In a surprising 5-0 vote, the SEC yesterday adopted amendments to Rule 10b5-1, the SEC’s rule governing pre-arranged trading plans, as well as amendments to related disclosure and other rules. The amendments impose significant restrictions on the adoption and use (from an affirmative defense perspective) of Rule 10b5-1 trading plans by directors, officers and persons other than issuers. The amendments also include several new disclosure and reporting requirements.
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.”
Summary of Changes to Rule 10b5-1
The amendments impose new requirements for insiders to avail themselves of the affirmative defense to insider trading provided by Rule 10b5-1(c). These new requirements include:
Cooling-Off Periods for Insiders. Rule 10b5-1 trading plans put in place by directors and “officers” (as defined in Rule 16a-1(f)) of an issuer must include a cooling-off period for both plan adoptions and modifications. The cooling-off period prevents trades from occurring under a plan until the later of: (i) 90 days following plan adoption or modification or (ii) two business days following the disclosure in Forms 10-K or 10-Q of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification). Persons that are not directors and officers are required to observe a shorter 30-day cooling-off period for both plan adoptions and modifications. In a departure from the proposed rule, issuers are not subject to cooling-off periods. There is no financial hardship exception from the cooling-off periods.
Modifications that do not change the sales or purchase prices or price ranges, the amount of securities to be sold or purchased, or the timing of transactions 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.
Director and Officer Certifications. Directors and officers of the issuer must personally certify pursuant to a representation in 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.”
Limitations on the Number of Trading Plans. Other than with respect to issuer Rule 10b5-1 plans, the affirmative defense under amended 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. The final amendments allow the following accommodations without jeopardizing the availability of the affirmative defense:
- 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 of 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 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 (i.e., assuming the later plan were put in place the day the earlier plan terminated and the appliable cooling-off period were then observed).
- Maintaining multiple Rule 10b5-1 plans if the insider has in place another Rule 10b5-1 plan or plans that only authorize 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 (i.e., qualified “sell-to-cover” transactions). This accommodation does not extend to sales incident to the exercise of options, which involve discretionary action on the part of the insider.
Extension of Good Faith Requirement. The amendments expand the current good faith requirement in Rule 10b5-1 to require that the person entering into the plan act in good faith with respect to the plan following adoption. As an example, the affirmative defense would not be available for a trader who improperly influences the timing of a corporate disclosure to benefit a planned trade.
Summary of 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, which is not discussed herein), to provide for new disclosure requirements concerning Rule 10b5-1 plans and related issuer policies and practices.
Quarterly and Annual Disclosures. Pursuant to new Item 408, quarterly disclosure in Forms 10-K and 10-Q will be required if, during the last completed quarter, any director or officer of the issuer adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement.” A description of the material terms of such arrangement is required, which include the name and title of the director or officer, date of adoption or termination, duration, and aggregate number of securities to be sold or purchased. Terms with respect to price are not required.
Annually, issuers will be required to disclose in their Form 10-Ks and proxy statements whether they have adopted insider trading policies and procedures, and if not, to explain why not. A copy of any such policies must be filed as an exhibit to Form 10-K. As a result, and contrary to general practice historically, issuer insider trading policies will now become public documents.
Compensation Disclosures. Pursuant to new Item 402(x), issuers will be required to disclose in their proxy statements their policies and practices on the timing of awards of stock options, SARs and/or similar option-like instruments in relation to the disclosure of MNPI, along with a discussion of how the board determines when to grant such awards. Issuers are also required to disclose whether and how the board or compensation committee considers MNPI when determining the timing and terms of an award and whether the issuer has timed the disclosure of MNPI to affect the value of executive compensation. For issuers that are subject to the CD&A, this narrative disclosure could be included in the CD&A, which may already discuss these topics to some extent.
New tabular disclosures are also required regarding awards made to named executive officers during the last completed fiscal year at any time during any period beginning four business days before the filing of a periodic report or the filing or furnishing of a current report on Form 8-K that discloses MNPI (including earnings information) and ending one business day after the filing or furnishing of such report. Among other information about the awards, the tabular disclosure will include 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 MNPI.
Tagging. Consistent with recent SEC rule amendments, the new disclosures described above must also be tagged using inline XBRL.
Summary of Section 16 Reporting Changes
Section 16 Forms. With regard to Section 16, Forms 4 and 5 filers will now need to indicate by checkbox on those forms whether a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c).
Accelerated Reporting of Gifts. The amendments also amend Rule 16a-3 to require that dispositions of bona fide gifts of equity securities be reported on Form 4 within two business days of the gift, rather than on a delayed basis on Form 5 as had previously been permitted. Notably, acquisitions by gift are still eligible for deferred reporting on Form 5.
Relatedly, the adopting release clarifies that the terms “trade” and “sale” in Rule 10b5-1(c)(1) include bona fide gifts of securities and that the Rule 10b5-1(c) affirmative defense is available to such gifts. This position may require issuers to revisit their insider trading policies and treatment of gifts.
Timing and Treatment of Legacy Plans
The above changes become effective 60 days from publication in the Federal Register, with the Section 16 changes first effective for Forms 4 and 5 filed on or after April 1, 2023. The new disclosures in Form 10-K, Form 10-Q, and proxy or information statements will be first required in the filing that covers the first full fiscal period beginning on or after April 1, 2023. A further six-month delay applies for Smaller Reporting Companies to comply with these new disclosure requirements.
The amendments to Rule 10b5-1(c)(1) will not affect the affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the revised rule’s effective date, except to the extent that such a plan is modified after the effective date.
Select Departures from the Proposing Release
The adopting release retreated from a few of the amendments initially proposed. Notably, the adopting release:
- Does not subject issuers to a cooling-off period.
- Does not require directors or officers to make a separate certification that they entered a 10b5-1 plan in good faith or to retain such a certification for ten years.
- Provides some exceptions for multiple overlapping plans, as described above.
- Replaces the certification that the plan be “operated in good faith” with a condition that the person entering the plan “has acted in good faith with respect to” the plan.
- Does not require quarterly disclosure of the issuer’s entry into trading plans.
- Does not require disclosure of the pricing terms in plans entered into by directors and officers.
- Does not require disclosure of the issuer’s insider trading policies and procedures within the body of the annual report or proxy/information statement, and instead requires an exhibit filing.
- Narrowed the tabular disclosure requirements in the final amendments to Item 402(x) of Regulation S-K, including to eliminate the share repurchase disclosure trigger.