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 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.
The final rules also include the following new disclosure obligations, where issuers must provide the following:
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.
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.
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.
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.
As such, insiders and issuers should consider the following now:
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.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following: