On December 14, 2022, the Securities and Exchange Commission (SEC) adopted amendments to certain existing rules, as well as implementing new disclosure requirements (collectively, the Amendments), with an overarching intent of modernizing Rule 10b5-1 under the Securities Exchange Act of 1934. In so doing, the SEC's stated goal is to maintain the fairness and integrity of the securities markets by strengthening investor protections against insider trading, with the aim of improving investor confidence.
Background and Overview
The Amendments come over 20 years after the Commission initially adopted Rule 10b5-1, which provides an affirmative defense to insider trading when, subject to certain conditions, the trade was conducted pursuant to a plan entered into in good faith at a time when the trader was not aware of material nonpublic information. In recent years, an increasing number of commenters had expressed concern that insiders can benefit from the liability protections of Rule 10b5-1 while still trading on the basis of material nonpublic information, to the detriment of investors and the securities markets. The Amendments can be grouped generally into the following categories:
- Amendments to Rule 10b5-1, including a cooling period, certifications, and limitations on the use of overlapping or single trade plans.
- Enhanced disclosure in issuers' 10-Q and 10-K filings regarding the use of 10b5-1 plans by executive officers and directors and company policies regarding the same.
- New Proxy Statement tabular and narrative disclosure of certain equity compensation awards made close in time to the issuer's disclosure of material nonpublic information.
- Section 16 disclosure changes, including form updates to require identification of transactions made pursuant to a Rule 10b5-1 Plan, and to disclose all bona fide gifts of securities on Form 4.
Rule 10b5-1 Related Amendments
Cooling-off Period. A cooling-off period is a waiting period between the date that a trading plan is adopted and the date of the first transaction under the plan. Historically, cooling-off periods were not required, and although many companies already imposed cooling-off periods as a best practice, there was no uniformity in this regard.
Under the Amendments, a cooling-off period will be required for directors and Section 16 officers until the later of: (1) 90 days following plan adoption or modification (with modifications expressly including changes to the amount, price, or timing of the purchase or sale of the securities (or change to a written formula, algorithm or program that affects those items)); or (2) two business days following disclosure in periodic reports of the issuer's financial results for the quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification). Persons other than directors and Section 16 officers employing Rule 10b5-1 plans will be subject to a shorter 30-day cooling-off period. Of note is the fact that the SEC determined not to subject issuer 10b5-1 plans to any similar requirement (though in the commentary they noted that the issue was subject to continued consideration).
Certifications. Directors and Section 16 officers will be required to certify, via representations in their Rule 10b5-1 plan, that (1) they are not aware of material nonpublic information 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 10b5-1. As with cooling off periods, many existing plans already contain these representations as a recommended practice, but the requirement that they be included will create a level of uniformity in this regard.
Restricting Multiple Overlapping Rule 10b5-1 Trading Arrangements and Single-Trade Arrangements. The SEC has identified as a concern the establishment and use of multiple, overlapping plans to exploit material nonpublic information by setting up multiple plans and then canceling the less favorable plan(s) based on the existence of material nonpublic information. As a result, the Amendments include a limitation (with certain, narrowly construed exceptions) on the ability to use multiple overlapping Rule 10b5-1 plans; and an additional limitation (again with certain narrow exceptions) on the ability to rely on the Rule 10b5-1(c) affirmative defense for a single-trade plan to only one such plan during any consecutive 12-month period. Neither of these restrictions will be applied to issuer plans.
The Amended Good Faith Condition. Rule 10b5-1 already required that a trading arrangement be entered into in good faith in order to qualify for the affirmative defense. However, the SEC has noted that some traders may try to influence corporate disclosures to benefit their trading plans. As a result, the amendments include a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to that plan.
Additional Disclosures Regarding Rule 10b5-1 Trading Arrangements
To date, there have been no mandatory disclosure requirements concerning the use of Rule 10b5-1, making it difficult for investors to determine whether traders were misusing material nonpublic information. To increase transparency, the SEC has adopted Item 408 of Regulation S-K, which will require issuers to include new disclosures in their periodic reports.
Quarterly Reports on Form 10-Q. Issuers must disclose the adoption or termination, and description of material terms (including date, duration and amount, but not pricing) of Rule 10b5-1 plans and “certain other written trading arrangements” by the issuer's directors and Section 16 officers for the trading of its securities. This disclosure does not extend to issuer plans.
Annual Disclosure on Form 10-K. Issuers must disclose whether the registrant has adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of the registrant's securities by directors, officers, and employees or the registrant itself that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the registrant. Any such policies and procedures that have been adopted must be filed as exhibits; if they have not been adopted, an explanation must be provided.
Proxy Statement Disclosure Regarding Option Grants and Similar Equity Instruments
The SEC has adopted a new provision to Regulation S-K, Item 402(x), with a stated goal of enhancing disclosure of executive and director compensation to improve delivery of this information to investors. Item 402(x) will require issuers to discuss their policies and practices on the timing of awards of stock options, SARs and/or similar option-like instruments in relation to the disclosure of material nonpublic information, including how the board determines when to grant such awards; 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, and whether the registrant has timed the disclosure of material nonpublic information for the purpose of affecting the value of executive compensation.
In addition, Item 402(x) will require tabular disclosure of each award of stock options, SARs, or similar option-like instruments granted in the four business days before the filing of a periodic report or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information (including earnings information but excluding reports solely consisting of new option awards under Item 5.02(e)) and ending one business day after a triggering event. The table will require disclosure of typical award information as well as the percentage change in market price of the underlying securities between the closing market price of the security one trading day prior to and one trading day following the disclosure of material nonpublic information). Information disclosed pursuant to Item 402(x) (as well as new Item 408) must be tagged in accordance with Rule 405 of Regulation S-T.
Changes Relating to Section 16 Filings
Changes to Forms 4 and 5. The amendments will require revisions to Forms 4 and 5, necessitating filers to indicate by checkbox that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c). Although it is currently common practice to note in such filings transactions undertaken under a Rule 10b5-1 plan, the existence of checkboxes will bring a level of uniformity to such filings, and are intended to help the public to better understand how trading plans that rely on the revised Rule 10b5-1(c) affirmative defense are being used.
Reporting of Gifts on Form 4. Prior to the amendments, Section 16 reporting persons could report “bona fide” gifts via Form 5 within 45 days after the issuer's fiscal year end. The SEC has noted that the delayed reporting of gifts on Form 5 may allow Section 16 reporting persons to make stock gifts while in possession of material nonpublic information. Under the final amendments, Section 16 reporting persons will be required to report dispositions of bona fide gifts of equity securities on Form 4, instead of Form 5, in accordance with Form 4's current two business day filing deadline.
Effective Date and Applicability
The final amendments to Rule 10b5-1 will become effective 60 days following publication of the adopting release in the Federal Register. Issuers will be required to 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 that begins on or after April 1, 2023. Section 16 reporting persons will be required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023.
All registrants, including smaller reporting companies (SRCs) and emerging growth companies (EGCs), must comply with the new amendments; however, SRCs will not be required to comply with the new disclosure and tagging requirements in Exchange Act periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statements that are required to include the Item 408, Item 402(x), and/or Item 16J (with respect to Form 20-F) disclosures in the first filing that covers the first full fiscal period that begins on or after October 1, 2023. In addition, consistent with the scaled approach with respect to executive compensation, they would be permitted to limit their disclosures with respect to Item 402(x) similar to other Item 402 disclosure.
Buchanan's cross-disciplinary team of securities and executive compensation attorneys are ready to help your company prepare for the implementation of the SEC's new requirements and navigate the impact of these new rules on your company.