On December 14, 2022, in its final meeting of the year, the Securities and Exchange Commission adopted final rules relating to Rule 10b5-1 trading plans.
Background of 10b5-1 Plans
Rule 10b5-1(c) establishes an affirmative defense to illegal insider trading whereby corporate insiders can establish a plan to buy or sell their company’s stock over a future period of time. The plan must be adopted in good faith while the insider does not have material nonpublic information. Trading will be executed by a broker-dealer administering the plan. The plan can continue to trade even if the insider later acquires material nonpublic information.
The SEC explained in the adopting release that the amendments are “designed to address concerns about abuse of the rule to trade securities opportunistically on the basis of material nonpublic information in ways that harm investors and undermine the integrity of the securities markets.” These plans allow corporate insiders to diversify their personal wealth despite the near-constant possession of material nonpublic information.
10b5-1 plans have been criticized for their flexibility and the potential for abuse by insiders who activate and deactivate plans just prior to major movements in the stock price or who take advantage of overlapping plans.
Changes to the Rule 10b5-1 Plan Requirements
The new rules represent a significant expansion of the requirements for the affirmative defense under Rule 10b5-1(c)(1), particularly for insiders, and of the disclosure requirements relating to insider trading plans, policies and procedures.
1. Mandatory “cooling off” periods. While many current 10b5-1 plans include a cooling-off period (the time between a plan’s adoption or material modification and the first trade under the plan), the SEC adopted a mandatory cooling-off period for executive officers and directors, running from the date of adoption of a plan until the later of 90 days or two business days following the issuer’s disclosure of financial results in the issuer’s periodic report for the fiscal quarter during which the plan was adopted or modified (up to a maximum of 120 days). For other persons, such as employees, who seek to benefit from the affirmative defense, the mandatory cooling-off period is 30 days. Note that modifications that do not change the sales or purchase price or price range, the amount of securities to be sold or purchased, or the timing of a transaction under a Rule 10b5-1 plan (such as an adjustment for stock splits or a change in account information) will not trigger a new cooling-off period. Significantly, the SEC did not adopt a cooling-off period for issuers that maintain 10b5-1 plans.
2. Director and officer certifications. Directors and officers of the issuer must personally certify at the time of adoption of a Rule 10b5-1 plan that (i) they are “not aware of any material nonpublic information about the security or issuer” and (ii) they are “adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of this section.” These certifications are already customary in many broker-facilitated 10b5-1 plan arrangements.
3. Restriction on number of trading plans. The affirmative defense under Rule 10b5-1 generally will no longer apply to multiple, overlapping plans, and will limit the use of single-trade plans (i.e., a plan covering a single trading event) to one during any consecutive 12-month period. Exceptions to this are:
- Using more than one broker-dealer or other agent to execute trades as part of a single “plan,” provided the contract with each broker-dealer or other agent, when taken together, meets all the applicable conditions and remains subject to the provisions of Rule 10b5-1(c)(1).
- Substituting a broker-dealer or other agent without altering the existing plan’s purchase or sale instructions.
- Maintaining two separate Rule 10b5-1 plans, so long as trading under the later plan is not authorized to begin until after all trades under the earlier plan are completed or expire without execution, and provided that the later plan observes the applicable cooling-off period beginning on the date of termination of the earlier plan.
- Maintaining multiple Rule 10b5-1 plans if an insider has in place another Rule 10b5-1 plan that only authorizes the sale of securities as necessary to satisfy tax withholding obligations incident to the vesting of a compensatory award, such as restricted stock or stock appreciation rights, and the insider does not otherwise exercise control over the timing of such sales. Note that the exception does not apply to sales related to the exercise of options.
4. Good faith requirement. The amendments expand the current good faith requirement in Rule 10b5-1 to require that the person act in good faith with respect to the plan following adoption. The amendment addresses concerns regarding whether a person may try to improperly influence the timing of corporate disclosures to benefit their trades under a Rule 10b5-1 plan.
New Disclosure Requirements
Currently, there are no required disclosures concerning the use of Rule 10b5-1 plans by issuers or insiders. The rule amendments add new Item 408 to Regulation S-K, amend Item 402 of Regulation S-K, and make conforming amendments to Forms 10-Q and 10-K (and Form 20-F) to provide for new disclosure requirements concerning Rule 10b5-1 plans and related issuer policies and practices.
1. Rule 10b5-1 Plans. Issuers must report in their quarterly reports the adoption, material modification and termination of Rule 10b5-1 plans by their directors and named executive officers as well as the material terms (other than pricing) of such plans.
2. Insider Trading Policies. Issuers must indicate in their annual reports and proxy statements whether they have adopted insider trading policies and procedures or explain why such policies and procedures have not been adopted. Such insider trading policies and procedures must be filed as exhibits to an issuer’s annual report.
3. Option Grant Policies.
(a) Issuers must disclose in their annual reports their grant policies and practices with respect to options and similar awards and how the board takes into account material nonpublic information when determining the timing and terms of awards.
(b) Issuers must provide annual tabular disclosure showing stock option grants made within the period of four business days before the filing of a periodic report on Form 10-Q or Form 10-K or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information (including earnings information) and ending one business day after a triggering event, and the percentage change in the market price of the underlying securities between those two dates.
Section 16 Reporting Changes
Form 4 and 5 filers will be required to check certain boxes to indicate whether a purchase or sale was made under a plan that is intended to satisfy the affirmative defense provisions of Rule 10b5-1(c) and the date of adoption of any such plan. In such case, the filer must provide the date of adoption of the plan and can also voluntarily provide additional information relevant to the transaction.
Currently, corporate insiders may disclose bona fide gifts of equity securities on a Form 5 on a delayed reporting schedule (within 45 days after the issuer’s fiscal year). Under the amendments, officers and directors will no longer be permitted to report gifts of securities on Form 5; such gifts will now be subject to the two-day reporting requirements of Form 4.
Timing and Takeaways
While the amendments adopted by the SEC, including the amendments to Rule 10b5-1(c), will become effective 60 days after the adopting release is published in the Federal Register, the amendments to Rule 10b5-1(c) will not apply to 10b5-1 plans entered into before the effective date of the new rules unless such plans are modified after such effective date and such modification is deemed to be the adoption of a new plan under the new rules as discussed above. In addition, the new disclosure requirements are subject to phase-in rules. Filings of Forms 4 and 5 will be required to comply with the new disclosures (discussed above) starting April 1, 2023, and issuers will be required to comply with the new disclosure requirements (including the disclosure requirements regarding trading plans adopted by directors and officers) in Forms 10-Q, 10-K and 20-F and proxy or information statements in the filing that covers the first full fiscal period that begins on or after April 1, 2023. For domestic calendar-year issuers, that will be the Form 10-Q for the period ending June 30, 2023; the compliance date for the disclosure requirements applicable to issuers is deferred until October 1, 2023, for smaller reporting issuers.
We recommend that companies and corporate insiders work with their counsel to review their current practices regarding 10b5-1 plans and make appropriate changes to maintain the affirmative defense. While many companies have insider trading policies and option grant practices that are largely consistent with the proposed rules, these policies have often not been prepared with a view to public disclosure. Companies will need to formalize written disclosures of policies and practices related to the oversight of insider trading and track the disclosure of material nonpublic information in combination with the grant of equity awards.