The SEC adopted final rules imposing new conditions and disclosure requirements on Rule 10b5-1 trading plans, increasing transparency into inside trading plans and related disclosures by SEC registrants.

The Securities and Exchange Commission (SEC) adopted Final Rules imposing new conditions and disclosure requirements on Rule 10b5-1 trading plans. According to the SEC, these amendments were finalized to improve investor confidence in the securities markets and enhance liquidity and capital formation, while continuing to provide appropriate flexibility to traders who would like to plan securities transactions in advance, when they are not aware of material nonpublic information.

On December 14, 2022, the SEC adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 and new related disclosure requirements for companies (registrants) who are SEC reporting companies. The SEC’s overriding concern was that the existing 10b5-1 plan requirement allowed insiders to trade securities opportunistically on the basis of material nonpublic information.[1]

The amended rules require lengthy cooling-off periods for persons other than registrants before trading can commence under a Rule 10b5-1 plan. The amendments further provide that directors and officers must include representations in their plans certifying at the time of the adoption of a new or modified Rule 10b5-1 plan that: (1) they are not aware of any material nonpublic information about the registrant 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.

The amendments also restrict the use of multiple overlapping trading plans and limit the ability to rely on the affirmative defense for a single-trade plan to one single-trade plan per twelve-month period for all persons other than registrants.

With respect to registrants, the amendments require more comprehensive disclosure about their policies and procedures related to insider trading, including quarterly disclosure by them regarding the use of Rule 10b5-1 plans and certain other trading arrangements by directors and officers for the trading of registrant securities.

Finally, to add complexity to the SEC reporting maze, the final rules require disclosure of a registrant’s policies and practices around the timing of option grants and the release of material nonpublic information and require that registrants report on a new table the grant of any option awards 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 material nonpublic information, including earnings information, other than a Form 8-K that discloses a material new option award grant under 8-K Item 5.02(e), and ending one business day after a triggering event.

Insiders that report on Forms 4 or 5 will be required to indicate by checkbox that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose the date of adoption of the trading plan. Also, bona fide gifts of securities that were previously permitted to be reported on Form 5 will now be required to be reported on Form 4.

Primarily, Regulation S-K was amended – Items 402, 408 and 601. Also, Rule 10b5-1 was amended as well as Schedule 14A, Rule 16a-3, Form 4, Form 5, Form 10-Q and Form 10-K.

BACKGROUND

Since the SEC adopted Rule 10b5-1 in 2000, it has been concerned that insider trading practices may have been manipulated while insiders were in possession of material nonpublic information. These situations could have occurred with corporate insiders adopting multiple overlapping 10b5-1 plans and subsequently selectively cancelling certain trades under those plans while they were aware of material nonpublic information or commencing trades pursuant to a new plan shortly after the adoption of a 10b5-1 plan. All of this suggested, in the SEC’s view, that some trades may have been made on the basis of material nonpublic information.

RULE AMENDMENTS

The SEC adopted the following rule amendments:

• Amended the affirmative defense of Rule 10b5-1(c)(1) to: (1) include a lengthy cooling-off period applicable to directors and “officers” (as defined by Rule 16a-1(f))[2] and a 30-day cooling off period applicable to all other persons other than the registrant; (2) include a certification condition for directors and officers; (3) limit the ability of persons other than the registrant to use multiple overlapping Rule 10b5-1 plans; (4) limit the ability of such persons to rely on the affirmative defense for a single-trade plan to one single-trade plan during any consecutive 12-month period; and (5) add a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to that plan;
• Required: (1) quarterly disclosure by registrants regarding the use of Rule 10b5-1 plans and certain other trading arrangements by a registrant’s directors and officers for the trading of its securities; and (2) annual disclosure regarding a registrant’s insider trading policies and procedures in new Item 408 of Regulation S-K and corresponding amendments to Forms 10-Q and 10-K;
• Added a mandatory Rule 10b5-1(c) checkbox to Forms 4 and 5 (the reporting forms in respect of trades made by executive officers, directors and owners of 10% or more of an registrant’s voting equity securities);
• Required certain tabular and narrative disclosures regarding awards of options, stock appreciation rights (“SARs”), and/or similar option-like instruments granted to corporate insiders shortly before and immediately after the release of material nonpublic information in new paragraph (x) to Item 402 of Regulation S-K;
• Required registrants to tag the information specified by new Items 402(x), 408(a), and 408(b)(1) in Inline XBRL; and
• Required reporting of dispositions of equity securities by bona fide gifts on Form 4, rather than annually in the discretion of the filing person on Form 5.

Note that the cooling-off period for officers and directors the SEC adopted includes both a fixed (90-day) and a variable (two business days after the disclosure of the registrant’s financial results) component. According to the SEC’s adopting release, this cooling-off period is targeted at reducing information asymmetries in general as well as providing separation in time between adoption of a 10b5-1 plan and trading under the plan so as to reduce the ability of corporate insiders to trade on material nonpublic information.

With respect to the cooling off period, the SEC adopted a new paragraph to Rule 10b5-1(c)(1) that specifically provides that a modification or change to the amount, price, or timing of the purchase or sale of the securities (or a modification or change to a written formula or algorithm, or computer program that affects the amount, price, or timing of the purchase or sale of the securities) underlying a contract, instruction, or written plan as described in Rule 10b5-1(c)(1)(i)(A) is a termination of such contract, instruction, or written plan, and the adoption of a new contract, instruction, or written plan, and such new adoption will trigger a new cooling-off period. Under the final amendment, 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.

The SEC did not adopt a cooling off period for registrants at the present, noting, however, that it believes “that further consideration of potential application of a cooling-off period to the registrant is warranted.”

DIRECTOR AND OFFICER CERTIFICATIONS

Under the final rule, if a director or “officer” (as defined in Exchange Act Rule 16a-1(f)) of the registrant of the securities adopts a Rule 10b5-1 plan, as a condition to the availability of the affirmative defense, such person will be required to include a representation in the plan certifying that at the time of the adoption of a new or modified Rule 10b5-1 plan: (1) he or she is not aware of material nonpublic information about the registrant or its securities; and (2) and is adopting the contract, instruction, or plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5.

In our view, this is regulatory overkill, but the SEC clearly wants to place burdens on insiders requiring them to state that they are not breaking the law. The SEC believes the certification condition is intended to reinforce directors’ and officers’ cognizance of their obligation not to trade or enter into a trading plan while aware of material nonpublic information about the registrant or its securities. Note that it is the responsibility of officers and directors to determine whether they are aware of material nonpublic information when adopting Rule 10b5-1 plans, and that the affirmative defense under Rule 10b5-1 requires them to act in good faith and not to adopt such plans as part of a plan or scheme to evade the insider trading laws.

Further, because registrants must provide disclosure regarding the material terms (other than price) of their directors’ and officers’ Rule 10b5-1 plans under new Item 408(a) of Regulation S-K, any representation made as part of such plans will also likely be requested by and made available to the registrant to facilitate its compliance with the disclosure requirement. Obviously, registrants should request this in connection with any 10b5-1 Plan adopted by an officer or director.

PROHIBITION OF OVERLAPPING 10B5-1 PLANS, MULTIPLE- AND SINGLE-TRADE ARRANGEMENTS

The SEC added a condition to the Rule 10b5-1(c)(1) affirmative defense that persons, other than registrants, may not have another outstanding 10b5-1 plan that would qualify for the affirmative defense under the amended Rule 10b5-1 for purchases or sales of any class of securities of a registrant on the open market during the same period. However, the amendment provides that insiders may employ multiple plans to satisfy certain tax obligations incident to equity compensation.

Further, a series of separate contracts with different broker-dealers or other agents acting on behalf of the person (other than the registrant) to execute trades thereunder may be treated as a single “plan,” provided that the contracts with each broker-dealer or other agent, when taken together as a whole, meet all of the applicable conditions of and remain collectively subject to the provisions of Rule 10b5-1(c)(1). We believe that persons who wish to make trades of this type will need to work closely with their brokers.

Further, a trader may maintain two separate Rule 10b5-1 plans at the same time so long as trading under the later-commencing plan is not authorized to begin until after all trades under the earlier-commencing plan are completed or expire without execution.

With respect to “single-trade” plans, the amended rule provides that if the plan is designed to effect the open-market purchase or sale of the total amount of securities as a single transaction, the plan will not receive the benefit of the affirmative defense unless: (1) the person who entered into the plan has not, during the prior 12-month period, adopted another plan that was designed to effect the open-market purchase or sale of the total amount of securities subject to that plan in a single transaction; and (2) such other contract, instruction, or plan in fact was eligible to receive the affirmative defense. A person (other than the registrant) will be able to rely on the Rule 10b5-1(c)(1)(ii) affirmative defense for only one single-trade plan during any 12-month period. Thus, the defense will only be available for a single-trade plan if the person had not, during the preceding 12-month period, adopted another single-trade plan, where the other plan qualified for the affirmative defense under Rule 10b5-1.

The SEC added additional disclosure requirements for registrants regarding Rule 10b5-1 trading arrangements, noting that there were no mandatory disclosure requirements concerning the use of Rule 10b5-1 trading arrangements or other trading arrangements by registrants or corporate insiders. The SEC proposed new Item 408 of Regulation S-K and corresponding amendments to Form 10-Q and 10-K to require quarterly disclosure regarding the use of Rule 10b5-1 and other trading arrangements by a registrant and its directors and officers with respect to the trading of the registrant’s securities as well as annual disclosure of a registrant’s insider trading policies and procedures.

The final rule adds significant new disclosure requirements. The rule requires registrants to:

(1)          disclose whether, during the registrant’s last fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report), any director or “officer” (as defined in Rule 16a-1(f)) has adopted or terminated (i) any contract, instruction or written plan for the purchase or sale of securities of the registrant that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) (a “Rule 10b5-1(c) Trading Arrangement”), and/or (ii) any written trading arrangement for the purchase or sale of securities of the registrant that meets the requirements of a non-Rule 10b5-1 Trading Arrangement as defined in Item 408(c) of Regulation S-K (a “Non-Rule 10b5-1 Trading Arrangement”); and

(2)          provide a description of the material terms of the Rule 10b5-1 Trading Arrangement or non-Rule 10b5-1 Trading Arrangement other than terms with respect to the price at which the individual executing the respective trading arrangement is authorized to trade, such as:

• The name and title of the director or officer;
• The date of adoption or termination of the trading arrangement;
• The duration of the trading arrangement; and
• The aggregate number of securities to be sold or purchased under the trading arrangement.

With respect to any trading arrangement subject to disclosure under Item 408(a), the registrant must indicate whether such trading arrangement is a Rule 10b5-1 Trading Arrangement or is a Non-Rule 10b5-1 Trading Arrangement.

In addition, any modification or change to a Rule 10b5-1 plan by a director or officer that falls within the meaning of new Rule 10b5-1(c)(1)(iv) would also be required to be disclosed under Item 408(a) of Regulation S-K as the SEC concluded that such a modification constitutes the termination of an existing plan and the adoption of a new contract, instruction, or written plan.[3]

Under the final rule, a trading arrangement with respect to a director or “officer” (as defined in Rule 16a-1(f)) would be a “Non-Rule 10b5-1 Trading Arrangement” where the director or officer asserts that, at a time when he or she was not aware of material nonpublic information about the security or the registrant of the security, he or she:

• Adopted a written arrangement for trading the securities; and
• The trading arrangement:
  • Specified the amount of securities to be purchased or sold and the price at which and the date on which the securities were to be subsequently purchased or sold;
  • Included a written formula or algorithm, or computer program, for determining the amount of securities to be purchased or sold and the price at which the securities were to be purchased or sold; or
  • Did not permit the covered person (usually a broker) to exercise any subsequent influence over how, when, or whether to effect purchases or sales; provided, in addition, that any other person who, pursuant to the Trading Arrangement did exercise such influence must not have been aware of material nonpublic information when doing so.[4]

Registrants will need to confirm the above information with its directors and officers on a quarterly basis prior to filing the registrant’s periodic reports on Forms 10-Q and 10-K.

DISCLOSURE OF INSIDER TRADING POLICIES AND PROCEDURES

Under the final rule, registrants will be required to disclose whether they have adopted:

• Insider trading policies and procedures governing the purchase, sale, and other dispositions of their securities by directors, officers, and employees, or the registrant itself, that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and
• Any listing standards applicable to the registrant.

If a registrant has not adopted such insider trading policies and procedures, it must explain why it has not done so. In other words this is a de facto requirement to adopt such policies. These disclosures will be required in annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C.[5]

RULE 10b5-1 AND NON-RULE 10b5-1 TRANSACTIONS ON FORMS 4 AND 5

The SEC added a Rule 10b5-1(c) checkbox as a mandatory disclosure requirement on Forms 4 and 5. A Form 4 or 5 filer would be required to indicate via the checkbox whether a transaction reported on that form was intended to satisfy to Rule 10b5-1(c). Filers will also be required to provide the date of adoption of the Rule 10b5-1 plan, and would have the option to provide additional relevant information about the reported transaction.

DISCLOSING TIMING OF CERTAIN EQUITY AWARDS

With respect to narrative disclosure, the final SEC rule requires registrants to discuss 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 material nonpublic information, including how its board determines when to grant such awards (for example, whether such awards are granted on a predetermined schedule); whether, and if so, how, the board or compensation committee takes material nonpublic information into account when determining the timing and terms of an award, and whether the registrant has timed the disclosure of material nonpublic information for the purpose of affecting the value of executive compensation. This is a new layer of disclosure and registrants will need to review closely their policies with respect to these issues. This disclosure will need to be crafted in advance of filings.

DISCLOSURES OF OPTION GRANTS AND EQUITY AWARDS TIMED TO RELEASE OF MATERIAL NONPUBLIC INFORMATION

The new rules also provide that, if, during the last completed fiscal year, stock options, SARs, and/or similar option-like instruments were awarded to a named executive officer (“NEO”) within a period starting 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), other than a Current Report on Form 8-K disclosing a material new option award grant under Item 5.02(e), and ending one business day after a triggering event, the registrant must provide the following information concerning each such award for the NEO on an aggregated basis in the tabular format set forth in the rule:

• The name of the NEO;
• The grant date of the award;
• The number of securities underlying the award;
• The per-share exercise price;
• The grant date fair value of each award computed using the same methodology as used for the registrant’s financial statements under generally accepted accounting principles; and
• 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 material nonpublic information.

The table must include only option awards granted in the period beginning four business days preceding a triggering event and ending one business day after a triggering event.

Lastly, the SEC combined the final two columns of the proposed table into a single column that requires disclosure of the percentage change in the market value of the securities underlying the award between the closing market price of the securities one trading prior to the disclosure of material nonpublic information and one trading day following the disclosure of material nonpublic information.

The Table shall include:

(A) The name of the named executive officer (column (a));

(B) On an award-by-award basis, the grant date of the option award reported in the table (column (b));

(C) On an award-by-award basis, the number of securities underlying the options, (column (c));

(D) On an award-by-award basis, the per-share exercise price of the options (column (d));

(E) On an award-by-award basis, the grant date fair value of each award computed using the same methodology as used for the registrant’s financial statements under generally accepted accounting principles (column (e)); and

(F) For each instrument reported in column (b), disclose 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 the trading day beginning immediately following the disclosure of material nonpublic information (column (f)).

Disclosure of option awards is also required in the one-business day period after the filing or furnishing of Forms 8-K, 10-Q, or 10-K. This will be a regulatory headache for registrants and the grant of awards will need to be carefully thought through vis-à-vis potential public disclosure.

TAG REQUIREMENTS

The amendments require registrants to tag the information specified by new Items 402(x), 408(a), and 408(b)(1) of Regulation S-K, and new Item 16J(a) of Form 20-F, in Inline XBRL in accordance with Rule 405 and the EDGAR Filer Manual.

REPORTING OF GIFTS ON FORM 4

Under the final amendments, Section 16 reporting persons will be required to report dispositions of bona fide gifts of equity securities on Form 4 (rather than Form 5) in accordance with Form 4’s filing deadline (that is, before the end of the second business day following the date of execution of the transaction) instead of the optional disclosure under Form 5 once per year.

TRANSITION

• The new trading plan requirements are effective on February 27, 2023, which is 60 days following publication of the final rules in the Federal Register.
• 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;
• Registrants who are not smaller reporting companies will be required to comply with the new disclosure and tagging requirements in Exchange Act periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statements that are required to include the Item 408, Item 402(x), and/or Item 16J disclosures in the first filing that covers the first full fiscal period that begins on or after April 1, 2023.
• Registrants that are smaller reporting companies will be required to comply with the new disclosure and tagging requirements in Exchange Act periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statements that are required to include the Item 408, Item 402(x), and/or Item 16J disclosures in the first filing that covers the first full fiscal period that begins on or after October 1, 2023.

[1] See SEC Release, Insider Trading Arrangements and Related Disclosures, 33-11138; 34-96492, December 14, 2022.

[2] Under the final rules, a director or “officer” (as defined in Rule 16a-1(f)) who adopts (including a modification of) a Rule 10b5-1 plan would not be able to rely on the Rule 10b5-1 affirmative defense unless the plan provides that trading under the plan will not begin until the later of (1) 90 days after the adoption of the Rule 10b5-1 plan or (2) two business days following the disclosure of the registrant’s financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted (but in any event, the required cooling-off period is subject to a maximum of 120 days after adoption of the plan).

[3] The final rules clarify that new Item 408(a) of Regulation S-K does not require disclosure of the price at which the individual executing the trading arrangement is authorized to trade.

[4] The SEC did not adopt the proposal to require corresponding disclosure regarding the use of trading arrangements by a registrant. The SEC also did not extend disclosure obligations to plans adopted by the insiders other than officers and directors because it concluded that collecting such information could be significantly burdensome for the registrant.

[5] The amendments to Item 601 of Regulation S-K and Form 20-F to require registrants to file a copy of their insider trading policies and procedures as an exhibit to Forms 10-K and 20-F, respectively.