On December 14, 2022, the Securities and Exchange Commission adopted final rules amending Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, to impose new conditions to the availability of the Rule 10b5-1 affirmative defense to insider trading liability. The final rules also create new disclosure requirements, including disclosure of issuers’ insider trading policies, the use of Rule 10b5-1 plans by directors and officers, and the timing of option grants. The changes will likely require updates to public companies’ policies and practices and to the forms of Rule 10b5-1 trading plans used by insiders.
First established in 2000, Rule 10b5-1 provides an affirmative defense to insider trading liability if certain conditions are met. Rule 10b5-1 trading plans are widely adopted as means by which company insiders can sell securities in a manner designed to protect themselves from claims of insider trading based on their knowledge of certain company information. In December 2021, the SEC published proposed rules relating to possible changes to Rule 10b5-1, which the SEC described as addressing issues and gaps in the existing rule and enhancing investor protections concerning insider trading. In response to comments from the public, the final rules include modifications to some elements of the proposed rules, including a shortened mandatory cooling-off period.
The Final Rules
The principal changes to the Rule 10b5-1 affirmative defense in the final rules include the following:
- Mandatory Cooling-Off Period
The new rules institute a requirement that Rule 10b5-1 trading plans adopted by persons other than the issuer will be subject to a mandatory cooling-off period. For directors and officers of an issuer, no purchases or sales of such issuer’s securities may occur under a 10b5-1 trading plan until the later of (a) 90 days after adoption or modification of the plan or (b) two business days following disclosure of such issuer’s financial results in Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted or modified, but in no event is the cooling-off period required to exceed 120 days. All persons, other than the issuer and directors or officers of the issuer, are subject to a cooling-off period of 30 days. 10b5-1 trading plans implemented by an issuer will not be subject to cooling-off periods. A change to an existing 10b5-1 plan related to the amount, price or timing of purchases or sales under the plan is considered a termination of the plan and adoption of a new plan, which is subject to a new cooling-off period.
- Limitations on Multiple Overlapping Plans and Single-Trade Plans
The final rules provide for a new limitation on multiple overlapping Rule 10b5-1 plans and prohibit persons other than issuers from using multiple overlapping Rule 10b5-1 plans for transactions in securities of the issuer on the open market during the same period. There are a few limited exclusions to this prohibition, including an exception for 10b5-1 plans providing for sell-to-cover transactions in connection with tax withholding obligations upon vesting of an equity award. Under this exception, the additional plan or plans may only authorize eligible sell-to-cover transactions and only sell such securities as are necessary to satisfy the tax withholding obligations arising exclusively from the vesting of a compensatory award, provided that the insider does not otherwise exercise control over the timing of such sales. The exception does not include sales made to cover taxes in connection with the exercise of option awards, as option exercises occur at the discretion of the insider. There is also an exception to the prohibition on multiple plans for two trading plans that are maintained simultaneously if (a) trading under one plan cannot begin until all trades under the other plan are completed or the first-commencing plan has expired, and (b) the later-commencing plan complies with the applicable cooling-off period, which is deemed to begin on the date of the termination of the earlier-commencing plan.
In addition, the final rules provide for a new limitation on the use of “single-trade plans” designed to purchase or sell all securities as a single transaction. To rely on the affirmative defense of Rule 10b5-1, persons other than issuers may have only one single-trade plan during any consecutive 12-month period.
- Certification and Good-Faith Condition
Under the final rules, directors and officers of the issuer entering into Rule 10b5-1 trading plans must include a representation in the plan certifying that on the date of adoption of a new or modified plan, the individual is not aware of any material nonpublic information about the issuer and that the individual is adopting the plan in good faith. In addition, the amendments to Rule 10b5-1 require that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to that plan during its term.
The new disclosure obligations under the final rules include the following:
- Disclosure of Insider Trading Arrangements and Policies
The final rule changes add new Item 408 under Regulation S-K and corresponding amendments to Forms 10-Q and 10-K to require quarterly disclosure of Rule 10b5-1 trading arrangements and annual disclosure of an issuer’s insider trading policies, which must be filed as an exhibit to Form 10-K. Prior to the new rules, there were no mandatory disclosure requirements regarding the use of Rule 10b5-1 trading plans and issuers were not required to file their insider trading policies.
New Item 408 of Regulation S-K requires an issuer to disclose whether any director or officer adopted or terminated any Rule 10b5-1 trading arrangement or non-Rule 10b5-1 trading arrangement and provide a description of the material terms of such arrangement, including the name of the director or officer, date of adoption or termination, duration and number of securities to be traded under the plan. Disclosure of pricing terms under the trading arrangement is not required.
New Item 408 further requires an issuer to disclose whether the issuer has adopted insider trading policies and procedures designed to promote compliance with insider trading laws, or explain why it has not done so.
New Item 16J to Form 20-F requires similar annual disclosure of a foreign private issuer’s insider trading policies and procedures.
The disclosure requirements are not affected by issuer status as an emerging growth company or smaller reporting company, although smaller reporting companies are provided a longer transition period before being required to make these disclosures as discussed below.
- Disclosure of Awards Granted Close in Time to Release of Material Nonpublic Information
The final rules add new Item 402(x) of Regulation S-K, which requires executive compensation disclosure of the issuer’s policies and practices related to granting certain equity awards close in time to the release of material nonpublic information. The new disclosure obligation has both narrative and tabular components, including narrative disclosure about how the board determines when to grant such awards (for example, whether such awards are granted on a predetermined schedule).
The new table must be included if the issuer awarded options to a named executive officer in the period beginning four business days before the filing of a Form 10-Q or Form 10-K or the filing or furnishing of a Form 8-K that discloses material nonpublic information (other than a Form 8-K disclosing material new option awards under Item 5.02(e)), and ending one business day after the filing or furnishing of such a report. Information about each such award must be included in a table including the name of the recipient, grant date, number of securities underlying the award, per-share exercise price, grant date fair value 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 final rules provide that persons subject to Section 16 reporting must indicate by a new check mark on each of Form 4 and Form 5 whether a transaction reported on either form was made pursuant to a plan intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and provide the date of adoption of such plan in the “Explanation of Responses” portion of the form.
In addition, Section 16 reporting persons currently may report any “bona fide gift” on a delayed basis on Form 5. The new rules require reporting of gift transactions on Form 4 within two business days following the date of execution of the transaction.
Effective Dates and Next Steps
Companies may wish to promptly make their insiders aware of the pending changes and begin to implement new policies and procedures to comply with the new rules.
The new rules will become effective 60 days following publication of the adopting release in the Federal Register. For many companies with a calendar year end, the imposition of a trading blackout at the end of December 2022 means that the amendments to Rule 10b5-1 may be in effect by the time the trading window opens for the adoption of new Rule 10b5-1 plans. The amendments to Rule 10b5-1(c)(1) will not apply to an existing Rule 10b5-1 plan that was entered into prior to the effective date of the final rules, unless the plan is modified after such effective date.
The Section 16 changes will become effective for Forms 4 and 5 filed on or after April 1, 2023. Exchange Act periodic reports on Forms 10-K, 10-Q and 20-F, proxy statements and information statements covering the first full fiscal period that begins on or after April 1, 2023 (or October 1, 2023 for smaller reporting companies) will be required to comply with the new disclosure requirements. Companies will need to provide the new quarterly disclosures of Rule 10b5-1 trading arrangements beginning as early as the periodic report for the period ending June 30, 2023.
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