On December 14, 2022, the Securities and Exchange Commission (SEC) adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Rule 10b5-1 provides an affirmative defense to insider trading liability for individuals and companies where, subject to certain conditions, a trade was made pursuant to a written plan adopted before the trade. One important condition is that the trader had no material nonpublic information when the plan was adopted. The amendments also added related disclosure requirements for both individuals and issuers.
Through these amendments, the SEC has tightened the availability of the Rule 10b5-1 insider trading defense by codifying longstanding voluntary practices and requiring new disclosure obligations. We expect that the SEC will follow the adoption of these amendments with robust enforcement action.
Background
Adopted in 2000, Rule 10b5-1 provides a safe harbor for corporate insiders to buy or sell company stock. Under this rule, officers and directors can trade their company’s securities without violating insider trading rules and regulations. However, in order to rely on this affirmative defense, trades must be made pursuant to defined trading plans, often called “Rule 10b5-1 plans.”
These plans must be entered into at a point in time when the trading party is not privy to any material nonpublic information. For example, an officer should adopt their Rule 10b5-1 plan at the commencement of employment. If this is not possible (e.g., for a newly public company), the plan should be adopted during an open trading window. This will bolster the element of good faith and help avoid the appearance of impropriety. To address concerns that the current rule was being abused, the SEC adopted the following key amendments in December 2022:
- Rule 10b5-1 trading plans must include a “cooling off” period before trading can commence under the plan;
- Officers and directors must make certain representations at the time a plan is adopted or modified;
- Overlapping Rule 10b5-1 plans are restricted or prohibited;
- The affirmative defense to insider trading under Rule 10b5-1 is limited to one single-trade plan per 12-month period for all persons other than issuers; and
- A new requirement that persons entering into a Rule 10b5-1 plan must act in good faith for the duration of the plan.
We will cover each of these topics in turn below. We will also explain some nuances in how issuers are affected by changes to the Rule.
Changes For Individuals
Cooling-Off Period
The amendments require a minimum “cooling-off period” between when a Rule 10b5-1 plan is adopted or modified and when trading under the plan begins. This time frame differs slightly depending on the individual’s role within the company.
Directors and officers
The cooling-off period for officers and directors is the later of (1) 90 days after the adoption or modification of the plan or (2) two business days following the filing of the firm’s Form 10-Q or Form 10-K for the fiscal quarter when the new or modified plan was put into place. Regardless, the cooling-off period cannot be longer than 120 days.
Other insiders
With respect to other insiders, the cooling-off period is now set at 30 days after a Rule 10b5-1 trading plan is adopted or modified.
The SEC has not yet adopted a cooling-off period for issuers’ share repurchase plans. However, the matter is still under consideration, and investors, insiders, and issuers should keep an eye on this in 2023.
Director and Officer Representations
To qualify for the Rule 10b5-1 safe harbor, officers and directors adopting a trading plan will need to make certain representations, including:
- They are unaware of any material nonpublic information regarding the issuer or its securities, and
- They are adopting the trading plan in good faith and not as a scheme to evade the prohibitions of Rule 10b-5.
Because making representations like these carries a fair amount of risk for corporate insiders, directors and officers should ensure they are fully comfortable with them before signing. Insiders should speak with experienced legal counsel if they have any concerns.
Prohibition Against Overlapping Plans
The amended Rule 10b5-1 prohibits anyone other than the issuer from having more than one 10b5-1 plan in place to provide a safe harbor for certain insider transactions. Exceptions to this restriction include:
- Separate 10b5-1 plans are permitted when they are in place with different broker-dealers to execute trades of securities held in separate accounts. However, the contracts, when taken as a whole, must meet all the applicable conditions of the rule.
- Later-commencing plans may be permitted if trading under those plans is only authorized to begin after all trades under earlier plans are completed or expire without execution.
- Plans that authorize sell-to-cover transactions that permit only sales necessary to satisfy tax withholding obligations arising exclusively from the vesting of compensatory awards will still be allowed.
Regardless of the applicability of these exceptions, cooling-off periods must still be met. If you are an insider and have questions about vesting dates, plan provisions or applicability of Rule 10b5-1 plan exceptions, check with your firm’s human resources department, finance department, and legal department.
Limitations on Single Trades
A single-trade plan is a plan that is designed to permit the open market purchase or sale of the total amount of securities under the plan as a single transaction. The revised rule will prohibit anyone other than the issuer from relying on a Rule 10b5-1 affirmative defense for taking advantage of more than one single-trade plan in any 12-month period.
Good Faith Requirement
Finally, the amended rule requires anyone—including an issuer—entering into a Rule 10b5-1 trading plan to act in good faith regarding the plan for the duration of the Rule 10b5-1 plan. The former good faith provision only required an individual to act in good faith when entering the plan.
Changes For Issuers
Amendments to Rule 10b5-1 also ushered in some changes specific to issuers. Importantly, these amendments add disclosure items to Regulation S-K disclosure obligations, which we explain in detail below.
Disclosure of Insider Trading Policies and Procedures
The amendments to Rule 10b5-1 usher in Regulation S-K Item 408, which creates new disclosure and reporting obligations regarding insider trading, including the use of 10b5-1 plans. Under new Rule 408(b), an issuer is required to disclose whether it has adopted insider trading policies and procedures governing the purchase, sale, or other dispositions of the issuer’s securities by directors, officers, or employees, or the issuer itself. These policies should be designed to promote compliance with insider trading laws.
If the issuer has adopted such policies and procedures, it should disclose that it has done so on its Form 10-K or in its annual meeting proxy statement. If it makes such a disclosure, it will be required to file a copy of the policies and procedures as an exhibit to its annual report on Form 10-K. If no such policies or procedures are in place, the issuer will need to explain why. Foreign private issuers will need to provide analogous disclosure in their annual reports pursuant to new Item 16J in Form 20-F.
Disclosure of Adoption, Termination, or Changes to 10b5-1 Plans
Item 408(a) requires issuers to provide quarterly disclosure of whether any director or officer has adopted, modified, or terminated a Rule 10b5-1 plan or non-Rule 10b5-1 trading arrangement on Forms 10-Q and 10-K. These disclosures should include:
- A description of the material terms of each plan,
- The plan’s duration, and
- The total amount of securities to be purchased or sold under the Rule 10b5-1 trading plan.
Under this amendment, issuers are not required to disclose pricing terms. In its amendments, the SEC considered but did not require corresponding disclosures from issuers about insiders’ trading arrangements. This is another topic to watch in 2023 and beyond.
Disclosures Regarding Options
Under new Regulation S-K Item 402(x), all issuers, including smaller reporting companies and emerging growth companies, will be required to disclose on their Form 10-K or in their annual meeting proxy statement information about their policies on the timing of options awards in relation to the disclosure of material nonpublic information.
These disclosures should include:
- How the timing of awards is determined,
- Whether and how the presence of material nonpublic information is considered when determining the timing and terms of options awards, and
- Whether disclosure of material nonpublic information is timed or limited to impact the value of awards.
Issuers must also use a new, separate table to disclose any options granted in the last completed fiscal year to named executive officers that were granted within four business days before or one business day after either the (1) filing of a periodic report on Form 10-Q or 10-K or (2) filing of a current report on Form 8-K that contains material nonpublic information, not including a disclosure of a material new option award grant.
Disclosures For Section 16 Filers
The amendments will impose the following new disclosure requirements for Section 16 filers.
Rule 10b5-1 checkbox
The new amendments add a “checkbox” to Forms 4 and 5. Section 16 filers now must indicate whether a reported transaction was made under a 10b5-1 trading plan. If it was, filers now need to provide the date of the plan’s adoption.
Reporting gifts
Bona fide gifts of equity securities will now need to be reported on Form 4 instead of Form 5. This Form 4 will need to be filed prior to the end of the second business day following the date of the gift. Acquisitions of gifts may still be reported on Form 5 or any time earlier on Form 4.
Effective Dates
Section 16 reporting persons will be required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023. Issuers other than smaller reporting companies will need to comply with the amendments to Forms 10-Q, 10-K, 20-F or other Exchange Act report in the issuer’s first filing that covers the issuer’s first full fiscal period that begins on or after April 1, 2023.
For smaller reporting companies, these new disclosure requirements will begin for the first filing that covers the issuer’s first full fiscal period that begins on or after October 1, 2023.
Next Steps
Companies should carefully consider their policies, procedures, and compliance policies to ensure they are both prepared and equipped to make the appropriate disclosures and filings under the amended rules. They may also want to evaluate their existing Rule 10b5-1 trading policies and guidelines to ensure they comply with the new rules. Finally, issuers may want to review their compensation schedule to assess any possible revisions in light of new disclosure rules.