SEC Takes Aim at Rule 10b5-1 Trading Plans

Mike Bienenfeld, Jeff Cohen, Doug Davison, Alejandro Gordano, Mas Harntha, Jason Manketo, Luis Roth, Clara Pang, Alexander Parkhouse, Igor Rogovoy, Pam Shores, Cole Smith, Andrew Gaines, Jeremy Slotnick.

Under amendments adopted by the U.S. Securities and Exchange Commission, officers and directors of U.S. public companies will soon be required to satisfy additional conditions, such as cooling-off periods and certifications, in order to rely on Rule 10b5-1 of the U.S. Securities Exchange Act of 1934 as a defense to insider trading charges. The amendments would also require registrants to make, for the first time, specific disclosures regarding Rule 10b5-1 trading arrangements, as well as their insider trading plans and procedures.

The new conditions to Rule 10b5-1 become effective 60 days after the amendments are published in the Federal Register, which means they will likely become effective at the end of February or early March 2023. The new disclosure requirements become effective later: registrants (other than smaller reporting companies) will be required to make the new disclosures on Forms 10-Q, 10-K, and 20-F 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.

Rule 10b5-1

Insider trading is primarily regulated by Section 10(b) of the Exchange Act, which prohibits the use, in connection with the purchase or sale of any security, of “any manipulative or deceptive device or contrivance.” This includes the purchase or sale of a security on the basis of material nonpublic information (MNPI) about that security or its issuer, in breach of a duty owed to the issuer, its shareholders, or any person who is the source of the MNPI. Rule 10b5-1 states that a purchase or sale of an issuer’s security is made on the basis of MNPI if the person making the purchase or sale was aware of MNPI at the time of the purchase or sale.

Rule 10b5-1(c) provides an affirmative defense to insider trading where, among other things, the trade was made pursuant to a binding contract, an instruction to another person to execute the trade for the instructing person’s account, or a written plan adopted when the trader was not aware of MNPI.

Additional Rule 10b5-1 conditions

The Rule 10b5-1 amendments add new conditions to the availability of Rule 10b5-1(c)(1) as an affirmative defense to insider trading liability, including:

• Cooling-off periods – Currently, under Rule 10b5-1(c)(1), a trader can adopt a Rule 10b5-1 plan and execute a trade under the plan on the same day. To address concerns that corporate insiders may be aware of MPNI at the time of the adoption of a Rule 10b5-1 plan, the amendments establish the following “cooling-off” periods:
  • Directors and officers – A director or officer of the issuer who adopts a Rule 10b5-1 plan (including a modification of a plan, as described in the sidebar) 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: (i) 90 days after the adoption of the Rule 10b5-1 plan; or (ii) two business days following the disclosure of the issuer’s financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted or, for foreign private issuers, in a Form 20-F or Form 6-K that discloses the issuer’s financial results. The required cooling off period is subject to a maximum of 120 days after adoption of the plan.
  • Other persons – Persons other than directors or officers of the issuer (such as an employee) must comply with a 30-day cooling-off period.
  • Issuer – Issuers relying on Rule 10b5-1 for their share repurchase programs are not subject to a cooling-off period.
• Certifications – Under the final rule, in order to rely on the Rule 10b5-1 affirmative defense, directors and officers 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: (i) they are not aware of MNPI about the issuer or its securities; and (ii) they are 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. The certification can be included in the Rule 10b5-1 plan as representations, rather than prepared as a separate document to be presented to the issuer.
• Multiple overlapping plans – The amendments add a condition to Rule 10b5-1(c)(1) that persons, other than issuers, may not have another outstanding (and may not subsequently enter into any additional) contract, instruction or plan that would qualify for the Rule 10b5-1 affirmative defense for purchases or sales of any class of the issuer’s securities on the open market during the same period, with exceptions for:
  • a series of separate contracts with different broker-dealers or other agents acting on behalf of the person to execute trades (these may be treated as a single “plan,” provided that the contracts, when taken together as a whole, meet all applicable conditions of and remain collectively subject to Rule 10b5-1);
  • maintaining 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, unless the first trade under the later-commencing plan is scheduled to begin during the effective cooling-off period (in which case this exception is not available); and
  • a plan providing for an eligible “sell-to-cover transaction” (where an insider instructs their agent to sell securities in order to satisfy tax withholding obligations at the time an award vests) alongside an otherwise eligible Rule 10b5-1 plan.
• Single-trade plans – Under the amendments, a person (other than the issuer) can only rely on the Rule 10b5-1 affirmative defense for one single-trade plan during any 12-month period. 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. A plan is “designed to effect” the purchase or sale of securities as a single transaction when the contract, instruction, or plan has the practical effect of requiring such a result. By contrast, a plan is not designed to effect a single transaction where the plan leaves the person’s agent discretion over whether to execute the contract, instruction, or plan as a single transaction.
• Good faith requirement – Currently, the Rule 10b5-1(c) affirmative defense requires a trading arrangement to only be “given or entered into” in good faith. The amendments add the condition that the person who entered into the Rule 10b5-1 contract, instruction, or plan “has acted in good faith with respect to” the contract, instruction, or plan. As an example, the adopting release states that a corporate insider would not be acting in good faith respect to a Rule 10b5-1 plan if, while aware of MNPI, they directly or indirectly induce the issuer to publicly disclose that information in a manner that makes their trades under a Rule 10b5-1 plan more profitable (or less unprofitable). In such case, even if the Rule 10b5-1 plan was adopted or entered into in good faith, the corporate insider would not be entitled to the Rule 10b5-1 affirmative defense.

Disclosure of trading plans and insider trading policies

The amendments will require registrants to make, for the first time, disclosures in Exchange Act reports regarding the Rule 10b5-1 trading arrangements of their officers and directors, as well as their insider trading policies and procedures. These disclosures will be subject to the CEO and CFO certifications required by Section 302 of the U.S. Sarbanes-Oxley Act of 2002.

The new disclosures include:

• Insider trading policies – New Item 408(b) of Regulation S-K under the U.S. Securities Act of 1933 and new Item 16J of Form 20-F requires registrants to disclose in their annual reports their insider trading policies and procedures, or disclose why they have not adopted any. Item 601 of Regulation S-K and Form 20-F requires issuers to file a copy of their insider trading policies and procedures as an exhibit to Forms 10-K and 20-F, respectively.
• Equity grants – New Item 402(x) of Regulation S-K requires the disclosure of a registrant’s policies and practices on the timing of awards of stock options, stock appreciation rights or similar option-like instruments in relation to the disclosure of MNPI by the registrant, including how the board of director determines when to grant options, whether the board or compensation committee takes MNPI into account when determining the timing and terms of an award; and whether the registrant has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation. Tabular disclosure is required of each option 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 that contains MNPI (other than disclosure of a material new option award grant under Item 5.02(e) of Form 8-K).
• Trading arrangements – New Item 408(a) of Regulation S-K requires registrants to disclose:
  • whether, during the registrant’s last fiscal quarter, any director or officer has adopted or terminated any Rule 10b5-1(c) trading arrangements and/or any “non-Rule 10b5-1 trading arrangement” (as defined in the sidebar); and
  • 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.
• Inline XBRL – The disclosures in new Items 402(x), 408(a), and 408(b)(1) of Regulation S-K, and new Item 16J(a) of Form 20-F must be tagged using Inline eXtensible Business Reporting Language (“Inline XBRL”).
• Section 16 reporting – Section 16 directors and officers are required to disclose, by checking a box on Forms 4 and 5, whether a reported transaction was made pursuant to a trading arrangement intended to satisfy the Rule 10b-1(c) affirmative defense conditions. Corporate insiders subject to the reporting requirements of Exchange Act Section 16 are also required to promptly disclose bona fide gifts of securities on Form 4.

Implications and next steps for foreign private issuers

Foreign private issuers should review any Rule 10b5-1 trading plans that their directors or officers currently operate to confirm that they are appropriately updated to comply with amended Rule 10b5-1 from its effective date. These amendments will become effective in the first quarter of 2023, so reviews should be conducted sooner rather than later. The SEC has confirmed that the availability of the affirmative defense under existing Rule 10b5-1 plans entered into prior to the amended rule’s effective date is not affected by the amendments, except to the extent such plan is modified or changed after the effective date of the final rules.

In terms of disclosure, foreign private issuers will only be required to disclose their insider trading plans and procedures (as required by new Item 16J of Form 20-F), and tag these disclosures using Inline XBRL. They will not need to do so until their annual report covering the first full fiscal period beginning on or after April 1, 2023.

Notably, the SEC opted not to subject foreign private issuers to Section 16 reporting, as the SEC’s Investor Advisory Committee had recommended in 2021.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.