At an Open Meeting on December 14, 2022, the US Securities and Exchange Commission (SEC) adopted amendments to Rule 10b5-1 promulgated under the Securities Exchange Act of 1934 (Exchange Act), which impose new limitations on the ability of insiders of public companies to trade company shares without risking insider trading liability.
The amendments reflect the SEC’s conclusion that the affirmative defense afforded by 10b5-1 trading plans to company insiders included too much room for abuse. While the SEC recognized the role 10b5-1 plans play in providing flexibility to insiders to plan securities transactions in advance when they are not in possession of material nonpublic information (MNPI) about the issuer, the new amendments adjust the balance between company insiders’ interest in trading flexibility and the public’s interest in restricting trading by insiders in possession of MNPI.
During the Open Meeting, SEC Chairman Gary Gensler said that he believed the new limitations would increase investor confidence by further aligning shareholder and insider interests, decreasing the cost of capital for public companies and ensuring greater liquidity for insiders seeking to sell company shares.
To ensure the continued availability of the affirmative defense against allegations of insider trading, we recommend that companies review and update their insider trading policies to comport with the new rules, track compliance with the mandatory cooling-off periods and prepare to file the periodic disclosures called for by the new Rule 10b5-1 plan requirements. With the imposition of these new requirements and disclosure burdens, we expect the SEC Enforcement staff to employ even more resources in policing the Rule 10b5-1 landscape.
NEW CONDITIONS TO THE AVAILABILITY OF THE RULE 10b5-1 AFFIRMATIVE DEFENSE FOR PERSONS OTHER THAN ISSUERS
The amendments include the following new conditions for establishing a Rule 10b5-1 affirmative defense for persons other than issuers:
- Directors and officers, as defined in Section 16a-1(f) of the Exchange Act, may not commence trading of shares under a 10b5-1 plan during a cooling-off period, which runs from the date of adoption or modification of a 10b5-1 plan until the later of: (1) 90 days following plan adoption or modification or (2) two business days following the disclosure in a Form 10-Q or Form 10-K of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified (unless such disclosure exceeds 120 days following plan adoption or modification). Accordingly, the cooling-off period during which the Rule 10b5-1 affirmative defense is unavailable will never exceed 120 days.
- Persons other than directors and officers must refrain from selling company shares for 30 days following the adoption or modification of a 10b5-1 plan.
- Persons other than the issuer can only have one 10b5-1 trading plan at a time for all classes of securities of the issuer, except for the limited purpose of satisfying tax obligations incident to equity compensation awards. This limitation prevents insiders and rank-and-file employees from adopting overlapping 10b5-1 plans that could be used to selectively cancel certain trades while they are aware of MNPI, allowing them to buy or sell securities under the plans that provide the most advantageous price.
- The adoption of an additional 10b5-1 plan used solely to sell shares to satisfy tax withholding obligations incident to the vesting of equity compensation (sell-to-cover) will not trigger the cooling-off period requirements nor will it jeopardize the availability of the affirmative defense for trades already completed pursuant to the pre-existing 10b5-1 plan. However, after the completion of the necessary sell-to-cover transactions, insiders are nonetheless required to pause trading on any pre-existing plan for the applicable cooling-off period.
- Persons other than an issuer can only utilize one single-trade 10b5-1 plan during a consecutive 12-month period.
- At the time of the adoption or modification of a 10b5-1 plan, directors and officers must include a representation in the plan in which they certify that they are: (1) not aware of any MNPI and (2) adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5.
NEW FILING REQUIREMENTS FOR SECTION 16 FILERS
- Insiders making filings under Section 16 of the Exchange Act (Section 16 filers) must indicate in their Form 4 and Form 5 filings whether the purchase or sale reported on the form was made pursuant to a 10b5-1 plan by checking a new box on the topic that was added to these forms by the new rule.
- Section 16 filers must report any gifts of securities within two business days on Form 4 and may no longer report such gifts on a deferred basis on Form 5.
NEW FILING REQUIREMENTS FOR ISSUERS
The amendments treat issuer 10b5-1 plans differently from those of insiders as the amendments do not impose issuer cooling-off periods or restrict issuers from single-trade or overlapping plans. However, the amendments impose new disclosure requirements on issuers:
- New Item 402(x) under Regulation S-K of the Exchange Act requires an issuer to provide narrative and tabular disclosures regarding any options and stock appreciation rights awarded by the issuer within four business days before and one business day after the release of MNPI. These narrative disclosures must discuss the issuer’s policies and practices regarding the timing of award grants, as well as how the issuer takes MNPI into account when determining the timing and terms of an award. Smaller reporting companies (SRCs) and emerging growth companies may limit their disclosure to option grants awarded to principal executive officers (PEOs) and the two most highly compensated executive officers other than the PEO.
- New Item 408 under Regulation S-K requires an issuer to make: (1) quarterly disclosures in its Form 10-Q filings of the use of 10b5-1 plans and certain other trading arrangements by its officers and directors for the trading of its securities and (2) annual disclosure in its Form 10-K filings of its insider trading policies and procedures.
IMPLEMENTING THE NEW AMENDMENTS
The amendments will become effective 60 days following publication of the final rule in the Federal Register. While the amendments will impact 10b5-1 plans adopted or modified on or after the effective date, the amendments will not impact plans adopted before such date unless subsequently modified. The compliance deadline for SRCs is deferred by six months. The SEC stated that the disclosure obligations imposed by the amendments will commence as follows:
Starting April 1, 2023 (October 1, 2023, for SRCs), directors and officers will be required to disclose gifts of securities on Form 4 in accordance with the two-business day deadline, and to disclose whether trades were made pursuant to a 10b5-1 plan, by responding to the new checkbox when reporting trades on Forms 4 and 5.
Beginning with the filing that covers the first full fiscal period beginning on or after April 1, 2023 (or October 1, 2023, for SRCs), issuers will be required to comply with the new disclosure requirements in Forms 10-Q, 10-K and 20-F and in any proxy or information statements. For issuers with a December 31 fiscal year-end other than an SRC, the first periodic report to which the new disclosure requirements apply will therefore be the second calendar-quarter Form 10-Q.
Charles Darantiere, a law clerk in the Washington, DC, office, also contributed to this article.
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