On December 15, 2021, the U.S. Securities and Exchange Commission (SEC) proposed amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) to introduce new requirements for Rule 10b5-1 trading plans and elicit more comprehensive disclosure related to insider trading policies and the timing of certain option grants to officers and directors of public companies. This client alert briefly summarizes the proposed amendments and disclosure requirements. The SEC will seek comments to the proposed rule for 45 days after publication in the Federal Register.

Additional Conditions to Rule 10b5-1 Affirmative Defense

The SEC adopted Rule 10b5-1 in 2000 in order to facilitate trading in an issuer's securities by parties that frequently have access to material non-public information, such as directors and officers. Rule 10b5-1(c) provides an affirmative defense against a claim of insider trading for an insider who trades pursuant to a written trading plan that is established in good faith at a time when the insider is unaware of material non-public information and instructs a third party to conduct such trades. The SEC has previously raised concerns about manipulation of this rule, including trading plan adoption while in possession of material nonpublic information and frequent trading plan modifications or terminations. Due to this perceived activity, the SEC has proposed amendments to Rule 10b5-1 that would add the following additional conditions to the affirmative defense available under Rule 10b5-1(c):

• Cooling-off periods. The amendments would impose cooling-off periods between the date that a Rule 10b5-1 trading plan is adopted and the first trade under such plan. During a cooling-off period, no trades pursuant to the plan could be made. The proposed cooling-off periods are:
  • A minimum of 120 days for Section 16 officers and directors after the date of adoption of any Rule 10b5-1 trading plan.
    • This cooling-off period would essentially ensure that an issuer's quarterly earnings cycle, including the disclosure of financial results, occur before insiders trade under a Rule 10b5-1 trading plan.
  • A minimum of 30 days for issuers after the date of adoption of any repurchase plan under 10b5-1(c)(1).
  The cooling-off period would also apply after a modification to a Rule 10b5-1 trading plan, including a modification to cancel one or more trades.

  While not currently required by Rule 10b5-1, as a matter of practice, many companies currently require a cooling-off period between an insider's adoption of a Rule 10b5-1 plan and when trades commence or before a modification becomes effective, although the period is typically shorter than 120 days.

• Certification. The amendments would require Section 16 officers and directors, as a condition of establishing a Rule 10b5-1 trading plan, to certify i) that they are not aware of material nonpublic information about the issuer or its securities when adopting or modifying such plan and ii) that they are adopting a Rule 10b5-1 trading plan in good faith and not as part of a plan or scheme to evade the prohibitions of the Exchange Act. This certification would need to be retained by issuers for 10 years.

  While not currently required by Rule 10b5-1, most brokerages that offer Rule 10b5-1 trading plans require such a certification before a Rule 10b5-1 trading plan with the brokerage is entered and many companies have similar guidelines, such as requiring that a trading plan be adopted only during an open trading window.

• Restrictions on multiple overlapping Rule 10b5-1 trading plans and single trade arrangements. The affirmative defense under Rule 10b5-1(c) would not be available for the following arrangements:
  • Overlapping Rule 10b5-1 trading plans or arrangements for open market trades of the same class of shares.
    • Note that the proposed amendment would not apply to transactions where a person acquires or sells directly from the issuer.
  • More than one Rule 10b5-1 trading plan or arrangement in a 12-month period that is designed to cover a single trade.
  While not currently required by Rule 10b5-1, as a matter of practice, some companies currently prohibit overlapping trading plans.
• Good faith. The amendments would require any Rule 10b5-1 plan to be operated in good faith, in addition to the current requirement for plans to be entered into in good faith, to deter insiders from improperly influencing the timing of the announcement of material information in a way that benefits their planned trades under a Rule 10b5-1 trading plan.

Enhanced Disclosures

The proposed amendments would also require the following disclosures regarding Rule 10b5-1 trading plans, none of which is currently required:

• Quarterly disclosure of Rule 10b5-1 plans. In Forms 10-Q and Forms 10-K, issuers would need to disclose the adoption or termination of any Rule 10b5-1 plans or arrangements by Section 16 officers and directors or the company itself, if they occurred during the quarter covered by such report. Issuers would also need to describe the material terms of such plans.¹ Issuers should note that the current amendments consider any modification or amendment of a Rule 10b5-1 trading plan to be a termination of one plan and entry into a new plan, subject to disclosure.
• Annual disclosure of insider trading plan policies and procedures. Issuers would be required to disclose their insider trading policies and procedures in their Form 10-K.² If an issuer has not adopted insider trading policies and procedures, it must explain the reasons why it has not.
• Disclosure in Section 16 filings regarding 10b5-1 plans. An additional checkbox on Forms 4 and 5 would be added to indicate whether a reported transaction was made pursuant to a Rule 10b5-1 plan and the date that such plan was adopted. In addition, a second optional checkbox would be added to Forms 4 and 5 to allow a filer to indicate whether a transaction reported on the form was made pursuant to a plan that is not intended to satisfy the conditions of Rule 10b5-1. As a matter of practice, many insiders already disclose on Forms 4 and 5 if a trade is made pursuant to a Rule 10b5-1 plan.
• Annual disclosure of option grant policies and practices. Annual reports would need to include a description of the company's option grant policies and practices regarding the timing of option grants and the release of material information, and to provide a table showing i) any grants made during the 14 calendar days before or after the filing of a periodic report, an issuer share repurchase or the filing or furnishing of a Form 8-K that contains material information and ii) the market price of the shares underlying the options on the day before and after the release of such information.³
• Form 4 reporting of bona fide gifts. The amendments would also add a Form 4 reporting obligation for bona fide gifts from a Section 16 officer or director with respect to such transaction.

What to Do Now?

The SEC's recent concern over potential abuse of Rule 10b5-1 trading plans is well known, and these proposed rules are long anticipated. They are the first proposed amendments to Rule 10b5-1 since it was adopted more than 20 years ago, and the SEC has asked a number of questions seeking to better understand the breadth of views regarding the use of Rule 10b5-1 plans and the proposed amendments. Given the widespread use of Rule 10b5-1 plans, we expect a number of market participants to provide comments, as well as to seek clarifications and alternative amendments. Although not final and binding, the proposed amendments are yet another signal to insiders—both companies and individuals—contemplating entering into Rule 10b5-1 trading plans that the SEC will be increasing its scrutiny in this area.

[1] In the proposed rule, the SEC has provided examples of terms that may be deemed material. This may include the person or entity creating the plan, the date of adoption or termination, the duration of the plan, and the aggregate amount of securities to be purchased or sold pursuant to the plan.

[2] In the proposed rule, the SEC provided examples of the level of detail that it would expect in a description of an issuer’s insider trading policies and procedures, including an issuer’s process for analyzing whether insiders or the company have MNPI when conducting open-market share repurchases, an issuer’s process for documenting its analysis and approving insider requests to purchase and sell the issuer’s securities, or how the issuer enforces compliance with its insider trading policies and procedures.

[3] The new proposed disclosure requirements for option grants reflect the SEC’s stated concern that grants can be timed to be shortly before the announcement of material positive news which may drive up the price of the stock (“spring-loading”) or a planned award may be delayed so as to occur after the disclosure of material negative news which may lower the stock price (“bullet-dodging”). The SEC recently issued a Staff Accounting Bulletin regarding the potential accounting implications of spring-loaded option grants. See https://www.sec.gov/news/press-release/2021-246.