Section 16 Reporting for Derivative Securities: 2026 Practitioner Walkthrough

If you are a corporate secretary, general counsel, or CFO responsible for Section 16 compliance, derivative securities are where the filing errors happen. Stock options, RSUs, warrants, convertible notes, SARs, and similar instruments all require reporting under 17 CFR § 240.16a-4, and the rules are layered in ways that catch even experienced practitioners. This walkthrough covers exactly what counts as a derivative security, how to report each transaction type on Form 4, where short-swing profit liability hides, and what the 2022 Rule 10b5-1 amendments changed for planned exercises.

Key takeaway: Derivative securities must be reported separately from the underlying equity they relate to, but they are treated as the same class of equity for determining insider status. Get both right, or the filing is wrong.

What Counts as a Derivative Security Under Section 16?

Rule 16a-1(c) defines a derivative security broadly: any option, warrant, convertible security, stock appreciation right, or similar right with an exercise or conversion privilege at a price related to an equity security, or any instrument with a value derived from the value of an equity security.

In practice, the following instruments all qualify:

• Stock options (both incentive stock options and non-qualified options)
• Restricted stock units (RSUs) and performance share units (PSUs)
• Stock appreciation rights (SARs) and phantom stock
• Warrants and rights
• Convertible notes and convertible preferred stock
• Forward contracts and prepaid variable forwards referencing company stock
• Collar arrangements where the value is tied to the underlying equity price

The rule does not cover instruments where the exercise or conversion price is entirely unrelated to the market price of the underlying equity, or certain foreign currency transactions. A fixed-price convertible bond where the conversion premium is set at issuance and never adjusts based on market price sits in a gray zone that warrants a facts-and-circumstances analysis before concluding it falls outside the definition.

RSUs and PSUs deserve special attention. Many compliance teams treat them as direct equity grants. They are not. RSUs and PSUs represent a right to receive shares in the future, contingent on vesting or performance conditions, and the SEC treats them as derivative securities for Section 16 purposes. The grant must be reported on Form 4 (Table II) within two business days. The vesting and settlement then require a separate dual-entry filing, discussed below.

The 10% threshold calculation includes derivatives. Under Rule 16a-1, shares issuable upon exercise or conversion of derivative securities are counted toward the 10% beneficial ownership threshold that triggers Section 16 reporting for non-director, non-officer shareholders. A large option holder who has never exercised may already be a Section 16 reporting person.

Call Equivalent vs. Put Equivalent: Why the Distinction Matters

The direction of the derivative position determines how you report it and how short-swing profit liability attaches.

Rule 16a-1 distinguishes between:

• Call equivalent positions: rights that increase in value as the underlying equity increases (long calls, long stock options, warrants, RSUs, convertible debt held long). Exercise or conversion is treated as a purchase of the underlying.
• Put equivalent positions: rights that increase in value as the underlying equity decreases (long puts, short forward contracts). Exercise or conversion is treated as a sale of the underlying.

This distinction matters for two reasons. First, it determines which table and which transaction codes you use on Form 4. Second, it determines how Rule 16b-6 matches the derivative transaction against other transactions in the underlying stock for short-swing profit purposes. A call equivalent acquisition matched against a sale of the underlying stock within six months can generate disgorgement liability even if the option was never exercised.

Form 4 Mechanics for Derivative Securities: Table I vs. Table II

Form 4 uses two separate tables, and derivative transactions require entries in both when an exercise or conversion occurs. This is the single most common filing error the SEC flags.

The governing rule is 17 CFR § 240.16a-4(a): "both derivative securities and the underlying securities to which they relate shall be deemed to be the same class of equity securities, except that the acquisition or disposition of any derivative security shall be separately reported."

Separate reporting means separate table entries. Every time a derivative position is opened or closed, Table II gets an entry. Every time the underlying shares are acquired or disposed of as a result, Table I gets an entry.

Transaction Codes for Derivative Securities

Using the wrong transaction code is a reportable error that requires an amended Form 4. The key codes for derivative transactions are:

For a compensatory option grant, use code 'A' in Table II. For the exercise, use code 'M' in Table II (closing the derivative) and code 'M' in Table I (opening the underlying equity position). Do not use 'X' and 'M' interchangeably without confirming which applies to the specific transaction structure.

The Dual-Entry Requirement: Step-by-Step for Common Transactions

This is where most Form 4 filings go wrong. The rule requires two separate entries whenever a derivative position is exercised or converted. Here is the correct treatment for the three most common scenarios.

Standard Option Exercise

An insider exercises 10,000 stock options at a $20 strike price. The company delivers 10,000 shares.

1. Table II, code 'M': Report the closing of the derivative position. Enter the number of derivative securities exercised (10,000 options), the exercise price ($20), and the expiration date.
2. Table I, code 'M': Report the acquisition of 10,000 underlying shares at $20 per share.

Two entries. Both required. Filing only the Table I entry (the share acquisition) leaves the derivative position open on the record, which is incorrect.

Cashless Option Exercise

A cashless exercise, where the broker sells enough shares to cover the exercise price and the insider receives only the net shares, requires three entries, per SEC Division of Corporation Finance guidance:

1. Table II, code 'M': Close the full derivative position (all options exercised).
2. Table I, code 'M': Report the acquisition of all shares issuable upon exercise (the gross share count, not the net).
3. Table I, code 'S': Report the sale of the shares used to pay the exercise price.

Many filers report only the net share acquisition. That omits both the derivative closing entry and the sale of shares used to fund the exercise. Both are reportable.

RSU Vesting and Settlement

An insider's 5,000 RSUs vest. The company delivers shares and withholds 1,500 shares to cover income tax.

1. Table II, code 'M': Close the RSU derivative position (5,000 units).
2. Table I, code 'M': Report the acquisition of 5,000 underlying shares.
3. Table I, code 'F': Report the withholding of 1,500 shares for tax purposes as a separate disposition to the issuer.

The 'F'-coded tax withholding entry surprises many filers. It is a separate reportable transaction, not a footnote to the share acquisition. The SEC's C&DI guidance on this point is explicit.

The Two-Business-Day Filing Deadline for Derivative Transactions

The clock starts on the transaction date, not the settlement date, not the date the company processes the exercise, and not the date the insider receives notice.

The SEC accelerated the Form 4 deadline to two business days in 2003 (previously 10 days). For derivative transactions:

• For an option exercise: the transaction date is the date the insider elects to exercise, not the date shares are delivered.
• For an RSU vesting: the transaction date is the vesting date specified in the award agreement.
• For a derivative grant (option grant, RSU grant): the transaction date is the grant date.
• For a tax withholding at RSU vesting: the transaction date is the same as the vesting date, so all three entries for an RSU vest typically share the same transaction date and must all appear on a Form 4 filed within two business days of that date.

A Form 4 filed on the third business day after the transaction is late. There is no grace period. One day late means the delinquency must be disclosed in the company's annual proxy statement under Item 405 of Regulation S-K. The proxy disclosure names the individual, the number of late reports, and the number of transactions not timely reported. For executives at public companies, that is a reputational consequence that cannot be undone.

Key takeaway: Build the filing workflow around the transaction date, not the settlement date. For RSU vesting events, the two-business-day clock and the three-entry requirement both apply simultaneously.

When Cancelled or Expired Derivative Positions Do Not Need to Be Reported

Not every derivative event triggers a filing. Rule 16a-4(d) provides an important exemption: the cancellation or expiration of a long derivative security position is exempt from Section 16(a) reporting if it is also exempt from Section 16(b) under Rule 16b-6(d).

Rule 16b-6(d) exempts from short-swing profit liability the expiration or cancellation of a long derivative position that either:

• Was acquired in a transaction exempt under Rule 16b-3 (compensatory plans approved by the board or a committee of non-employee directors), or
• Expires worthless.

In practice, this means that when a compensatory stock option expires unexercised at the end of its term, or when unvested options are forfeited upon termination of employment, no Form 4 is required. This exemption is not mentioned in most Section 16 compliance resources, and compliance teams sometimes file unnecessarily for these events. Confirm the Rule 16b-3 approval structure is in place before relying on the exemption.

Short-Swing Profit Liability and Derivative Securities: Rule 16b-6

For a detailed calculation walkthrough, see Finrep's short-swing profit rule calculation guide. The derivative-specific mechanics under Rule 16b-6 are worth understanding separately.

The core rule: derivative transactions are deemed purchases or sales of the underlying equity for short-swing profit matching purposes.

• Under Rule 16b-6(a), acquiring a derivative security (e.g., purchasing a call option) is treated as a purchase of the underlying at the exercise price.
• Under Rule 16b-6(b), disposing of a derivative security (e.g., selling a call option) is treated as a sale of the underlying.

This creates a trap that catches insiders who never exercise: an insider who acquires a call option and then sells the underlying stock in the open market within six months may face disgorgement liability, even if the option sits unexercised. The acquisition of the derivative is matched against the sale of the underlying. Section 16(b) disgorgement is strict liability, as Paul Hastings confirms: intent is irrelevant, and any profit from a purchase and sale (or sale and purchase) within six months is recoverable by the issuer or any shareholder suing derivatively.

The Rule 16b-3 exemption. Most compensatory derivative transactions qualify for the Rule 16b-3 exemption from short-swing profit liability, provided the grant or exercise is approved by the board, a committee of non-employee directors, or shareholders. Without this exemption, every option grant followed by a sale of the underlying shares within six months would trigger disgorgement. Confirm the approval structure is documented before relying on Rule 16b-3.

Indirect Beneficial Ownership of Derivative Securities

Section 16 reporting covers derivative securities held indirectly, not just those held in the insider's own name. Per Paul Hastings' Section 16 guide and SEC C&DI guidance, indirect ownership includes:

• Derivative securities held through a trust where the insider is the trustee with investment discretion or the sole beneficiary
• Derivative securities held through a partnership where the insider is the general partner
• Derivative securities held through a corporation in which the insider has a controlling interest
• Derivative securities held by an immediate family member sharing the insider's household

Each indirect holding must be reported on Form 4 with the nature of indirect beneficial ownership disclosed in the filing. The SEC's C&DI guidance addresses how to report derivative securities held through entities, including the correct disclosure of the relationship.

Under Rule 16a-3(g), an issuer may file Section 16 reports on behalf of insiders if designated as filing agent. Many companies do this for compensatory equity events. The insider remains legally responsible for accuracy and timeliness. Delegation to the company does not transfer liability for a late or incorrect filing.

The 10b5-1 Interaction: What Changed in 2023 and What It Means for Derivative Exercises

The SEC's 2022 amendments to Rule 10b5-1, effective February 27, 2023, added conditions that directly affect how insiders structure planned option exercises and RSU sales.

Key changes for derivative reporting purposes:

• Cooling-off period: Directors and officers must wait the later of 90 days after plan adoption or the next quarterly earnings release date (up to a maximum of 120 days) before trading under a new 10b5-1 plan. This applies to plans covering derivative security exercises.
• Certification requirement: At plan adoption, insiders must certify that they are not aware of material non-public information and that the plan is being adopted in good faith.
• Form 4 checkbox: As of April 1, 2023, Form 4 includes a checkbox to indicate whether a reported transaction occurred under a Rule 10b5-1 plan adopted under the amended rule. If checked, a footnote must disclose the plan adoption date.
• Quarterly disclosure: Companies must now disclose in their 10-Q and 10-K filings whether any director or officer adopted, modified, or terminated a Rule 10b5-1 plan during the quarter, including plans covering derivative exercises.

For compliance teams, this means the Section 16 filing workflow and the 10b5-1 plan administration workflow must be coordinated. A plan adopted to cover a scheduled option exercise triggers both the cooling-off period analysis and the quarterly disclosure obligation. For a full treatment of the cooling-off period mechanics, see Finrep's 10b5-1 plan cooling-off period walkthrough.

SEC Enforcement Posture on Section 16 Derivative Reporting

The SEC's EDGAR system flags late Form 4 filings automatically. The Office of Market Intelligence uses those flags to prioritize enforcement referrals. Civil penalties for Exchange Act violations, including Section 16 reporting failures, can reach $100,000 per violation for individuals under the Sarbanes-Oxley Act penalty tiers, per SEC enforcement releases.

Enforcement actions have targeted insiders who:

• Failed to report option grants at all
• Reported option exercises without the corresponding Table I share acquisition entry
• Failed to report derivative securities held through controlled entities
• Filed Form 4s days or weeks after the two-business-day deadline

The proxy statement delinquency disclosure under Item 405 of Regulation S-K is the most common consequence for a single missed deadline. The company must disclose the name of the delinquent filer, the number of late reports, and the number of transactions not timely reported. Institutional shareholders and proxy advisory firms treat repeated delinquencies as a governance concern.

For a detailed look at the current enforcement environment, see Finrep's Section 16 late filing penalties and enforcement guide.

Common Mistakes and How to Avoid Them

FAQ

Do I need to report both the derivative transaction and the underlying share transaction when I exercise options? Yes. Under Rule 16a-4(b), exercising a call equivalent position (such as a stock option) requires two separate Form 4 entries: one in Table II closing the derivative position, and one in Table I recording the acquisition of the underlying shares. Filing only one entry is a reportable error.

Are RSUs derivative securities for Section 16 purposes? Yes. RSUs and PSUs are treated as derivative securities because they represent a contingent right to receive shares in the future. The grant is reported in Table II. At vesting, the conversion into shares requires entries in both Table II (closing the RSU position) and Table I (opening the equity position), plus a separate 'F'-coded entry if shares are withheld for taxes.

What happens if a compensatory option expires worthless? No Form 4 is required. Under Rule 16a-4(d), the cancellation or expiration of a long derivative position is exempt from Section 16(a) reporting if it is also exempt from Section 16(b) under Rule 16b-6(d), which covers options acquired under a board-approved compensatory plan that expire worthless.

Can a derivative acquisition trigger short-swing profit liability without an exercise? Yes. Under Rule 16b-6(a), acquiring a derivative security is treated as a purchase of the underlying at the exercise price. If the insider sells the underlying stock in the open market within six months of acquiring the derivative, the two transactions can be matched for disgorgement purposes even if the derivative was never exercised.

Who is responsible for a late Form 4 if the company files on the insider's behalf? The insider. Under Rule 16a-3(g), an issuer may act as filing agent, but the insider remains legally responsible for the accuracy and timeliness of every filing. Delegation does not transfer liability.

How does the 2023 Rule 10b5-1 cooling-off period affect planned option exercises? Directors and officers must wait the later of 90 days after adopting a new 10b5-1 plan or the next quarterly earnings release (up to 120 days) before executing any trades under the plan, including derivative exercises. Plans covering option exercises adopted after February 27, 2023 must also include an insider certification of good faith at adoption. See Finrep's 10b5-1 plan cooling-off period walkthrough for the full mechanics.