On December 14, 2022, the U.S. Securities and Exchange Commission (SEC) unanimously adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934, which adds new conditions to the use of the affirmative defense to insider trading liability available under Rule 10b5-1(c)(1), and imposed additional disclosure obligations regarding insider trading plans, policies and procedures.
Rule 10b5-1 provides an affirmative defense to insider trading liability under Section 10(b) of the Exchange Act and Rule 10b-5 in circumstances where, subject to certain conditions, the trade was pursuant to a binding contract, an instruction to another person to execute the trade for the instructing person’s account or a written plan adopted when the trader was not aware of material nonpublic information (MNPI). The final rule and amendments generally follow the January 2022 proposed rules and amendments but include certain modifications, notably not imposing a cooling-off period or limitations on multiple plans or single-trade plans for issuers “at this time.”
The SEC’s stated dual aim of these amendments is to strengthen investor protections concerning insider trading and to help shareholders understand when and how insiders are trading in securities for which they may at times have MNPI.
Amendments to Rule 10b5-1
The amendments to Rule 10b5-1 update and add to the conditions that must be met for the affirmative defense to apply. Specifically, these new amendments:
- add a mandatory cooling-off period before trading can commence for directors and officers (defined as an issuer’s Section 16 officers) of the later of (i) 90 days following plan adoption or modification or (ii) two business days following the disclosure in the issuer’s periodic reports of its financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification);
- add a mandatory cooling-off period before trading can commence of 30 days for persons other than issuers or directors and officers;
- provide that a modification or change to the amount, price or timing of the purchase or sale of the securities (or a modification or change to a written formula or algorithm, or computer program that affects the amount, price or timing of the purchase or sale of the securities) underlying a contract, instruction or written plan is a termination of such contract, instruction or written plan, and the adoption of a new contract, instruction or written plan, and such new adoption will trigger a new cooling-off period (there is no financial hardship exception from the cooling-off periods);
- provide that directors and officers must include representations in their trading plans certifying at the time of the adoption of a new or modified Rule 10b5-1 trading plan that (i) they are not aware of any MNPI about the issuer or its securities and (ii) 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 (these certifications are not required when a director or officer terminates an existing Rule 10b5-1 trading plan and does not adopt a new or modified Rule 10b5-1 trading plan);
- include a limitation on the ability of persons (other than issuers) to use multiple overlapping Rule 10b5-1 trading plans (subject to an exception for plans for certain “sell-to-cover” transactions in which an insider instructs its agent to sell securities to satisfy tax withholding obligations at the time an award vests) but clarify that persons (other than issuers) may have two separate Rule 10b5-1 plans at the same time so long as trading under the later-commencing plan is not authorized to begin until after all trades under the earlier-commencing plan are completed or expire without execution;
- include a limitation on the ability of persons (other than issuers) to rely on the affirmative defense for a single-trade plan to one single-trade plan per 12-month period; and
- extend the good-faith requirement to require that persons entering into a Rule 10b5-1 trading plan act in good faith with respect to the plan following adoption.
With respect to existing Rule 10b5-1 trading plans, the SEC specifically provided that the amendments do not affect the affirmative defense available under such plans so long as they were entered into prior to, and are not modified or changed after, the effective date of the final rules (60 days from publication in the Federal Register).
New Disclosure Requirements
The amendments also create new, more comprehensive disclosure requirements, including:
- annual disclosure (subject to Inline XBRL tagging) of the issuer’s policies and practices related to the grant of stock options, SARs or similar option-like instruments close in time to the release of MNPI, including how the board determines when to grant such awards; whether the board or compensation committee takes MNPI into account when determining the timing and terms of the awards and, if so, how the board or compensation committee takes MNPI into account when determining the timing and terms of such an award; and whether the issuer has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation (Item 402(x)(1) of Regulation S-K);
- annual disclosure (subject to Inline XBRL tagging), in a new table, of any awards of stock options, SARs or similar option-like instruments that were awarded in the period beginning four business days before certain triggering events, and ending one business day after a triggering event. The triggering events are the filing of a periodic report on Form 10-Q or 10-K or the filing or furnishing of a current report on Form 8-K that discloses MNPI, including earnings information, other than a Form 8-K that discloses a material new option award grant under Item 5.02(e) of Form 8-K (Item 402(x)(2) of Regulation S-K);
- quarterly disclosure (subject to Inline XBRL tagging) by the issuer regarding the use of Rule 10b5-1 trading plans and certain other trading arrangements by its directors and officers for the trading of its securities, including the material terms of such plans or arrangements other than the pricing terms (the amendments do not include corresponding disclosure regarding the use of trading plans or arrangements by the issuer) (Item 408(a) of Regulation S-K);
- annual disclosure (subject to Inline XBRL tagging) of the issuer’s insider trading policies and practices, including disclosure of whether the issuer has adopted insider trading policies and practices governing the purchase, sale or other disposition (e.g., gift) of the issuer’s securities by its directors and officers or the issuer itself and, if not, why not and a requirement to file the issuer’s insider trading policy as an exhibit to its annual report (Item 408(b) of Regulation S-K);
- a new checkbox on Forms 4 or 5 that insiders will be required to use to indicate whether a reported transaction was intended to satisfy the affirmative-defense conditions of Rule 10b5-1(c) and a requirement to disclose the date of adoption of the trading plan; and
- a requirement that bona fide gifts of securities previously permitted to be reported on Form 5 be reported on Form 4.
Effective Date of Amendments
The amendments will become effective 60 days following publication of the adopting release in the Federal Register, and Section 16 reporting persons (i.e., the issuer’s directors and officers and shareholders who own more than 10% of a class of the issuer’s equity securities) will be required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023. Issuers that are smaller reporting companies will be required to comply with the new disclosure and related XBRL tagging 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 October 1, 2023. All other issuers will be required to comply with the new disclosure requirements 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.
Continued Enforcement Focus Expected
In its announcement, the SEC noted that the amendments were in reaction to having heard from “courts, commenters, and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information.” The SEC Enforcement Division’s focus on potential abuses of Rule 10b5-1 trading plans — evidenced by a recently settled administrative proceeding against the CEO and former president of an issuer for insider trading in connection with transactions under a Rule 10b5-1 trading plan entered into while in possession of MNPI — is expected to continue.
One potential area ripe for scrutiny is the gifting of securities. In this regard, the SEC reaffirmed its position that MNPI can be misused in the context of gifts, stating that the Exchange Act does not require the sale of securities to be for value; instead, it noted that “the terms ‘sale’ and ‘sell’ each include any contract to sell or otherwise dispose of.” The SEC also stated that “a donor of securities violates Section 10(b) if the donor gifts a security of an issuer in fraudulent breach of a duty of trust and confidence when the donor was aware of material nonpublic information about the security or issuer, and knew or was reckless in not knowing that the donee would sell the securities prior to the disclosure of such information.” It acknowledged, however, that “the affirmative defense under Rule 10b5-1(c)(1) is available for planned securities gifts.”
In light of the new Rule 10b5-1 amendments and disclosure obligations, issuers should take the following actions:
- review and update insider trading policies, in particular regarding bona fide gifts and approval of insiders’ Rule 10b5-1 trading plans to prepare for the new disclosure requirements (if an issuer does not have a formal written insider trading policy, it should strongly consider adopting one to avoid having to disclose why it has not done so);
- confirm awareness of all existing insider Rule 10b5-1 trading plans (e.g., to the extent D&O questionnaires have not yet been distributed, consider adding a question regarding the existence of such plans);
- review stock option, SAR and option-like grant policies and practices — specifically regarding the timing of these awards; and
- host director and officer training sessions focused on areas of the new rules that may be of interest to them, including the disclosure of charitable gifts, the limitation on single-trade plans and the implications of modifying existing Rule 10b5-1 trading plans.
For additional guidance on the information in this alert, please contact any of the authors, any member of McGuireWoods’ securities and capital markets or securities enforcement and regulatory counseling teams, or your primary McGuireWoods contact.
McGuireWoods’ securities and capital markets team assists private and public companies in capital-raising efforts through private and public offerings, and assists public companies with their reporting obligations under the Securities Exchange Act of 1934, including Forms 10-K, 10-Q and 8-K, Section 16 reports and DEF 14A (proxy statements), as well as with Regulation FD and Regulation G compliance. We prepare insider trading policies, develop training programs and assist with other aspects of securities transactions engaged in by company officers, directors and significant security holders, including 10b5-1 plans and Rule 144 compliance.
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