SEC Adopts Significant Changes to Rule 10b5-1 Affecting Trading by Insiders

The US Securities and Exchange Commission (SEC) on December 14, 2022, finalized amendments to Rule 10b5-1 that will both amend the Rule 10b5-1(c)(1) affirmative defense to insider trading liability and create new disclosure requirements applicable to insiders’ use of Rule 10b5-1 plans and companies’ insider trading policies.

The US Securities and Exchange Commission’s final amendments to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (Exchange Act), mandate additional disclosure and establish firm regulatory guiderails applicable to insider trading. Rule 10b5-1 plans are commonly used to establish an affirmative defense by insiders who authorize future trading pursuant to a binding contract or plan entered into in good faith while not in the possession of material nonpublic information (MNPI). Future trades conducted pursuant to the plan can be consummated even if the insider is in possession of MNPI. The final amendments will significantly impact the use of Rule 10b5-1 plans by companies and their insiders.

As adopted, the final rules impose significant new guiderails on insiders’ and companies’ ability to establish and trade in Rule 10b5-1 plans; require new disclosure relating to Rule 10b5-1 plans, insider trading policies, and certain grants of awards; and include changes to Forms 4 and 5 filed under Section 16 of the Exchange Act. The final rules also include a number of changes from the proposals, which we address below.

New Conditions for Rule 10b5-1 Affirmative Defense

New Statutory Cooling-Off Period

The final rules mandate a cooling-off period for directors and officers that prohibit such insiders from trading in a Rule 10b5-1 plan until the later of (1) 90 days following the plan’s adoption or modification; or (2) two business days following the company’s disclosure of its financial results for the fiscal quarter in which the plan was adopted or modified in a Form 10-K, 10-Q, 20-F, or 6-K (an earnings release is not sufficient), subject to a maximum cooling-off period of 120 days.

In addition, the final rules impose a cooling-off period of 30 days for individuals other than directors and officers. Issuers would not be subject to a cooling-off period, a change from the proposed rules last year.

Certification of Lack of MNPI

Directors and officers will be required to include a representation in their Rule 10b5-1 plan certifying that at the time the plan is adopted or modified, (1) they are not aware of MNPI about the issuer or its securities, and (2) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5 of the Exchange Act.

No Overlapping Plans; Limits on Affirmative Defense for Individuals

The amendments prohibit individuals from using multiple overlapping Rule 10b5-1 plans. Individuals may only rely on the Rule 10b5-1 affirmative defense for a single-trade plan to one such plan during any consecutive 12-month period. These limitations are subject to exceptions to permit plans directing sell-to-cover transactions to pay withholding tax upon vesting of equity awards and series of plans at different brokers that operate as a single plan, including with respect to modifications. In a departure from the proposals, the multiple overlapping plans restriction will apply to any class of securities of the issuer instead of to plans covering only the same class of securities.

New Disclosure Requirements Regarding Rule 10b5-1 Plans and Insider Trading Policies

The final rules also include the following new disclosure obligations, where issuers must provide the following:

• Disclosure in their quarterly reports of the use of Rule 10b5-1 plans by directors and officers. Specifically, the required disclosure must include the following: (1) for plans adopted by directors or officers, their names and titles; (2) the date of adoption or termination of the plan; (3) the duration of the plan; and (4) the aggregate number of securities to be sold or purchased under the plan.
• Disclosure in their annual reports regarding whether they have adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of company securities by insiders and, if they have adopted such policies and procedures, that they file such policies and procedures as an exhibit to the related annual report.
• Certain tabular and narrative disclosures regarding their option grant policies and practices, including tabular disclosure showing grants made within a period starting four business days before and ending one business day after the issuer’s release of MNPI, indicating the market price of the underlying securities on the trading day before and after the release of such information.
• Tagging of the required disclosures in Inline XBRL.

Changes to Section 16 Filings for 10b5-1 Transactions and Gifts

Forms 4 and 5 will now include a checkbox requiring filers to indicate whether a reported transaction was made pursuant to a trading plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1. Filers also must disclose the date of adoption of the applicable Rule 10b5-1 plan.

Also, the new rules amend Rule 16a-3 of the Exchange Act to require that bona fide gifts of issuer securities be reported on Form 4. Previously, insiders were permitted to report such gifts on Form 5.

Considerations

Cooling-Off Period

The goal of the cooling-off period is to create a lag between the establishment of the plan and the trading so that any knowledge the insider has at the time they establish the plan will be of diminished value in anticipating market dynamics at the time of the trade(s). This has been, and continues to be, a focus of the SEC’s Division of Enforcement.

The final rule represents a dramatic change in the timing requirements for establishing and first using a Rule 10b5-1 plan and attempts to ensure that employees cannot hide behind the Rule 10b5-1 shield when trading while in possession of MNPI. The new cooling-off requirement has the effect of requiring insiders to establish parameters for trades so far in advance of the trade date that they may have difficulty anticipating their financial needs or investing strategies, and thus be unwilling to enter into a plan in the first place.

Certification Requirements

The certification potentially adds liability, but a Rule 10b5‑1 affirmative defense already was predicated upon an insider not having MNPI when entering into a trading plan, and dealers frequently required this certification as a representation. Additionally, the requirement that the trading arrangement be entered into and operated in good faith is more expansive than the existing requirement that the Rule 10b5-1 plan just be entered into in good faith.

Prohibition on Overlapping Plans

This prohibition may affect some users of Rule 10b5-1 plans, but the majority of arrangements will not be affected by such changes.

Timing and Next Steps

Most of the new disclosure requirements will go into effect in the second half of 2023 or early 2024 for companies with a December 31 fiscal year-end, while the new Rule 10b5-1 conditions will become effective for plans adopted or modified on or after the effective date of the new rules.

• The final rules will become effective 60 days following publication of the adopting release in the Federal Register. Existing plans will not be subject to the new requirements unless modified after the effective date.
• Insiders who are subject to the reporting requirements of Section 16 must comply with the new disclosure requirements on Forms 4 and 5 for reports filed on or after April 1, 2023.
• Issuers must comply with the new disclosure requirements in Exchange Act periodic reports on Forms 10-Q, 10-K, and 20-F and in any proxy or information statements in the first filing that covers the first full fiscal period beginning on or after April 1, 2023 (or October 1, 2023, in the case of smaller reporting companies).

As such, insiders and issuers should consider the following now:

• Insiders should carefully assess the new limitations of Rule 10b5-1 plans, especially the cooling-off periods and limitations on overlapping plans, and consider the early adoption of these provisions for plans going into effect prior to the statutory effective date.
• Companies should review and update their insider trading policies, any separate Rule 10b5-1 plan guidelines, and any other related company policies to ensure compliance with the newly adopted rules.
• In light of the new requirement for tabular disclosure showing grants made within four business days of an issuer’s release of MNPI, issuers and their boards may wish to reassess their current procedures for granting awards ahead of early 2023 grants.

Conclusion

As adopted, the final rules will have the general effect of making Rule 10b5-1 trading arrangements less desirable, and those individuals and issuers considering such arrangements will need to weigh additional factors in deciding whether to use such arrangements.