In December 2022, the SEC adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 and new disclosure requirements to enhance investor protections against insider trading. Rule 10b5-1 under the Securities Exchange Act of 1934 provides an affirmative defense from insider trading liability on the basis of material nonpublic information (“MNPI”) as long as the conditions set forth in Rule 10b5-1 are met. In recent years, studies have shown that some trading plans designed to comply with Rule 10b5-1 have been abnormally profitable, suggesting that at least some corporate insiders were exploiting the liability protections of Rule 10b5-1 plans to trade opportunistically on the basis of MNPI. The SEC’s amendments address these abusive practices by adding requirements for insiders to avail themselves of the affirmative defense under Rule 10b5-1, and impose new disclosure obligations on insiders and companies.
Rule 10b5-1 originally provided an affirmative defense against insider trading liability if trades were undertaken in accordance with a written plan adopted in good faith when the insider was not aware of MNPI. The amendments impose additional conditions for the affirmative defense, including:
Cooling-Off Periods. Rule 10b5-1 now requires that a director or officer[1] may not trade under a Rule 10b5-1 plan until the later of: (a) 90 days after plan adoption or certain modifications of a Rule 10b5-1 plan or (b) two business days after filing of a Form 10-Q or Form 10-K (or, for foreign private issuers, a Form 20-F or Form 6-K) disclosing the issuer’s financial results for the quarter in which the plan was adopted or modified (subject to a maximum of 120 days after adoption or modification). Persons that are not directors or officers may trade under a Rule 10b5-1 plan after a 30-day cooling-off period following adoptions and modifications of a Rule 10b5-1 plan. Importantly, modifications that do not alter the sale or purchase prices or ranges, the amount of securities to be sold or purchased, or the timing of trades under a 10b5-1 plan do not trigger a cooling-off period; however, modifications that do alter such terms are treated as equivalent to adoptions of a new plan and, accordingly, will require compliance with a fresh cooling-off period. The SEC did not impose cooling-off periods on issuers at this time, but said further consideration is warranted to mitigate risk of investor harm from misuse of Rule 10b5-1 plans by issuers, such as in the share repurchase context.
Certifications. Directors and officers must certify in their 10b5-1 plans at time of adoption or modification that they (a) are not aware of MNPI about the issuer or its securities and (b) are adopting the plan in good faith and not as part of a plan or scheme to evade insider trading prohibitions of Rule 10b-5.
Extension of Good Faith Requirement. The good faith obligation extends beyond the adoption of a 10b5-1 plan to require that the insider continue to act in good faith throughout the duration of the plan. This obligation is also intended to help ensure that insiders do not engage in opportunistic trading under a Rule 10b5-1 plan, and to deter insiders from influencing the timing of company disclosures to benefit trades under their plan.
Restrictions on Multiple, Overlapping Plans and Single-Trade Plans. The affirmative defense against insider trading liability will not be available if the insider has another outstanding contract, instruction or plan that would qualify for the affirmative defense under Rule 10b5-1 for purchases or sales of the issuer’s securities during the same period.[2] The affirmative defense will also not be available to an insider for more than one single-trade plan during any 12-month period. These restrictions do not apply to Rule 10b5-1 plans of issuers.
By Issuers. To provide greater detail and transparency to investors regarding the use of Rule 10b5-1 plans and insider trading policies and procedures relating to the protection of MNPI, issuers will be required to make new disclosures in their Exchange Act reports. If, during the last fiscal quarter, any director or officer has adopted or terminated a 10b5-1 plan or a pre-arranged trading plan that does not qualify as a Rule 10b5-1 plan (including modifications to any such plans), issuers must provide a description of the material terms of such plans, including the name and title of the director or officer, date of the adoption or termination, duration, and aggregate number of shares to be sold or purchased. Issuers are not required to disclose the price at which trades are authorized to be made under the plan. On a yearly basis, issuers are required to disclose (in Form 10-K, Form 20-F and in any proxy statements) whether the issuer has adopted insider trading-related policies and procedures governing the purchase, sale or other disposition of their securities by directors, officers, employees or the issuer itself and, if not, to explain why that is the case. A copy of such policies and procedures must be filed as an exhibit to such Form 10-K or Form 20-F.
The amendment also requires additional executive compensation information under new Item 402(x) of Regulation S-K, which requires issuers to disclose in their Form 10-K, Form 20-F and proxy or information statements, their policies and practices regarding the timing of stock option grants in relation to the release of MNPI. A description is required of how the board of directors determines when to grant such awards (for example, whether awards are granted on a predetermined schedule). Furthermore, issuers must disclose if and how the board considers MNPI in determining the timing and terms of an award, including whether the issuer times the public release of MNPI for the purpose of affecting the value of equity awards (e.g., “spring-loading” option grants to occur immediately before the release of positive MNPI or “bullet dodging” option grants to occur immediately after the release of negative MNPI).
New Item 402(x) of Regulation S-K requires tabular disclosure for equity awards granted to Named Executive Officers within four business days before, and one business day after, the filing of a periodic report on Form 10-Q or 10-K or the filing or furnishing of a current report on Form 8-K that contains MNPI (including earnings information), The table must also disclose the percentage change in the market price of securities from one trading day before, to one trading day after, the disclosure of MNPI.
By Directors, Officers & 10% Shareholders. Persons required to file reports under Section 16(a) of the Exchange Act must indicate by checkbox on their Form 4 and Form 5 filings whether a reported trade is pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and must disclose the date of adoption of the trading plan. In addition, dispositions by a bona fide gift of equity that was previously permitted to be reported on a delayed basis on Form 5 must now be reported on Form 4 within two business days pursuant to revised Rule 16a-3. Acquisitions by gift may still be reported on Form 5. It should be noted that the SEC clarified that the affirmative defense of Rule 10b5-1(c)(1) is available for bona fide gifts of equity securities.
The changes summarized above are effective February 27, 2023 (60 days from publication in the Federal Register). Existing Rule 10b5-1 plans will not be affected, unless modified after the February 27, 2023 effective date. The Section 16 changes apply to Forms 4 and 5 filed on or after April 1, 2023. New disclosures in Form 10-Q, Form 10-K , Form 20-F and proxy or information statements will be mandated in filings that cover the first full fiscal period beginning on or after April 1, 2023. A delay of six months applies to smaller reporting companies with respect to such issuer disclosure requirements.
Public companies should review their insider trading policies and procedures as well as their option grant policies and practices in light of the new rules and prepare for the enhanced public disclosure requirements applicable in their Exchange Act reports and for their directors and officers.
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[1] “officer” is defined as an issuer's president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer. Officers of the issuer's parent(s) or subsidiaries shall be deemed officers of the issuer if they perform such policy-making functions for the issuer.
[2] There are several exceptions that permit the affirmative defense for multiple plans under specified circumstances, which are beyond the scope of this summary.