On December 14, 2022, the Securities and Exchange Commission (the “SEC”) adopted amendments to modernize Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and add new disclosure requirements to enhance investor protections against insider trading. Rule 10b5-1, which was adopted in 2000, provides a safe harbor for corporate insiders such as officers and directors to buy or sell company stock without violating insider trading regulations under Section 10(b) of the Exchange Act, and Rule 10b-5, if trades are made pursuant to pre-determined trading plans, also known as Rule 10b5-1 plans, entered into at a time when such parties are not privy to any material nonpublic information.
SEC Chair Gary Gensler noted, “Over the past two decades…we’ve heard from courts, commenters, and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information.”
The amendments adopted by the SEC:
- Adopt a cooling-off period before trading can commence under a Rule 10b5-1 plan;
- Require that officers and directors make certain representations at the time of the adoption of a new or modified Rule 10b5-1 plan;
- Restrict the use of multiple overlapping trading plans;
- Limit the ability to rely on the affirmative defense for a single-trade plan to one single-trade plan per 12 month period for all persons other than issuers; and
- Add a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to the plan.
Under the amended rule, Rule 10b5-1 plans will be required to incorporate a cooling-off period between adoption of such plan and the initial trade thereunder in order to qualify for the Rule 10b5-1 safe harbor. Specifically, the amendments require a cooling-off period for officers and directors for the later of (1) 90 days following the adoption of a Rule 10b5-1 plan; or (2) two business days following the disclosure of the issuer’s financial reports in an Annual Report on Form 10-K or a Quarterly Report on Form 10-Q for the fiscal quarter in which the Rule 10b5-1 plan was adopted or, for a foreign private issuer, in a Form 20-F or a Form 6-K that discloses the issuer’s financial results. In no case can the cooling-off period exceed 120 days following the adoption of the plan before any trading can commence under the trading arrangement. In addition, the amendments require a cooling-off period of at least 30 days for persons other than officers and directors of an issuer before any trading can commence under the trading arrangement or modification. The cooling-off periods are intended to provide time between the adoption of a Rule 10b5-1 plan and the commencement of trading under such plan to minimize the ability of an insider to benefit from trading on material nonpublic information.
In addition to the foregoing, the amendments provide 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 trading plan is a termination of such plan and the adoption of a new plan which triggers a new cooling-off period.
Officer and Director Certification Requirement
Pursuant to the amendments, in order to qualify for the Rule 10b5-1 safe harbor, officers and directors adopting a trading plan will need to provide representations that: (i) they are not aware of any material nonpublic information about the issuer or its securities and (ii) 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.
Prohibition on Overlapping 10b5-1 Plans
Pursuant to the amended rules, the Rule 10b5-1 safe harbor will not be available to persons (other than issuers) who have, or subsequently enter into, overlapping plans for purchases or sales of any class of securities of the issuer. This means that persons (other than the issuer) may only have one trading plan for all of an issuer’s securities, rather than one trading plan for each class of an issuer’s securities. The SEC indicated:
[t]his condition is intended to address the concerns . . . about an insider’s use of multiple overlapping plans in ways that could allow material nonpublic information to factor into the trading decision . . . .With a sufficient number of different plans, an insider could achieve a desired trading outcome. For example, an insider could adopt several plans to sell their company stock at varying prices in excess of the current share price, and then cancel the plans authorizing trades at the lowest of these prices upon learning nonpublic information that the insider expects to substantially increase the share price.
The SEC indicated that, subject to certain conditions, a series of separate trading plans with different broker-dealers or agents acting on behalf of a person (other than the issuer) to execute trades thereunder may be treated as a single “plan,” and a modification of any such trading plan will be a modification of each other trading plan. In addition, a broker-dealer or agent executing trades on behalf of an insider pursuant to a Rule 10b5-1 plan may be substituted for a different broker-deal or agent so long as the purchase or sales instructions applicable to the substituted broker are identical. Notwithstanding the foregoing, a plan modification, such as the substitution or removal of a broker that is executing trades pursuant to a Rule 10b5-1 arrangement on behalf of an insider that changes the purchase or sales instructions is a termination of such plan and the adoption of a new plan (see “Cooling-Off Period” above).
Persons (other than issuers) may maintain two separate Rule 10b5-1 plans at the same time so long as trading under the plan that is the second plan commenced is not authorized to begin until after all trades under the initial plan are completed or otherwise expire. Notwithstanding the foregoing, a person (other than an issuer) cannot avail himself or herself to the foregoing provision with respect to the second plan if the first trade under the second plan is scheduled to begin during the “effective cooling-off period”— the cooling-off period that would be applicable to the second plan if the date of adoption of the second plan were deemed to be the date of termination of the initial plan. The SEC also adopted a modification for plans authorizing certain “sell-to-cover” transactions in which an insider instructs its agent to sell securities to satisfy tax withholding obligations at the time of vesting. An insider will not lose the benefit of the affirmative defense with respect to a Rule 10b5-1 plan if it has another plan that would qualify for the affirmative defense, so long as the additional plan only authorizes qualified sell-to-cover transactions.
Limitation on Single-Traded Plans
The SEC also adopted limitations on single-trade plans which apply to Rule 10b5-1 plans of all persons other than the issuer. A “single-trade plan” is a 10b5-1 plan designed to effect the purchase or sale of securities as a single transaction. Pursuant to the amended rules, only one single-trade plan will qualify for the safe harbor under Rule 10b5-1 in any 12-month period. The amended rules include an exception to this restriction for “sell-to-cover” transactions as described above.
Good Faith Requirement
The amended rule requires that a person must act in good faith with respect to the plan and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5.
The SEC noted:
Currently, there are no mandatory disclosure requirements concerning the use of Rule 10b5-1 trading arrangements or other trading arrangements by issuers or corporate insiders. The lack of comprehensive public information about the use of these arrangements— whether pursuant to a Rule 10b5-1 plan or otherwise— creates an environment in which it is more difficult for investors to assess whether those parties may be misusing their access to material nonpublic information. This lack of transparency may allow improper trading to go undetected and thereby undermine the deterrent impact of our insider trading laws. In addition, the lack of public information about the use of these arrangements by corporate insiders limits investors’ ability to assess potential incentive conflicts and information asymmetries when making investment and voting decisions. Requiring more robust disclosure of particular trading arrangements should reduce potential abuse of the rule, and inform investors and the Commission regarding potential violations of Rule 10b-5.
The amendments also mandate the following new disclosure requirements:
- Annual disclosure of an issuer’s insider trading policies and procedures;
- Quarterly disclosure by an issuer regarding the use of Rule 10b5-1 plans and certain other written trading arrangements by an issuer’s directors and officers for the trading of its securities;
- Tabular and narrative disclosures regarding awards of options, stock appreciation rights and/or similar option-like instruments granted to insiders shortly before and immediately after the release of material nonpublic information. Specifically, the new amendments require tabular disclosure of each award granted within four business days before and one business day after the filing of a periodic report or the filing or furnishing of a Current Report on Form 8-K (“Form 8-K”) that contains material nonpublic information (other than disclosure of a material new option award grant under Item 5.02(e) of Form 8-K);
- Inline XBRL tagging of the required disclosures;
- A requirement that Section 16 filers indicate, by checkbox, that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c); and
- Require reporting of dispositions of equity securities by bona fide gifts on Form 4, rather than on Form 5.
The final rules will become effective 60 days following after their publication 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. Issuers will be required to comply with the new disclosure requirements in Exchange Act periodic reports on Annual Reports on Form 10-K and Form 20-F, Quarterly Reports on Form 10-Q and in any proxy or information statements in the first filing that covers the first full fiscal period that begins on or after April 1, 2023. Issuers that are smaller reporting companies will be required to comply with the new disclosure requirements in Exchange Act periodic reports on Annual Reports on Form 10-K and Form 20-F, Quarterly Reports on Form 10-Q and in any proxy or information statements in the first filing that covers the first full fiscal period that begins on or after October 1, 2023. The final rules are available here and the fact sheet summarizing the rule is available here.
This publication, which we believe may be of interest to our clients and friends of the firm, is for general information only. It should not be relied upon as legal advice as facts and circumstances may vary. The sharing of this information will not establish a client relationship with the recipient unless Sheppard Mullin is or has been formally engaged to provide legal services.