SEC Unanimously Approves New 10b5-1 Plan Conditions and Expands Required Disclosures

On December 14, 2022, the US Securities and Exchange Commission (SEC) unanimously approved a final rule¹ adopting several significant amendments to the affirmative defense from insider trading liability contained in Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (Exchange Act), and related rules that will require significant additional public disclosures by insiders and issuers. This client alert discusses both the new rules and some of their potential impacts. The final rule reflected several notable changes to the requirements contemplated by the initial proposal made by the SEC in December 2021 that combine to make the final rules less prescriptive and restrictive (particularly for issuers) than many had feared, but several long-standing practices in this important area will still need to be reconsidered and adjusted going forward.

The major changes effected pursuant to the new rules, which are described in more detail below, are:

• new mandatory “cooling-off” periods for 10b5-1 plans;
• new prohibitions on “overlapping” 10b5-1 plans;
• new limitations on more than one “single-trade” 10b5-1 plans per 12-month period;
• a new requirement to act in good faith with respect to 10b5-1 plans in addition to the existing requirement that all 10b5-1 plans be entered into in good faith;
• new requirements for issuers to make quarterly disclosures about the operation and implementation of 10b5-1 plans and to file their insider trading polices (if any) as exhibits to their annual reports; and
• a new checkbox on Form 4 and Form 5 indicating whether a reported transaction was effected pursuant to a 10b5-1 plan.

The final rules also add new disclosure requirements related to grants of options and similar instruments made close in time to disclosure of material nonpublic information. The rules also eliminated an exemption that had allowed insiders to report “bona fide” gifts of securities on an annual basis on Form 5, rather than on a current basis on Form 4 like other dispositions of securities.

The new rules and requirements take effect:

• on February 27, 2023 (60 days after the final adopting release was published in the Federal Register), with respect to the amendments to Rule 10b5-1;
• on April 1, 2023, with respect to changes applicable to reporting under Section 16 of the Exchange Act; and
• in SEC filings that cover the first full fiscal period that begins on or after April 1, 2023 (or October 1, 2023, for smaller reporting companies), with respect to changes applicable to other Exchange Act reporting and disclosure requirements.

Background

The SEC’s purpose in adopting the new rules was to help curb certain potential and perceived abuses that may have allowed insiders to benefit from the affirmative defense under Rule 10b5-1 while they were actually trading securities opportunistically on the basis of material nonpublic information. However, the fundamental structure of Rule 10b5-1 remains the same now as it was before the amendments: there is an affirmative defense to insider trading liability available in connection with any purchase or sale of securities made by a person (including the issuer) pursuant to a contract, instruction or written plan (commonly referred to as a “10b5-1 plan”) if, among other conditions:

• the 10b5-1 plan specifies the amount, price and date of the trade, includes a written formula or algorithm, or computer program, for determining the amount, price and date of the trade or otherwise prevents the person from exercising any subsequent influence over how, when or whether purchases or sales are effected; and
• the person entering into the 10b5-1 plan did not possess material nonpublic information at the time the 10b5-1 plan was entered into.

The new rules eliminate certain historical practices through the addition of several new conditions to the availability of the affirmative defense. The new rules also expand the required public disclosure about the trading activity of insiders, which will increase transparency and could therefore help expose potentially problematic practices or, perhaps more importantly, discourage pursuit of such practices in the first place. Whether the new rules will ultimately be viewed as striking the right balance between eliminating and discouraging opportunistic behavior and eliminating and discouraging beneficial trading activity by insiders remains to be seen.

New Mandatory “Cooling-Off” Periods

Perhaps the most impactful amendment made to Rule 10b5-1 is the addition of mandatory “cooling-off” periods to 10b5-1 plans of directors, “officers”² and any other person seeking to use the affirmative defense, except for issuers. 

For directors and officers, trading of securities under a 10b5-1 plan may not commence until the later of (i) 90 days following adoption or modification of the 10b5-1 plan, or (ii) two business days following the disclosure of the issuer’s financial results in a Form 10-K or Form 10-Q for the fiscal quarter in which the directors’ or officers’ 10b5-1 plan was adopted or modified. While this is still a much longer period than the 30 days that is most commonly used in 10b5-1 plans in the current marketplace on a voluntary basis, it is significantly lower than the 120 days contemplated by the SEC’s initial proposal. The final rule also clarified that in no case shall a “cooling-off’ period applicable to directors and officers exceed 120 days.

For all persons who are not directors or officers (such as employees of the issuer who regularly obtain material nonpublic information in the ordinary course of carrying out their responsibilities), a “cooling-off” period of 30 days following adoption or modification of the 10b5-1 plan would apply. 

A modification of an existing 10b5-1 plan is considered a termination of the old plan and the adoption of a new plan, and any new plan established by a modification of an old plan would trigger a new “cooling-off” period of the same duration. The SEC’s adopting release also makes clear, however, that a modification to a 10b5-1 plan that does not change the amount, price, or timing of the purchase or sale of the securities (for example, in connection with substituting in a new broker-dealer when an insider transfers securities from an account at one financial institution to another) will not trigger a new “cooling-off” period.

Furthermore, while the initial proposal included a “cooling-off” period for issuers, the final rule did not contain this requirement. This may, however, not be the last word on the subject. In the adopting release, the SEC stated that it is continuing to consider whether regulatory action is needed to mitigate any risk of investor harm from the misuse of Rule 10b5-1 plans by the issuer, such as in the share repurchase context.³

Limitations on “Overlapping” and “Single-Trade” Plans

The final rule also amends Rule 10b5-1 to generally prohibit the availability of the affirmative defense under Rule 10b5-1(c) when a person (other than an issuer) has “overlapping” 10b5-1 plans whereby trades under two separate 10b5-1 plans may be effected during the same period of time. However, there are certain limited exceptions to this general prohibition, including that additional 10b5-1 plans can be used solely for purposes of engaging in “sell-to-cover” transactions, whereby securities are sold as necessary to satisfy tax withholding obligations arising exclusively from the vesting of equity awards, provided the award holder does not otherwise exercise control over the timing of the sales, such as would occur if the withholding obligation arose from the award holder’s election to exercise an option or similar instrument, but not for obligations arising upon the vesting of restricted stock, restricted stock units or similar instruments. 

Another new limitation is that the Rule 10b5-1 affirmative defense will only be available for one “single-trade” plan in any 12-month period. As with the limitation on “overlapping” plans, there are certain limited exceptions, including for “sell-to-cover” plans.

While the limitations on issuers using “overlapping” or “single-trade” plans that were contained in the initial proposal were not adopted in the final rule, as was the case with the “cooling-off” period for issuers contained in the initial proposal and not adopted in the final rule, the SEC made clear in the adopting release that future action in this area is still under consideration.

Expanded Good Faith Condition

The new rules add a condition that a person using a 10b5-1 plan must “act[] in good faith with respect to” to 10b5-1 plans in addition to the existing condition that all 10b5-1 plans be “entered into in good faith.” Some of the practices that raised public concern under the prior rules that could have potentially been addressed by this expanded good faith condition⁴  have been effectively banned by the new conditions to the affirmative defense described above, so it may not be clear just what acting in bad faith in this context could entail until the SEC pursues enforcement actions along these lines. However, the SEC did provide at least one example of what would qualify as bad faith in the adopting release: if an insider, while aware of material nonpublic information, directly or indirectly induces the issuer to publicly disclose that information in a manner that makes their trades under a 10b5-1 plan more profitable (or less unprofitable).

New Representation Requirements

The final rule also includes a new requirement that directors and officers must make representations in their respective 10b5-1 plans that the director or officer is:

• not aware of any material nonpublic information; and
• “adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions” of 10b5-1.

Many 10b5-1 plans already contain similar representations. Moreover, while these representations must be certified by the director or officer in their personal capacities, the SEC made clear in the adopting release that the representations are intended to reinforce directors’ and officers’ cognizance of their existing obligations in asserting a 10b5-1 affirmative defense and do not enhance the risk or potential liability directors and officers could be subject to if they violate the rules. More specifically, the SEC also noted in the adopting release that a director’s or officer’s completion of the certification would reflect their personal determination that they do not have material nonpublic information at the time of adoption of a 10b5-1 plan.⁵

Additional 10b5-1 Plan Reporting Requirements for Issuers

The new rules establish a new Item 408(a) of Regulation S-K to require that issuers disclose in their Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q, whether any 10b5-1 plan or “non-Rule 10b5-1 trading arrangement”⁶ was implemented, modified or terminated by the issuer’s directors and officers during the quarterly period covered by such periodic filing. The material non-price terms of any such plan or arrangement must also be disclosed, including the name and title of the insider, the date of adoption, modification or termination, the duration of the plan or arrangement and the number of securities authorized to be purchased or sold pursuant to the plan or arrangement. 

Previously, no SEC rule required disclosure about 10b5-1 plans or similar arrangements adopted by directors and officers, and, as a practical matter, the new rules will require issuers to adopt procedures to collect and report on this information. 

Additional Insider Trading Policies Reporting Requirements for Issuers

Under new Item 408(b) of Regulation S-K, issuers will now also be required to annually disclose in their annual reports or annual meeting proxy statements whether such issuer has adopted policies and procedures related to insider trading, or explain why such issuer has not done so.

The full text of any insider trading policy will also need to be attached as an exhibit to the issuer’s annual report, a requirement that was not included in the initial proposal, which instead contemplated a full summary of any insider trading policy. Although most issuers have insider trading policies only some of them publicly disclose those policies, and, for those that do, it is generally on their websites.

Additional Reporting Requirements for Section 16 Filers

Form 4 and Form 5 will be amended to include a checkbox where Section 16 reporting persons must indicate whether the reported transaction was made pursuant to a 10b5-1 plan and intended to satisfy the affirmative defense conditions of Rule 10b5-1(c). 

The SEC’s final rule will also amend Exchange Act Rule 16a-3 to require the disclosure of “bona fide” gifts on Form 4 within two business days of the gift. Previously, “bona fide” gifts did not trigger a Form 4 filing and were eligible for deferred reporting on Form 5, which must be filed 45 days after the end of the issuer’s fiscal year end. Related to this change, the SEC also clarified that “bona fide” gifts that may also be subject to the insider trading liability of Exchange Act Section 10(b) may also be protected by the affirmative defense under Rule 10b5-1(c) if conducted pursuant to a compliant 10b5-1 plan. 

Additional Reporting Requirements Related to Option Grants

The final rule also adds a new Item 402(x) of Regulation S-K, which will require issuers to make annual disclosures about their policies and practices with respect to granting options and similar instruments relative to disclosure of material nonpublic information.  These annual disclosures will include a detailed table providing information about the change in market price of the securities underlying each relevant award on the trading day before and after disclosure of material nonpublic information.

Implications and Next Steps

Issuers and others using, considering using or otherwise involved in the implementation of 10b5-1 plans and insider trading matters generally need to review the new rules in detail and ensure that all those who need to know how the legal requirements are changing - including directors and officers - know what they need to know when they need to know it. We also offer a few other observations:

• 10b5-1 Plans. We expect that brokerage firms will review their standard 10b5-1 plan agreements and update them as necessary to comply with the new rules. Existing 10b5-1 plans should be reviewed (and potentially amended) for compliance with the new rules, although the adopting release is clear that 10b5-1 plans in existence prior to February 27, 2023, the effective date for the amendments to Rule 10b5-1, can continue to take advantage of the affirmative defense based on the currently effective provisions. Given the new conditions imposed on persons adopting 10b5-1 plans, it is possible that over time more insiders will develop a preference for effecting purchases or sales during open trading windows as opposed to under 10b5-1 plans.
• Insider Trading Policies. Insider trading policies should be reviewed to ensure that they comply with the new rules and reflect any new compliance practices issuers desire to adopt in light of the new rules. In reviewing, issuers should also keep in mind that their insider trading policies will be filed as an exhibit to next year’s annual report for the first time. Systematic public disclosure of insider trading policies will allow for more rigorous comparison in this area of issuers against each other, including by investors, and could result in greater standardization in market practices.
• Form 10-Q/10-K Disclosures. Issuers need to be ready for new Exchange Act reporting obligations, which will start in the periodic report covering the quarter ending after April 1, 2023 (i.e., the Form 10-Q for the quarter ending June 30, 2023 for companies with December 31 fiscal-year-ends), for all issuers other than smaller reporting companies, for which they will start in the periodic report covering the quarter ending after October 1, 2023. Disclosure policies and procedures will need to be up to the task of collecting new types of information outside of the issuer’s direct control from directors and officers.
• Section 16 Reporting. Many issuers prepare and file Section 16 reports on behalf of covered insiders, and the reporting amendments under the new rules will also have to be factored into filings reporting gifts and trades made under 10b5-1 plans.

 

¹ Available at https://www.sec.gov/rules/final/2022/33-11138.pdf.

² As defined in Exchange Act Rule 16a-1(f) and representing those officers that are subject to Section 16 under the Exchange Act.

³ When the 10b5-1 amendments were first proposed, they were accompanied by a companion proposal regarding issuer share repurchases that would also have had profound effects on current practices by, among other things, requiring issuers to publicly report all share repurchases within one business day on new Form SR. Shortly before releasing the final rule on 10b5-1 plans, the SEC reopened the comment period for share repurchase proposals to allow for further consideration in light of the economic effects of the excise tax on share repurchases contained in the Inflation Reduction Act of 2022, which became law after the share repurchase rule was proposed. It remains to be seen whether the SEC will finalize this other proposal (according to the most recent Regulatory Flex Agenda, it is scheduled to do so in April 2023) and, in doing so, include any additional requirements related to 10b5-1 plans that would apply only to issuers.

⁴ Such as insiders adopting multiple overlapping plans and subsequently selectively canceling certain trades under such plans while they are aware of material nonpublic information to obtain the most advantageous price or commencing trades pursuant to a new plan shortly after the adoption of such plan.

⁵ The SEC also notes in the adopting release that legal counsel can assist directors and officers in understanding the meaning of the terms “material” and “nonpublic information,” which are facts and circumstances determinations defined in part by relevant case law.

⁶ As defined by the SEC, this generally includes trading arrangements that meet the two fundamental conditions of the affirmative defense under Rule 10b5-1 described under “Background” above but do not necessarily meet the other conditions that are now required under the new rules. As time goes on, these disclosures should reveal whether some directors and officers continue to rely primarily on only making trading decisions when they do not possess material nonpublic information to guard against potential insider trading liability rather than complying with the additional restrictions necessary to meet all the conditions to the affirmative defense, as amended.