On December 14, 2022, the U.S. Securities and Exchange Commission adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) and new disclosure requirements designed to enhance investor protections against insider trading (Amendments). The Amendments impose new conditions upon insiders seeking to avail themselves of the affirmative defense afforded by Rule 10b5-1. The new disclosures included in the Amendments require that companies provide information about (i) insider trading activities, including those outside of the scope of Rule 10b5-1, (ii) certain equity awards granted proximate in time to the company’s SEC filings, and (iii) the company’s insider trading policies and procedures. The Amendments also change, and accelerate, reporting under Section 16 of the Exchange Act of gifts of securities and make other revisions to Section 16 reports (Forms 4 and 5).
This alert summarizes the key provisions of the Amendments and provides suggested actions in response.
Rule 10b5-1 provides an affirmative defense to company insiders, such as executives and directors, when purchasing and selling the company’s securities while in possession of material nonpublic information (e.g., during a trading blackout period), provided the transactions are made under trading plans that meet certain conditions. These conditions currently include a requirement that any such transactions be made pursuant to a contract, instruction or plan (a Plan) that specifies, in absolute terms or by a definitive formula, the amount and price at which the subject securities are to be bought or sold and the date or time frame for execution of the transaction(s). Once established, the insider may not exercise any control over the completion of any transactions under the Plan. Such plans must be established in good faith and when the insider is not aware of material, nonpublic information about the company.
In response to concerns that the existing provisions of Rule 10b5-1 could be manipulated by insiders to engage in transactions in violation of Rule 10b-5 and other anti-fraud provisions of the securities laws, yet still benefit from the affirmative defense of the rule, the SEC issued a rule proposal in December 2021 that we summarized in our prior alert. The Amendments as finally adopted include significant changes from the rule proposal.
Amendments to Rule 10b5-1
Cooling-off Period. The Amendments provide that Plans must include a mandatory cooling-off period between the date that the Plan is adopted and the commencement of trading under the Plan. For officers (as defined under Exchange Act Rule 16(a)(1)(f)) and directors this minimum cooling-off period runs from the date of adoption of the Plan to the later of:
- 90 days following adoption; or
- Two business days following the disclosure of the company’s financial results in a Form 10-Q or Form 10-K (or Form 20-F or 6-K for foreign private issuers) for the fiscal quarter in which the Plan was adopted (but not to exceed 120 days following Plan adoption).
Plans adopted by persons other than officers and directors must include a 30-day minimum cooling-off period. In an important distinction from the rule proposal, Plans established by companies for transactions in their own securities are not subject to cooling-off periods.
Many commenters expressed concern that under the proposed amendments minor changes to a Plan could be regarded as termination of the Plan and adoption of a new one, triggering a new cooling-off period. In response, the Amendments add a new section to Rule 10b5-1 clarifying when a modification to a Plan would be deemed a termination and adoption of a new Plan. Under the Amendments, the following will be deemed a termination of such Plan and adoption of a new Plan:
- Any modification or change to the amount, price or timing of the purchase or sale of the securities underlying a Plan, or
- The removal or substitution of a broker executing trades under the Plan that changes the price or date of execution.
While companies commonly include in their insider trading policies cooling-off periods for newly adopted and revised plans, these cooling-off periods are typically shorter than the cooling-off period that will apply to officers and directors under the Amendments.
Officer and Director Representation. Under the Amendments, Plans adopted by officers and directors must include representations that the adopting person is:
- Not aware of material nonpublic information about their company or its securities, and
- Adopting the Plan in good faith and not “as part of a plan or scheme to evade the prohibitions” of Rule 10b5-1.
The requirement to specifically make these representations is in addition to the existing provisions of Rule 10b5-1 that the adopting person simply not be aware of material nonpublic information at that time of adoption of the Plan and that the Plan be entered into in good faith and not as part of a plan or scheme to evade the prohibitions of the rule. The SEC notes in the Adopting Release its belief that the new representations will not create an independent basis for liability against the officer or director adopting the Plan.
Acting in Good Faith. As noted above, Rule 10b5-1 currently requires that Plans be “entered into” in good faith. The Amendments expand the good-faith requirement to also include a provision that the insider has “acted in good faith with respect to” the Plan. Many commenters expressed concern that meaningful uncertainty about the availability of the rule’s affirmative defense may be created by expanding the “good faith” requirement from the insider’s state of mind at the time of adoption of the Plan to his or her state of mind throughout the term of the Plan. They noted that the requirement that the Plan be “operated in good faith” (the language in the proposed amendment) is ambiguous. We do not believe that the SEC’s change to a requirement that the insider “has acted in good faith with respect to” the Plan resolves the ambiguity. For instance, under what specific circumstances might the SEC or a private plaintiff allege that an insider who controls or influences the timing of public announcements by the company has not acted in good faith with respect to his or her Plan depending on the timing of an announcement relative to the timing of a Plan trade? Or is there an absence of “good faith” if an insider terminates a Plan while in possession of material non-public information? And if such challenge is made, might it mean that the affirmative defense otherwise available under the Plan has been lost for all previous transactions under the Plan? The good-faith requirement, as currently in place and as expanded per the Amendments, is not limited to officers and directors and applies to anyone adopting a Plan, including a company adopting a Plan to trade in its own securities.
Prohibition of Overlapping Plans. The Amendments require that an insider (other than the company) adopting a Plan has no other Plan in place (and does not subsequently enter into any additional Plan during the term of the Plan) that would qualify for the affirmative defense of Rule 10b5-1 for open market transactions in the company’s securities. This provision was added in response to observations that some insiders adopt multiple overlapping 10b5-1 plans for open market trades and then cancel plans that would yield less profitable trades. The Amendments provide several carve-outs from this prohibition of overlapping plans:
- A series of separate contracts with different broker-dealers or other agents acting on behalf of the person to execute trades thereunder may be treated as a single Plan, provided that the individual constituent contracts with each broker-dealer or other agent, when taken together as a whole, meet all the applicable conditions of, and remain collectively subject to, Rule 10b5-1, including that a modification of any individual contract acts as modification of the whole Plan;
- A person may have a later commencing Plan under which trading is not authorized to begin until after all trades under an earlier commencing Plan are completed or expired without execution, provided, however, that the cooling-off period for the later commencing Plan must start on the date of termination of the earlier commencing Plan (rather than on an earlier date on which the later commencing Plan is adopted); and
- So-called “eligible sell to cover transactions” providing for sales of the underlying securities to fund tax payments due on the vesting of equity awards will not be considered a separate overlapping Plan if such arrangements satisfy the conditions specified in the Amendments. However, such permitted transactions do not include sales of underlying securities to fund the exercise price of stock options or other sales that may be coincident with vesting.
Limit Single Trade Plans. Under the Amendments, a person (other than the company) may only adopt one Plan designed to cover a single trade and be eligible for Rule 10b5-1’s affirmative defense during any 12-month period.
Other Rule and Form Amendments
Amendments to Forms 4 and 5. Forms 4 and 5 are amended to include a mandatory checkbox for reportable transactions that were made pursuant to a 10b5-1 Plan.
Disclosure of 10b5-1 Plans and Other Trading Arrangements. The Amendments add Regulation S-K Item 408, which will require companies to disclose quarterly on Form 10-Q (or Form 10-K for the fourth quarter) whether any officer or director has adopted or terminated a Plan intended to qualify under Rule 10b5-1 or any “non-Rule 10b5-1 trading arrangements.” The disclosure must be made using Inline eXtensible Business Reporting Language (Inline XBRL). A “non-Rule 10b5-1 trading arrangement” is one in which the adopting person asserts that they were not aware of any material nonpublic information about the company at the time of the adoption of the arrangement and specifies in absolute terms or by a definitive formula the amount and price at which the subject securities are to be bought or sold and the date or time frame for execution of the transaction(s). Item 408(a) also requires disclosure of the material terms (other than pricing terms) of each Plan intending to qualify under Rule 10b5-1 and non-Rule 10b5-1 trading arrangement, such as:
- The name and title of the director or officer involved,
- The date of adoption or termination,
- The duration, and
- The aggregate amount of the company’s securities to be sold or purchased.
The company must also specify whether the trading arrangement is intended to qualify for the affirmative defense of Rule 10b5-1. Absent additional guidance from the staff, it is unclear whether a simple execution order will be deemed a non-Rule 10b5-1 trading arrangement, or which other non-pricing terms will be deemed material.
Insider Trading Policies and Procedures Disclosure. Subsection (b) of Regulation S-K Item 408 will require companies to disclose in their annual reports on Form 10-K and in their proxy statements whether (and if not, why not) they have adopted insider trading policies and procedures that govern the purchase, sale or other disposition of their securities by directors, officers, employees or the company itself that are reasonably designed to promote compliance with insider trading laws, rules and regulations and any applicable listing standards, provided that the Form 10-K requirement can be satisfied by valid forward incorporation of the proxy statement disclosure. The Amendments also provide for analogous disclosure for foreign private issuers through the adoption of a new Item 6J in Form 20-F.
These disclosures and the disclosures under new Item 408(a) are subject to the principal executive and principal financial officer certifications required by Section 302 of the Sarbanes-Oxley Act and must be tagged using Inline XBRL.
If a company discloses that it has adopted insider trading policies and procedures under Item 408(b), it must file them as exhibits to Form 10-K and Form 20-F. While policies are generally well-defined in a specific document, absent additional guidance from the staff, it is unclear what level of granularity will be required when disclosing insider trading procedures.
Equity Compensation Award Disclosure. A new subsection of Regulation S-K, Item 402(x), requires companies to provide narrative disclosures regarding their stock option grant policies, including how the board or compensation committee considers material nonpublic information when deciding the timing and terms of stock option awards and whether the company has timed the disclosure of material nonpublic information for the purpose of affecting executive compensation. For the purpose of this disclosure, options include SARs and similar instruments with option-like features.
In addition, new disclosure will be required if during the last fiscal year a company made grants of stock options to a named executive officer (NEO) within a period that begins four business days before and ends one business day after one of the following filings:
- The filing of a periodic report, or
- The filing or furnishing of a Form 8-K disclosing material nonpublic information (including earnings information and excluding option award grants under Item 5.02(e)).
If triggered, the company must disclose in tabular format:
- The name of the NEO,
- The grant date of the award,
- The number of securities underlying the award,
- The per-share exercise price,
- The grant date fair value of each award, and
- The percentage change in the market price of the underlying securities between the closing market price of the security one trading day prior to and one trading day following the disclosure of material nonpublic information.
The disclosure under 402(x) will also be subject to Inline XBRL tagging.
Gift Disclosures. Insiders required to report trades under Section 16 of the Exchange Act will be required to disclose the disposition of bona fide gifts of securities on Form 4 within two business days after such a gift is made. Currently such gifts may be reported on a Form 5, which is due 45 days after the end of the company’s fiscal year. In the adopting release, the SEC has acknowledged that the affirmative defense under Rule 10b5-1 is available for planned gifts of securities. The checkbox in Forms 4 and 5 discussed above will be applicable to reporting such gifts.
Companies should assess the appropriateness or desirability of requiring their directors or officers to establish Plans for transactions in their securities in light of the increased burdens presented by the Amendments. Companies with insiders that have Plans or that have established their own Plans should consider taking the following steps to meet the obligations under the Amendments:
- Establish appropriate policies and procedures to ensure that the company reviews such Plans and any other trading arrangements of Section 16 officers and directors;
- Revise the company’s insider trading policies to comply with the new requirements for Plans such as the cooling-off period and gift reporting requirements;
- Document the company’s procedures for handling insider trading activities under the insider trading policy;
- Consider adopting an equity grant policy that provides for equity grants to be made on pre-established dates, or timing grants to be made outside of the period preceding filings that trigger specific disclosure.
We believe that companies and their executives and advisors will have questions about uncertainties inherent in the Amendments and about how other companies and insiders and the SEC’s staff are responding to these uncertainties. We will closely monitor developments regarding these questions and developing practices.
The Amendments become effective 60 days following their publication in the Federal Register.
The amendments to Forms 4 and 5 apply to reports filed on or after April 1, 2023.
The disclosure and tagging obligations under Regulation S-K Items 408 and 402(x) and Item 16J apply for the first filing covering the first full fiscal period that begins on or after April 1, 2023. Smaller reporting companies would have an additional six months to comply (i.e., disclosure and tagging obligations would begin for filings covering the first full fiscal period after October 1, 2023).
The amendments to Rule 10b5-1 would not affect the affirmative defense available to Plans adopted under the current Rule 10b5-1 prior to the effective date of the Amendments. However, the Amendments will apply to the extent any such plan is modified or changed with respect to the amount, price or timing of the purchase or sale of the securities after the effective date.