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On December 14, 2022, the U.S. Securities and Exchange Commission (“SEC”) finalized amendments to Rule 10b5-1 that will both amend the Rule 10b5-1(c)(1) affirmative defense to insider trading liability and create new disclosure requirements applicable to the use of Rule 10b5-1 plans and the insider trading policies of public companies. There are multiple rule changes impacting disclosure and policy requirements for both companies and officers and directors (referred to as “insiders”) as well as other parties[1] during 2023, so an awareness of the changes and careful planning is warranted.
The use of a properly implemented 10b5-1 plan can establish an affirmative defense by insiders or other persons from a claim of unlawful trading under SEC Rule 10b-5, which generally prohibits fraud in connection with the purchase or sale of securities. A 10b5-1 plan authorizes future trading pursuant to a binding contract or plan entered into in good faith while the plan adopter is not in the possession of material nonpublic information (“MNPI”). The plan sets time, price or amount parameters around the securities to be purchased or sold. Future buying or selling of securities conducted pursuant to the plan can be consummated even if the insider is in possession of MNPI at the time of the trade.
The final amendments to Rule 10b5-1 and related rules and forms adopted the Securities Exchange Act of 1934 (the “Exchange Act”) will significantly impact the use of Rule 10b5-1 plans by companies and their insiders. As adopted, the final amendments:
- impose significant new guiderails on insiders’ and companies’ ability to establish and trade in Rule 10b5-1 plans;
- require new disclosure by Exchange Act-reporting companies relating to Rule 10b5-1 plans, insider trading policies, and certain grants of awards; and
- include changes to Forms 4 and 5 filed under Section 16 of the Exchange Act where reported trades are made pursuant to a 10b5-1 plan.
I. New Conditions For Rule 10b5-1 Affirmative Defense
New Statutory Cooling-Off Period
Previously, trades under a 10b5-1 plan could be executed immediately after adoption of the plan, provided the person adopting the plan was not in possession of MNPI at the time the plan was adopted. However, the amended rule mandates a “cooling-off period” for directors and officers that prohibit such insiders from trading in a Rule 10b5-1 plan until the later of (i) 90 days following the plan’s adoption or modification; or (ii) two business days following the company’s disclosure of its financial results for the fiscal quarter in which the plan was adopted or modified in a Form 10-K, 10-Q, 20-F, or 6-K (note: an earnings release is not sufficient), subject to a maximum cooling-off period of 120 days.
In addition, the amended rule imposes a cooling-off period of 30 days for individuals other than directors and officers. Issuers would not be subject to a cooling-off period if the issuer adopted a 10b5-1 plan (which is common in connection with a company stock buyback programs).
Certification of Lack of MNPI
Directors and officers will be required to include a certification in their Rule 10b5-1 plan certifying that at the time the plan is adopted or modified, (1) they are not aware of MNPI about the issuer or its securities, and (2) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5 of the Exchange Act.
No Overlapping Plans; Limits on Affirmative Defense for Individuals
Whereas previously a person could adopt multiple 10b5-1 plans that run concurrently, the amended rules prohibit individuals from using multiple overlapping Rule 10b5-1 plans. Individuals may only rely on the Rule 10b5-1 affirmative defense for a single-trade plan during any consecutive 12-month period. These limitations are subject to exceptions to permit (i) plans directing “sell-to-cover” transactions to pay withholding tax upon vesting of equity awards or (ii) a series of separate contracts with different broker-dealers to execute trades pursuant to a single 10b5-1 trading plan.
II. New Disclosure Requirements Regarding Rule 10b5-1 Plans and Insider Trading Policies
The final amendments also include the following new disclosure obligations for Exchange Act reporting issuers, where issuers must provide the following:
- Disclosure in their quarterly reports of the use of Rule 10b5-1 plans by directors and officers. Specifically, the required disclosure must include the following: (i) for plans adopted by directors or officers, their names and titles; (ii) the date of adoption or termination of the plan; (iii) the duration of the plan; and (iv) the aggregate number of securities to be sold or purchased under the plan. Previously, public disclosure of the adoption of a 10b5-1 plan was not required.
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Disclosure in their annual reports regarding whether they have adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of company securities by insiders and, if they have adopted such policies and procedures, that they file such policies and procedures as an exhibit to the related annual report. While this requirement will not be in effect for 2022 annual reports, we recommend early adoption by filing insider trading policies this year as an exhibit with the 2022 Form 10-K.
- Certain tabular and narrative disclosures regarding their option grant policies and practices, including tabular disclosure showing grants made within a period starting four business days before and ending one business day after the issuer’s release of MNPI, indicating the market price (and percentage change) of the underlying securities on the trading day before and after the release of such information.
- Tagging of the required disclosures in Inline XBRL.
III. Changes to Section 16 Filings For 10b5-1 Transactions and Gifts
Forms 4 and 5 filings under Section 16 of the Exchange Act will now include a checkbox requiring filers to indicate whether a reported transaction was made pursuant to a trading plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1. Filers also must disclose the date of adoption of the applicable Rule 10b5-1 plan.
Also, the new rules amend Rule 16a-3 of the Exchange Act to require that bona fide gifts of issuer securities be reported on Form 4. Previously, insiders were permitted to report such gifts on Form 5.
IV. Considerations
Cooling-Off Period
The goal of the cooling-off period is to create a lag between the establishment of the plan and the trading so that any knowledge the insider has at the time they establish the plan will be of diminished value in anticipating market dynamics at the time of the trade(s). This has been, and continues to be, a focus of the SEC’s Division of Enforcement.
The final amendments represents a dramatic change in the timing requirements for establishing and first using a Rule 10b5-1 plan and attempts to ensure that insiders cannot hide behind the Rule 10b5-1 shield when trading while in possession of MNPI. The new cooling-off requirement has the effect of requiring insiders to establish parameters for trades so far in advance of the trade date that they may have difficulty anticipating their financial needs or investing strategies, and thus be unwilling to enter into a plan in the first place.
Certification Requirements
The certification potentially adds liability, but a Rule 10b5‑1 affirmative defense already was predicated upon an insider not having MNPI when entering into a trading plan, and brokers who execute trades under a plan frequently required this certification as a representation. Additionally, the requirement that the trading arrangement be entered into and operated in good faith is more expansive than the existing requirement that the Rule 10b5-1 plan just be entered into in good faith.
Prohibition on Overlapping Plans
This prohibition may affect some users of Rule 10b5-1 plans, but the majority of arrangements will not be affected by such changes.
V. Timing and Action Items
Most of the new disclosure requirements will go into effect in the second half of 2023 or early 2024 for companies with a December 31 fiscal year-end, while the new Rule 10b5-1 conditions will become effective for plans adopted or modified on or after the effective date of the new rules (February 27, 2023).
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The new rules will become effective on February 27, 2023. Existing plans will not be subject to the new requirements unless modified after the effective date.
- Insiders who are subject to the reporting requirements of Section 16 must comply with the new disclosure requirements on Forms 4 and 5 for reports filed on or after April 1, 2023.
- Issuers must comply with the new disclosure requirements in Exchange Act periodic reports on Forms 10-Q, 10-K, and 20-F and in any proxy or information statements in the first filing that covers the first full fiscal period beginning on or after April 1, 2023 (or October 1, 2023, in the case of smaller reporting companies).
As such, insiders and issuers should consider the following now:
- Insiders should carefully assess the new limitations of Rule 10b5-1 plans, especially the cooling-off periods and limitations on overlapping plans and consider the early adoption of these provisions for plans going into effect prior to the statutory effective date.
- Companies should review and update their insider trading policies, any separate Rule 10b5-1 plan guidelines, and any other related company policies to ensure compliance with the newly adopted.
- In light of the new requirement for tabular disclosure showing grants made within four business days of an issuer’s release of MNPI, issuers and their boards may wish to reassess their current procedures for granting awards ahead of early 2023 grants. Issuers should generally schedule ahead of time when options and equity grants will be authorized.
VI. Conclusion
Rule 10b5-1 remains an important affirmative defense for insiders against claims of unlawful trading and can help insiders gain the benefits associated with their equity compensation and ownership. However, amended Rule 10b5-1 and related rule changes will require public companies and their insiders to carefully weigh additional disclosure requirements in deciding whether to utilize such arrangements.
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If you have questions or would like additional information, please contact our the primary EGS attorney with whom you work.
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[1] While 10b5-1 plans are typically utilized by “insiders”, they can be adopted by other individuals or entities, including significant stockholders of a company. In this alert, references to “insiders” can therefore be applied as application to such other individuals or entities.
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