SEC Amends Rule 10b5-1 Trading Arrangement Conditions and Disclosure Requirements for Issuers and Section 16 Reporting Persons to Enhance Insider Trading Protections

Alerts / December 20, 2022
Key Takeaways
  • On Dec. 14, 2022, the Securities and Exchange Commission (SEC) adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (the Exchange Act) and enhanced disclosure requirements, in an attempt to establish guardrails around the use of Rule 10b5-1 trading plans and strengthen protections against insider trading.
  • Amendments to Rule 10b5-1(c)(1) add several conditions to and limitations on the availability of the affirmative defense to liability for insider trading under Rule 10b5-1.
  • Enhanced disclosure requirements include, among other things, disclosures regarding issuers’ policies and procedures related to insider trading and the timing of stock option grants in relation to the disclosure of material nonpublic information.
  • The rules under Section 16 of the Exchange Act were also amended to require that reported transactions effected pursuant to a Rule 10b5-1 trading plan be disclosed and that gifts of equity securities be reported on Form 4 within two business days.

On Dec. 14, 2022, the SEC voted to adopt amendments to Rule 10b5-1 and to enhance disclosure requirements, in an attempt to establish meaningful guardrails around the use of Rule 10b5-1 trading plans and strengthen protections against insider trading.

The amendments include updates to Rule 10b5-1(c)(1), which provides an affirmative defense to insider trading liability, to provide further conditions to and limitations on the availability of such defense. The amendments also require disclosure regarding issuers’ policies and procedures for insider trading and for granting options in advance of the release of material nonpublic information, as well as regarding insiders’ use of plans intended to comply with the requirements of the affirmative defense under Rule 10b5-1(c)(1) (referred to as 10b5-1 plans or trading arrangements) and gifts of securities.

The final rules differ in several respects from the proposed rules, most notably to exclude several of the proposed requirements regarding the use by issuers of Rule 10b5-1 plans.

The rules take effect 60 days after they are published in the Federal Register, though there are phase-in periods for the new disclosure requirements applicable to issuers and Section 16 reporting persons. The new disclosures in periodic reports on Forms 10-Q, 10-K and 20-F and proxy statements discussed herein will be required in the first filing that covers the first full fiscal period beginning on or after (i) for smaller reporting companies, Oct. 1, 2023, and (ii) for all other issuers, April 1, 2023. The changes pertaining to Section 16 reports described herein will be effective for reports filed on or after April 1, 2023.

Amendments to Rule 10b5-1(c)(1)

Rule 10b5-1(c)(1) established a safe harbor from liability for insider trading when it is apparent that a trade was not made based on material nonpublic information because the trade was made under a trading arrangement adopted when the insider was not aware of such information. Since the adoption of Rule 10b5-1(c)(1), many have raised concerns that there is potential within the safe harbor for an insider to engage in certain trading practices that exploit opportunities for abuse.

To reduce the risk of potentially improper trading practices under Rule 10b5-1 trading arrangements, the SEC has added the following conditions to the availability of the affirmative defense under Rule 10b5-1(c)(1):

  • Cooling-Off Periods: The insider must comply with a “cooling-off” period before trading after (i) the adoption of a Rule 10b5-1 trading arrangement or (ii) the modification of the amount, price or timing of the purchase or sale of the securities that are the subject of the trading arrangement or an instruction thereunder, as follows:
    • Where the insider is a director or officer (as defined in Rule 16a-1(f) under the Exchange Act), the cooling-off period runs until the later of (x) 90 days after the adoption or modification of the arrangement or (y) two business days after 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, in any event up to a maximum of 120 days.
    • Where the insider is any other person (other than the issuer), the cooling-off period runs until 30 days after the adoption or modification of the arrangement.

Notably, in a departure from its original rule proposal, the SEC has opted not to adopt a cooling-off period for issuers at this time.

  • 10b5-1 Plan Representations: Directors and officers must include representations in their 10b5-1 plans that, at the time of adoption and at the time of any modification: (i) they were not aware of material nonpublic information regarding the issuer or its securities, and (ii) they were adopting the contract, instruction or plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5.
  • Good Faith Requirement: Directors, officers and other persons (other than the issuer) shall have “acted in good faith with respect to” the Rule 10b5-1 trading arrangement in addition to the current requirement to act in good faith with respect to the adoption.

Further, the SEC specified the following new limitations on the availability of the affirmative defense under Rule 10b5-1, both of which apply to officers, directors or any other person (other than the issuer):

  • Restriction on Overlapping Trading Arrangements:
    • The affirmative defense under Rule 10b5-1(c)(1) is no longer available for multiple, overlapping trading arrangements for open market trades in the securities of the issuer; however, insiders may:
      • Adopt a second plan, without losing the affirmative defense, if the plan is used solely to satisfy certain tax obligations incident to the vesting of equity compensation (but not with respect to the exercise of options).
      • Have one later-commencing plan under which trading is not authorized to begin until after all trades under the earlier-commencing plan are completed or such plan has expired and a cooling-off period has ended.
    • In recognition of the fact that insiders often hold securities in different accounts, the final rule provides that a series of separate contracts with different broker-dealers to execute trades may be treated as a single “plan,” provided that the contracts with each broker-dealer, taken together as a whole, meet all the applicable conditions of and remain collectively subject to the provisions of Rule 10b5-1(c)(1).
  • Restriction on Single-Trade Arrangements: The affirmative defense under Rule 10b5-1(c)(1) will only be available for one single-trade plan in any 12-month period.

The final amendments also provide that a modification or change to the amount, price or timing of the purchase or sale of the securities underlying a Rule 10b5-1 plan is treated as a termination of the plan and the adoption of a new plan, and to the extent that insiders seek to continue to rely on the affirmative defense, they would be subject to a new cooling-off period.

Additional Disclosure Regarding Rule 10b5-1 Trading Arrangements and Insider Trading Policies

The SEC has adopted certain enhanced disclosure requirements in order to better allow investors, the SEC and other market participants to observe how directors and officers use Rule 10b5-1 plans and non-Rule 10b5-1 trading arrangements. The SEC has added a new Item 408 under Regulation S-K and amendments to Forms 10-Q, 10-K and 20-F and to the requirements under proxy and information statements on Schedules 14A and 14C to require:

  • The quarterly disclosure of the adoption or termination of any Rule 10b5-1 trading arrangements or non-Rule 10b5-1 trading arrangements by directors and officers, and the material terms (other than with respect to the authorized trading price) of any such plans.
  • The annual provision of the issuer’s insider trading policies and procedures as an exhibit to the issuer’s Form 10-K or 20F, as applicable, and its proxy or information statement on Schedules 14A and 14C. If, however, the issuer has not adopted such insider trading policies and procedures, it must explain why it has not.
Disclosure Regarding the Timing of Grants of Options, SARs and Similar Awards

The SEC has adopted amendments to Item 402 of Regulation S-K, which would require an issuer to disclose, in its annual reports and proxy or information statements, (i) its policies regarding equity incentive award grant timing in relation to the release of material nonpublic information and (ii) a table setting forth all options, stock appreciation rights, and other option-like awards awarded to a named executive officer or director within the period beginning four days before the filing of a periodic report by an issuer or of the filing or furnishing of a Form 8-K disclosing material nonpublic information, and ending one day after the applicable filing or furnishment.

The purpose of the narrative disclosure is to provide insight regarding the issuer’s practices regarding grants of options and option-like awards, and the purpose of the tabular disclosure is to highlight for investors award grants that may be more likely than most to have been made at a time that the board of directors was aware of material nonpublic information affecting the value of the award. The table must include for each named executive officer (as applicable) and on an award-by-award basis, (i) the grant date, number of shares and exercise price of the option award, (ii) the grant date fair value of each award computed using the same methodology as used for the issuer’s financial statements under GAAP, and (iii) the percentage change in the market price of the underlying securities between the closing market price of the security one trading day before and one trading day after the disclosure of material nonpublic information.

Section 16 Changes – Identifying Rule 10b5-1 Plan Transactions and Reporting of Gifts on Form 4

The SEC has added a Rule 10b5-1(c)(1) checkbox to Forms 4 and 5, which requires Section 16 reporting persons to indicate whether a trade reported on such form was made pursuant to an arrangement intended to satisfy the affirmative defense conditions of Rule 10b5-1(c)(1). If so, the filer must provide the date such Rule 10b5-1 trading arrangement was adopted and can also voluntarily provide additional information relevant to the reported transaction.

Finally, the SEC has adopted amendments to require prompt reporting of bona fide gifts of equity securities by Section 16 reporting persons. Previously, gifts of equity securities were required to be reported on Form 5 within 45 days after the issuer’s last fiscal year-end. The amendment, as adopted, requires filers to report a gift of equity securities on Form 4 before the end of the second business day following the transaction date.

Authorship credit: Jennifer R. Rodriguez, Brittany Stevenson and Janet A. Spreen

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