, A’s ownership interest is considered because all increases in the percentage ownership of a 5% shareholder during the testing period are taken into account.

5. On October 10, 2023, the SEC adopted amendments to rules governing beneficial ownership reporting requirements under Sections 13(d) and 13(g) of the Exchange Act. Among other things, the amendments shorten the initial Schedule 13D filing and amendment deadlines. The revised Schedule 13D filing deadlines became effective on February 5, 2024, and compliance with the revised Schedule 13G filing deadlines is required beginning on September 30, 2024.

6. See previous footnote.

Appendix A - Monitoring Material Changes in Stockholder Holdings

It is important for a corporation to generally monitor changes in its stockholder base on a routine basis. While there are outside vendors that provide this service, a corporation can also assign an internal employee with responsibility for such monitoring using the instructions below.

It will be fairly easy for the corporation to monitor holdings of stockholders who exceed the 5% threshold as Schedule 13D, Schedule 13G and Section 16 filings all appear on the SEC’s website for filings under the applicable corporation’s name:

• Start at https://www.sec.gov
• Under the “FILINGS” tab at the top of the page, click on “Company Filing Search”
• In the lookup box, type “[corporation name]” and then click “Search”
• Under the heading the reads “Latest Filings” click the box that says “View filings”
• At this point, a listing of all the corporation's SEC filings will appear other than Section 16 Reports. To see the Section 16 Reports, click the box that reads “Exclude insider transactions” (appearing above the listing of filings) and click “All”

Searching for Form 13F filings that contain references to holdings by institutional investors who do not exceed the 5% thresholder is a little less intuitive:

• Start at https://www.sec.gov
• Under the “FILINGS” tab at the top of the page, click on “EDGAR – Search & Access”
• Click on “EDGAR full text search”
• Under the search box, click “+ more search options”
• In the search field for Document word or phrase, type “[corporation name]”, and then click “Browse filing types” and select the options for 13F-HR, 13F-NT and 13FCONP (and click “Filter” in the bottom right corner). You can limit the date range of the search if you desire using the “Filed from” and “Filed to” options. Click “search”.

Responses by filers to Item 5(d) of Schedule 13D and to Item 6 of Schedule 13G, as applicable, should be further reviewed to determine whether any of the securities being reported are held by Tax Owners who are not the filers (i.e., not the Securities Owners). Where the response to such items is “not applicable,” left blank, or is otherwise unclear, and with respect to filers of Form 13F, a corporation can make further inquiry of the filer (by telephone and email) as to whether the filer holds securities on behalf of other Tax Owners, and whether any of such Tax Owners own as much as 5% of a class of the corporation’s equity securities. In other words, the information contained in the filings required under the Exchange Act may not be, in and of itself, sufficient to determine if there has been an ownership change for purposes of Code §382.