Key Takeaways

• Share repurchase/buyback proposal would:
  • Establish new Form SR for reporting repurchases of equity securities registered under Section 12 of the Securities Exchange Act of 1934 by issuers and affiliated purchasers.
  • Require issuers to furnish a Form SR with the SEC before the end of the first business day following the day of the buyback date.
  • Expand existing periodic disclosure regarding share repurchases.
• Rule 10b5-1 proposal would:
  • Add new conditions to the availability of the affirmative defense under Exchange Act Rule 10b5-1(c)(1), including minimum post-adoption cooling-off periods before trading can begin (120 days for directors and officers and 30 days for issuers), no overlapping Rule 10b5-1 plans for open market trades in the same class of securities, a limit of one single-trade plan per 12-month period and a requirement to operate (not just adopt) plans in good faith.
  • Create new certification and disclosure requirements regarding issuers’ insider trading policies and regarding the adoption and termination (including modification) of Rule 10b5-1 and certain other trading arrangements by directors, officers, and issuers.
  • Create new disclosure requirements for executive and director equity compensation awards granted during certain time periods.
  • Update Forms 4 and 5 to require Section 16 insiders to identify transactions made pursuant to a Rule 10b5-1(c)(1) trading arrangement and to disclose all gifts of securities on Form 4.

* * * * *

As expected,¹ the U.S. Securities and Exchange Commission released two significant rule proposals for issuers on December 15, 2021—one regarding issuer share repurchases and the other regarding issuer and director and officer Rule 10b5-1 insider trading plans. The share repurchase proposal was approved by a three-to-two vote and the Rule 10b5-1 proposal was approved unanimously.² The proposals are subject to a public comment period and final rulemaking.

Share Repurchase/Buyback Proposal

The SEC’s share repurchase proposal is premised on a concern that, although “there are legitimate business reasons for issuers to repurchase securities,”… “issuer repurchases could potentially be used to increase share prices in order to enhance executive compensation and insider stock value.” According to the SEC, these concerns, against the backdrop of an increasing volume of issuer share repurchases, suggest the need for expanded disclosure related to issuer share repurchases that “would allow [investors] to assess the impact of an issuer’s share repurchases on the issuer’s stock price.” Although many issuers are subject to existing quarterly disclosure obligations regarding their share repurchases, and many issuers voluntarily report information regarding their share repurchase plans, the proposal would require significantly more detailed, immediate and frequent disclosure.

New Exchange Act Rule 13a-21 and Form SR

The share repurchase proposal would add new Exchange Act Rule 13a-21 and Form SR³ that would require an issuer⁴ to report any purchase made by or on behalf of the issuer or any affiliated purchaser⁵ of shares or other units of any class of the issuer’s equity securities that is registered by the issuer pursuant to Exchange Act Section 12. The issuer would have to furnish a new Form SR before the end of the first business day following the day on which the issuer executes⁶ a share repurchase. The Form SR would require the following disclosure in tabular format, by date, for each class or series of securities:

• Identification of the class of securities purchased;
• The total number of shares (or units) purchased, including all issuer repurchases whether or not made pursuant to publicly announced plans or programs;
• The average price paid per share (or unit);
• The aggregate total number of shares (or units) purchased on the open market;
• The aggregate total number of shares (or units) purchased in reliance on the Rule 10b-18 safe harbor; and
• The aggregate total number of shares (or units) purchased pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c).

Proposed Revisions to Item 703, Form 20-F, and Form N-CSR

The share repurchase proposal would amend Item 703 of Regulation S-K, with corresponding changes to Form 20-F and Form N-CSR, to require an issuer to disclose:

• The objective or rationale for its share repurchases and process or criteria used to determine the amount of repurchases;⁷
• Any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions;
• Whether it made its repurchases pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and if so, the date that the plan was adopted or terminated;
• Whether purchases were made in reliance on the Rule 10b-18 non-exclusive safe harbor;
• Any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restrictions on such transactions.⁸

The proposal would also require that issuers check a box (added to the text that precedes the currently required tabular disclosure of issuer purchases of equity securities) if any of their directors or Section 16 officers purchased or sold shares or other units of the class of the issuer’s equity securities that is the subject of an issuer share repurchase plan or program within 10 business days before or after the announcement⁹ of an issuer purchase plan or program.

Rule 10b5-1 Proposal

Rule 10b5-1 under the Securities Exchange Act of 1934 provides directors, officers and issuers with an affirmative defense to Rule 10b-5 insider trading charges for trades 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, subject to several conditions.¹⁰

The basic concept behind the Rule 10b5-1 affirmative defense is simple: if an insider has no control over the stock sales and purchases (either because an external trading manager is used or because transactions occur according to a pre-determined formula), material non-public information cannot have been the basis for the transactions, and therefore no insider trading was committed. Similarly, to the extent a securities fraud class action points to a defendant’s purportedly “suspicious” stock trades in an attempt to raise a strong inference of scienter, a defendant may attempt to rebut such an inference by arguing that the trades were made pursuant to a Rule 10b5-1 plan.

In response to “concerns about abuse of the rule to opportunistically trade securities on the basis of material nonpublic information in ways that harm investors and undermine the integrity of the securities markets,”¹¹ the Rule 10b5-1 proposal would add a number of conditions to the availability of the affirmative defense under Rule 10b5-1 and add a number of disclosure obligations.

Cooling-Off Condition

Currently, Rule 10b5-1(c)(1) does not impose any waiting period between the date the trading arrangement is adopted and the date of the first transaction to be executed under the trading arrangement. To “reduce the risk that an insider could benefit from any material nonpublic information of which they may have been aware at the time of adopting the trading arrangement,” the proposal would amend Rule 10b5-1(c)(1) to add as a condition to the availability of the affirmative defense: (1) a minimum 120-day cooling-off period after the date of adoption of any Rule 10b5-1(c)(1) trading arrangement (including adoption of a modified trading arrangement) by a director or officer¹² before any purchases or sales under the new or modified trading arrangement; and (2) a minimum 30-day cooling-off period after the date of adoption of any Rule 10b5-1(c)(1) trading arrangement by an issuer before any purchases or sales under the new or modified trading arrangement. A “modification” of an existing Rule 10b5-1(c)(1) trading arrangement, including cancelling one or more trades, would be deemed equivalent to terminating the plan in its entirety, and the cooling-off period would therefore apply after a “modification” before any new trades could commence.

Certification Condition

To “reinforce directors’ and officers’ cognizance of their obligation not to trade or adopt a trading plan while aware of material nonpublic information, that it is their responsibility to determine whether they are aware of material non-public information when adopting Rule 10b5-1 plans, and that the affirmative defense under Rule 10b5-1 requires them to act in good faith and not to adopt such plans as part of a plan or scheme to evade the insider trading laws,” the proposal would amend Rule 10b5-1(c)(1)(ii) to provide that if a director or officer of the issuer of the securities adopts a Rule 10b5-1 trading arrangement, as a condition to the availability of the affirmative defense, such director or officer would be required to promptly furnish to the issuer a written certification at the time of the adoption of a new/modified trading arrangement stating:

• That they are not aware of material nonpublic information about the issuer or its securities; and
• That 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 Exchange Act Section 10(b) and Exchange Act Rule 10b-5.

These personal certifications would not be required where a director or officer terminates an existing Rule 10b5-1 trading arrangement and does not adopt a new/modified trading arrangement for which the affirmative defense is sought. As proposed, there would be no requirement to file these certifications, but the director or officer would be required to retain a copy of the certification for a period of ten years.

No-Overlapping Trading Arrangements Condition and Single-Trade Plan Limit Condition

Currently, there is no limit on the number of plans or other Rule 10b5-1(c)(1) trading arrangements that a person can have in effect simultaneously. The proposal expresses concern that setting up multiple overlapping Rule 10b5-1(c)(1) trading arrangements could allow insiders to “exploit inside information by setting up trades timed to occur around dates on which they expect the issuer will likely release material nonpublic information” and to circumvent the proposed cooling-off period. In response, the proposal would amend Rule 10b5-1(c)(1) to eliminate the affirmative defense for trades under a trading arrangement when the trader maintains another trading arrangement, or subsequently enters into an additional overlapping trading arrangement, for open market purchases or sales of the same class of securities. This limitation would not apply to transactions where a person acquires (or sells) securities directly from the issuer, such as acquiring shares through participation in employee stock ownership plans or dividend reinvestment plans, which are not executed by the director or officer on the open market.

For similar reasons, the proposal would amend Rule 10b5-1(c)(1)(ii) so that the affirmative defense would not be available for a single-trade plan if the trader had, within a 12-month period, purchased or sold securities pursuant to another single-trade plan.¹³

Good Faith Operation Condition

Currently, Rule 10b5-1 requires that the contract, instruction, or plan to purchase or sell securities was “given or entered into” in good faith. To “help deter fraudulent and manipulative conduct and enhance investor protection throughout the duration of the trading arrangement,” the proposal would amend Rule 10b5-1(c)(1)(ii) to add the condition that a contract, instruction, or plan be “operated” in good faith. For example, the affirmative defense would not be available to a trader who:

• Cancels or modifies their plan in an effort to evade the prohibitions of the rule; or
• Uses their influence to affect the timing of a corporate disclosure to occur before or after a planned trade to make such trade more profitable or to avoid or reduce a loss.

New Item 408 Disclosure

Currently, there are no mandatory disclosure requirements concerning the use of Rule 10b5-1 trading arrangements or other trading arrangements by companies or insiders, and issuers are not required to disclose their insider trading policies or procedures. The proposal expresses concern that the lack of a disclosure requirement “deprives investors of the ability to assess whether those parties may be misusing their access to material nonpublic information” and makes it harder for investors to assess how the issuer “protects material nonpublic information from misuse.”¹⁴

Proposed Item 408(a) of Regulation S-K would require issuers to disclose in Form 10-Q and Form 10-K:¹⁵

• Whether, during the issuer’s last fiscal quarter (the issuer’s fourth fiscal quarter in the case of an annual report), the issuer has adopted or terminated any contract, instruction or written plan to purchase or sell securities of the issuer, whether or not intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and provide a description of the material terms of the contract, instruction or written plan, including:
  • The date of adoption or termination;¹⁶
  • The duration of the contract, instruction or written plan; and
  • The aggregate amount of securities to be sold or purchased pursuant to the contract, instruction or written plan.
• Whether, during the issuer’s last fiscal quarter, any director or officer has adopted or terminated any contract, instruction or written plan for the purchase or sale of equity securities of the issuer, whether or not intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and provide a description of the material terms of the contract, instruction or written plan, including:
  • The name and title of the director or officer;
  • The date on which the director or officer adopted or terminated the contract instruction or written plan;
  • The duration of the contract instruction or written plan; and
  • The aggregate number of securities to be sold or purchased pursuant to the contract, instruction or written plan.

In addition, proposed Item 408(b) of Regulation S-K would require an issuer, in its annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C,¹⁷ to disclose whether the issuer has adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of the issuer’s securities by directors, officers, and employees or the issuer itself that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the issuer. If the issuer has adopted insider trading policies and procedures, it must disclose such policies and procedures.¹⁸ If the issuer has not adopted such insider trading policies and procedures, it must explain why it has not done so.

The proposal notes that Item 408(b) of Regulation S-K would not specify all details that an issuer should address in its insider trading policies, nor does it prescribe any specific language that such policies must include. The proposal suggests that such details may include: information on the issuer’s process for analyzing whether directors, officers, employees, or the issuer itself when conducting an open-market share repurchase have material nonpublic information; the issuer’s process for documenting such analyses and approving requests to purchase or sell its securities; or how the issuer enforces compliance with any such policies and procedures it may have, including through gifts of such securities.

The proposed Item 408 disclosures would be subject to the principal executive and principal financial officer certifications required by Section 302 of the Sarbanes-Oxley Act, and would be required to be tagged using Inline eXtensible Business Reporting Language.

New Section 16 Disclosure

Currently, persons subject to Section 16 reporting are required to disclose changes in their beneficial ownership on Form 4 or 5. Form 4 is due before the end of the second business day following the date of execution of the transaction it reports. Form 5 is not due until 45 days after year end.

The proposal would require a Form 4 or 5 filer to check a box on that form to indicate whether a sale or purchase reported on that form was made pursuant to a Rule 10b5-1(c) trading arrangement. Filers would also be required to provide the date of adoption of the Rule 10b5-1 trading arrangement, and would have the option to provide additional relevant information about the reported transaction. Forms 4 and 5 would also have a second, optional checkbox that would allow a filer to indicate whether a transaction reported on the form was made pursuant to a pre-planned contract, instruction, or written plan that is not intended to satisfy the conditions of Rule 10b5-1(c).

To address concerns the “length of the filing period for Form 5 may allow insiders to engage in problematic practices involving gifts of securities, such as insiders making stock gifts while in possession of material nonpublic information, or backdating a stock gift in order to maximize a donor’s tax benefit,” the proposal would amend Exchange Act Rule 16a-3 to require the reporting of dispositions of bona fide gifts of equity securities on Form 4 (instead of Form 5).

New Item 402 Disclosure

The proposal would add a new paragraph to Item 402 of Regulation S-K to address the SEC’s concern regarding the timing of option grants. The proposal notes that timing option grants to occur immediately before the release of positive material nonpublic information (“spring-loading”) can benefit executives with an option award that will likely be in-the-money as soon as the material nonpublic information is made public. Alternatively, if an issuer is aware of material nonpublic information that is likely to decrease its stock price, it may decide to delay a planned option award until after the release of such information (“bullet-dodging”).

Under the proposal, to identify if any such timed options are granted, a new paragraph would be added to Item 402 of Regulation S-K that would require tabular disclosure of each option¹⁹ award (including the number of securities underlying the award, the date of grant, the grant date fair value, and the option’s exercise price) granted to named executive officers²⁰ within 14 calendar days before or after the filing of a periodic report, an issuer share repurchase, or the filing or furnishing of a current report on Form 8-K that contains material nonpublic information; the market price of the underlying securities the trading day before disclosure of the material nonpublic information; and the market price of the underlying securities the trading day after disclosure of the material nonpublic information.²¹

Under the proposed rule, disclosure would also be required of the grant date fair value of each equity award computed in accordance with FASB ASC Topic 718.

In addition, the proposed rule would require narrative disclosure about an issuer’s option grant policies and practices regarding the timing of option grants and the release of material nonpublic information, including how the board determines when to grant options and whether, and if so, how, the board or compensation committee takes material nonpublic information into account when determining the timing and terms of an award.

The proposal would require this disclosure in annual reports on Form 10-K, as well as in proxy statements and information statements related to the election of directors, shareholder approval of new compensation plans, and solicitations of advisory votes to approve executive compensation.²² For issuers that are subject to CD&A, the proposed narrative disclosure could be included in CD&A. The disclosure would be required to be tagged using Inline eXtensible Business Reporting Language.

Enforcement Activity

Rule 10b5-1, under the existing regulatory framework, does not provide an exemption from the federal securities laws prohibiting insider trading. Rather, it provides only an affirmative defense. Importantly, this affirmative defense is not available if the insider is in possession of material non-public information at the time the plan is implemented or revised, if the plan is not entered in good faith, or if the plan is part of a scheme to circumvent the insider trading rules. Indeed, the SEC has, and can, bring an enforcement action against an individual for insider trading even when the trades were made pursuant to a 10b5-1 plan.

In October 2010, for example, the SEC announced a landmark US$22.5 million negotiated penalty in an action against Angelo Mozilo, a corporate executive alleged to have “engaged in insider trading in the securities … by establishing four 10b5-1 sales plans in October, November, and December 2006 while he was aware of [material non-public information].” Mozilo agreed to the penalty after his attempt to dismiss the case in federal court was denied, with the district court judge holding that because the “plans [were] adopted or amended while Mozilo was in possession of material nonpublic information, … the SEC has adequately stated a claim for insider trading against Mozilo under Section 10(b) and Rule 10b-5.”²³

More recently, in 2020, the SEC announced a US$20 million settlement in an action against an issuer involving accusations of the “improper initiation of, and repurchase of shares pursuant to, a [company’s] Rule 10b5-1 plan while in possession of [material non-public information].”²⁴ However, in settling the case, the SEC found only that the issuer had “fail[ed] to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that stock buyback transactions were executed in accordance with management’s authorization” in violation of Exchange Act Section 13(b)(2)(B).

Despite these high-profile exceptions, in general, however, there are few cases against insiders for insider trading when transactions were made pursuant to a plan.

Key Takeaways for Issuers

Although the proposals are subject to public comment and final rule action—and represent only the latest salvo in a years-long effort to address some of the perceived shortcomings of Rule 10b5-1 and its explicit mechanism for insiders to trade in the securities of the issuer, even when they are in possession of material non-public information about the issuer—it seems likely that many of the requirements will appear largely intact in the final rules. Accordingly, issuers should consider preparing in advance by:

• Adding disclosure controls and procedures with respect to share repurchases;
• Preparing the disclosure they would make in response to the new requirements;
• Re-examining the sufficiency of their policies and procedures relating to the use of Rule 10b5-1 plans;
• Providing additional training to officers and directors on the proper use of Rule 10b5-1 plans; and
• Instituting additional conditions relating to Rule 10b5-1 plans meant to satisfy the proposed conditions and good faith operation requirement, which might include:
  • Requiring company approval of adoption of, or participation in, all trading plans and/or plan templates;
  • Imposing a cooling-off period between the establishment or modification of a plan and the first trade pursuant to the plan;
  • Prohibiting multiple or overlapping plans with respect to the same security;
  • Limiting the number of single-trade plans;
  • Avoiding a pattern of frequently adopting, amending, or cancelling plans;
  • Imposing mandatory minimum effective periods for trading plans during which such plans cannot ordinarily be modified.

Implications for Private Litigation

Finally, trading by insiders has frequently been fodder for class action plaintiffs seeking to establish scienter to support a broader securities fraud action and to survive a motion to dismiss. Courts have held that “the scienter requirement is met where the complaint alleges facts showing either: (1) a motive and opportunity to commit the fraud; or (2) strong circumstantial evidence of conscious misbehavior or recklessness” (e.g., in cases where defendants “benefited in a concrete and personal way from the purported fraud”).²⁵ To the extent plaintiffs point to stock trades to support a strong inference of scienter, plaintiffs must allege that the trades were “unusual” or “suspicious.”²⁶ Courts have held that this determination turns on a number of factors: (1) the amount of net profits realized from the sales; (2) the percentages of holdings sold; (3) the change in volume of insider defendant’s sales; (4) the number of insider defendants selling; (5) whether sales occurred soon after statements defendants are alleged to have known were misleading; (6) whether sales occurred shortly before corrective disclosures or materialization of the alleged risk; and (7) whether sales were made pursuant to trading plans such as Rule 10b5–1 plans.²⁷ A defendant may attempt to rebut an inference of scienter by arguing that the trades were made pursuant to a Rule 10b5-1 plan. Thus, in this context, defendants are not limited to using a 10b5-1 plan as an affirmative defense; instead, a 10b5-1 plan may be used to undermine allegations on a motion to dismiss.²⁸

Ordinarily, the use of a non-discretionary trading plan that sells fixed quantities of stock on pre-scheduled dates undermines any inference of scienter.²⁹ However, courts have been willing to entertain arguments that the size and timing of sales pursuant to 10b5-1 trading plans can nevertheless support an inference of scienter. Similarly, plaintiffs have argued that where 10b5–1 trading plans are entered into during the class period, they may not be a cognizable defense to scienter allegations on a motion to dismiss as a “clever insider might maximize their gain from knowledge of an impending price drop over an extended amount of time, and seek to disguise their conduct with a 10b5–1 plan.”³⁰ Recent criticism of Rule 10b5-1 by regulators, including Chair Gensler’s renewed efforts to amend the rule to address perceived abuses, will likely further strengthen class action plaintiffs’ arguments seeking to rebut defendants’ use of 10b5-1 trading plans in class action securities fraud cases.

Of course, if Rule 10b5-1 is amended as proposed, any perceived abuses are likely to be curtailed, and insiders who adhere to the more stringent requirements are likely to have an even better chance to defeat allegations of scienter where any trades at issue occurred pursuant to a properly implemented or amended Rule 10b5-1 trading plan.