On December 15, 2021, the U.S. Securities and Exchange Commission issued a proposal (the Rule 10b5-1 proposal) that would amend Rule 10b5-1 of the Securities Exchange Act of 1934 (Exchange Act), and require, among other things, more disclosure regarding securities transactions involving insiders and related policies and procedures. Rule 10b5-1 provides an affirmative defense to claims of insider trading for securities traded pursuant to a pre-set trading plan (a 10b5-1 plan). The proposed amendments to Rule 10b5-1 are intended to address perceived abuses of Rule 10b5-1 by adding additional—or by modifying existing—requirements related to the proper adoption of 10b5-1 plans.
Concurrently, the SEC also proposed amendments to its rules regarding disclosure of securities repurchase programs or share buybacks by companies and their affiliates (the share repurchase proposal). This alert summarizes the key provisions for each of these proposals and provides some suggested actions in response.
Rule 10b5-1 Proposal
10b5-1 plans allow company insiders, such as executives and directors, to purchase and sell a company’s securities when they may be in possession of material nonpublic information (e.g., during a blackout period), provided that they establish trading plans that meet certain conditions specified under Exchange Act Rule 10b5-1(c).
Under the existing rule, such plans must be established in good faith and when the insider is not aware of material, nonpublic information. In recent years, lawmakers, academics and other commentators have expressed concerns that the current provisions of Rule 10b5-1(c) could be manipulated by insiders to engage in transactions in violation of Rule 10b-5 and other anti-fraud provisions of the securities laws, even when 10b5-1 plans are in place.
In its adopting release, the SEC cites abusive practices such as the use of multiple overlapping plans to selectively cancel individual trades based on material nonpublic information, commencing trades shortly after a new plan’s adoption and modifications of existing 10b5-1 plans. The SEC also identifies other transactions that may violate Rule 10b5-1 such as the granting of stock options and the gifting of securities in coordination with the release of material nonpublic information. The Rule 10b5-1 proposal is intended to reduce these and other potentially abusive practices.
Proposed Amendments to Rule 10b5-1
Cooling-off Period. Rule 10b5-1 does not currently provide for a “cooling-off period” whereby, following adoption of a plan, trades cannot occur for a specified period of time. Although advisors and other market participants have historically recommended or, in many cases, required such a seasoning period, the length and nature of “cooling-off periods” is not standardized across the industry and has generally been shorter than 120 days.
The proposed amendments provide that 10b5-1 plans entered into by officers subject to reporting under Section 16 of the Exchange Act (Section 16 officers) and directors would be required to include at least a 120-day mandatory cooling-off period before any trading can commence under the plan after its adoption or any amendments or modifications to the plan. 10b5-1 plans adopted by companies for trades in their own securities (such as in connection with some at‑the‑market offerings or accelerated share repurchase programs intended to qualify under Rule 10b5-1) must include a similar 30-day mandatory cooling-off period before any trading can commence under the plan.
For the sake of either of these cooling-off periods, a modification of a trading plan, including cancelling a trade, is equivalent to terminating the prior plan and adopting a new one, triggering a new cooling off period before trades under the modified plan.
The SEC anticipates that the proposed cooling-off periods would promote compliance with the requirement that adopting or modifying their 10b5-1 plans must be done at a time when the insider is not in possession of material nonpublic information. The SEC has requested comment on the proposed length of the cooling-off period.
Officer and Director Certification. Section 16 officers and directors would have to certify to their company in their individual capacity that they are not aware of material nonpublic information about their company or the security when they adopt a plan under the proposed amendments. Such officers and directors must also certify that the plan is adopted in good faith and not “as part of a plan or scheme to evade the prohibitions of Exchange Act Section 10(b) and Exchange Act Rule 10b5-1.” The certification would not require filing with the SEC, but a copy would need to be retained by the officer or director for a period of 10 years.
Operation of Plans in Good Faith. Under the proposed amendments, insiders would have to operate 10b5-1 plans in good faith to avail themselves of the protections of Rule 10b5-1(c)(1). This expands the current requirement that 10b5-1 plans be “entered into” in good faith.
Prohibition of Overlapping Plans. The proposed amendments would eliminate the affirmative defense under Rule 10b5-1(c) in the event the insider adopted multiple overlapping 10b5-1 plans for open market trades in the same class of securities. This restriction is intended to prevent companies and individuals from selectively executing trades based on material nonpublic information by cancelling one or more plans, while permitting favorable trading arrangements under other plans to continue.
Limit Single Trade Plans. Under the proposed amendments, the availability of the affirmative defense for a 10b5-1 plan designed to cover a single trade would only be available for one single-trade plan during any 12-month period.
Other Proposed Rule and Form Amendments
Amendments to Forms 4 and 5. Forms 4 and 5 would be amended to include a mandatory checkbox for reportable transactions that were made pursuant to a 10b5-1 plan. In addition, an optional checkbox would be added to report pre-planned transactions that would not satisfy the requirements of Rule 10b5-1(c).
Disclosure of 10b5-1 Plans and Other Trading Arrangements. Companies would be required to disclose quarterly on Form 10-Q (or Form 10-K for the fourth quarter) the adoption and termination of 10b5-1 plans and other trading arrangement of the company and its directors and officers, using Inline eXtensible Business Reporting Language (Inline XBRL). The proposed amendments would add Item 408(a) to Regulation S-K, which would require disclosure of the material terms of the 10b5-1 plan or arrangement, including the date of adoption or termination, the name and title of the director or officer involved, as applicable, the duration of the plan or arrangement, and the aggregate amount of the company’s securities to be sold or purchased under the plan or arrangement.
The proposed rule is ambiguous as to whether the material terms to be disclosed go beyond the listed items and would be required to include information such as the planned timing of trades, trigger prices, etc.
Insider Trading Policies Disclosure. The proposed amendments include new Item 408(b) of Regulation S-K, which would require companies to disclose in their annual reports on Forms 10-K or 20-F and 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, and employees that are reasonably designed to promote compliance with insider trading laws, rules, and regulations.
If they have adopted such policies and procedures, they must also disclose them (companies would be able to cross-reference to their codes of ethics if they contain insider trading policies). These disclosures would be subject to the principal executive and principal financial officer certifications required by Section 302 of the Sarbanes-Oxley Act and would be required to be tagged using Inline XBRL.
Equity Compensation Award Disclosure. A new subsection, Item 402(x) of Regulation S-K, would require companies to disclose grants of stock options, SARs and similar instruments granted within 14 calendar days before or after:
- the filing of a periodic report,
- a company’s share repurchase; or
- the filing or furnishing of a Form 8-K disclosing material nonpublic information (including earnings information).
Item 402(x) would also require information regarding the market price of the underlying securities the day before and the day after the disclosure of material nonpublic information. Companies would also be required to provide narrative disclosures regarding their option grant policies, including how the board or compensation committee considers material nonpublic information when deciding the timing and terms of awards. The disclosure under 402(x) would also be subject to Inline XBRL tagging.
Gift Disclosures. Insiders would be required to promptly disclose the disposition of gifts of securities on Form 4 within two business days after such a gift is made (instead of Form 5, which is the current requirement). This amendment is intended to address concern regarding the practice of insiders making gifts of equity securities while in possession of material nonpublic information by accelerating the current period for reporting such gifts (45 days after a company’s fiscal year end). By accelerating the timing of gift disclosures, the SEC believes investors and other market participants would be better able to evaluate the nature of such gifts.
Share Repurchase Proposal
With respect to share repurchases, the SEC seeks to adopt rule amendments (the share repurchase amendments) to, among other things, enhance the existing disclosure requirements regarding when companies repurchase their shares. Currently, under Item 703 of Regulation S-K, public companies must disclose in a tabular format in their periodic reports:
- the total number of shares purchased by the company or any affiliate during the quarter on a monthly basis by class;
- the average price paid per share;
- the total number of shares purchased via a publicly announced repurchase plan or program; and
- the maximum number (or approximate dollar value) of shares remaining for purchase under the plans.
Current Item 703 also requires footnote disclosure regarding the number of shares purchased other than through a publicly announced plan, the date each repurchase program was announced and their expiration and any terminated or discontinued plans.
According to the share repurchase proposal, the SEC intends the proposed changes to address concerns raised by some commentators regarding asymmetries that may exist between companies and investors with regards to information about the company and its future prospects, and the potential use of repurchases to increase executive compensation tied to share price. Consequently, the share repurchase amendments require more frequent and detailed reporting of corporate share repurchases using the Inline XBRL format.
Proposed Form SR
The share repurchase amendments would enact Exchange Act Rule 13a-21 and create Form SR, which would require a company—including a foreign private issuer and certain registered close-end funds— to daily report purchases of shares or units of any class of such company’s securities that is registered under Section 12 of the Exchange Act. The company would be required to furnish Form SR by the first business day following the day on which the repurchase transaction has been executed. Form SR would require the following information in tabular format for each class of securities purchased:
- the class;
- total number of shares;
- average price paid per share;
- the aggregate total number of shares purchased on the open market;
- the aggregate total number of shares purchased in reliance on the Rule 10b-18 safe harbor; and
- the aggregate total number of shares purchased pursuant to a 10b5-1 plan.
As proposed, Form SR would be furnished and not filed. The proposing release notes that securities trades do not settle until two days after the trade is executed, so the possibility exists that executed trades may not be completed or not completed in full. In such a case, the company would be required to file an amended Form SR to report any material errors or changes to information previously reported.
Revisions to Item 703
The share repurchase amendments would also expand the disclosure requirements under Item 703 for their quarterly filings on Form 10-Q and Form 10-K and similar provisions contained in Form 20-F and Form N-CSR. Under the amendments, a company must include the following in its Item 703 (or equivalent) disclosure:
- the objective or rationale for its share repurchases and the process or criteria for determining the amount of repurchases;
- any policies and procedures relating to purchases and sales by officers and directors during a repurchase program, including any restrictions on such transactions;
- whether the repurchases were made pursuant to a 10b5-1 plan, and the adoption or termination date of such plan; and
- whether the repurchases were made in reliance on Rule 10b-18, which provides a safe harbor from manipulation charges under the Exchange Act for company share repurchases.
Companies must also disclose (via checkbox that accompanies the Item 703 disclosure) if any of their Section 16 officers or directors purchased or sold shares 10 business days before or after the announcement of any repurchase program.
If the SEC adopts the Rule 10b5-1 proposal and the share repurchase proposal as currently drafted, companies should plan to do the following:
- establish appropriate policies and procedures to ensure that the company reviews the Rule 10b5-1 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 10b5-1 plans such as Section 16 officer and director certifications and the cooling-off period requirements;
- consider adopting an equity grant policy that provides for equity grants to be made on pre-established dates;
- assess the disclosure implications, including the stated rationale, for share repurchase programs under Item 703 and Form SR; and
- establish processes for the timely tracking and reporting of share repurchases.
Both proposals are subject to a 45-day comment period after their publication in the Federal Register. Although it is uncertain whether the rule proposals will be adopted in their current form, companies should start to anticipate measures necessary for compliance.