SEC Adopts Amendments to Rules Governing Rule 10b5-1 Trading Plans

On December 14, 2022, the Securities and Exchange Commission unanimously adopted final rules relating to Rule 10b5-1 plans. Properly structured, a Rule 10b5-1 plan provides an affirmative defense to Rule 10b-5 liability for insider trading. The SEC adopted the new rules to address its concerns that corporate insiders may be trading under Rule 10b5-1 in ways that harm investors and undermine the integrity of securities markets.

The newly-adopted rules implement amendments to the requirements for establishing the Rule 10b5-1 affirmative defense and require enhanced disclosures for trading plans. Trades made pursuant to plans that do not conform to the new requirements will not be entitled to the benefit of the affirmative defense provided by Rule 10b5-1.

As we discussed in a previous client alert, the proposed amendments were released for public comment in December 2021. The final amendments to Rule 10b5-1 and the new disclosure obligations differ from the proposal in the following key areas:

• For executive officers and directors, the SEC initially proposed a mandatory minimum cooling off period (also sometimes referred to as a “burn in” period) of 120 days between the time of adoption or modification of a Rule 10b5-1 Plan and the first trade executed under it. In the final amendments, for a plan to qualify for the affirmative defense, trading may not begin until the later of (i) the 90th day after adoption or material modification of the plan and (ii) two business days following the disclosure of the issuer’s financial results in a Form 10-Q, Form 10-K, Form 20-F. or Form 6-K (as applicable) for the fiscal quarter in which the plan was adopted or materially modified (subject to a maximum required cooling off period of 120 days). For non-executive officers and all other traders (other than the issuer), the minimum cooling off period must be at least 30 days. 
• The SEC clarified that plan modifications that do not change the sales or purchase prices or price ranges, the amount of securities to be sold or purchased, or the timing of transactions under a Rule 10b5-1 plan (such as an adjustment for stock splits or a change in account information) will not trigger a new cooling-off period.
• Unlike in the proposed amendments, the cooling off period requirement does not apply to Rule 10b5-1 plans adopted or modified by issuers to purchase their own shares. 
• To qualify for the Rule 10b-5 liability affirmative defense, directors and officers adopting a plan will be required to make representations that they are adopting the plan in good faith and that at such time they are not in possession of material nonpublic information concerning the issuer or its securities. The proposed rule contemplated that these statements would need to be included in a separate certification submitted to the issuer. Under the rule as adopted, these representations must be included in the language of 10b5-1 plan itself. 
• Under the final amendments, traders (other than issuers) with multiple overlapping Rule 10b5-1 plans will not be able to avail themselves of the affirmative defense to insider trading liability. As adopted, the amendments do provide some limited exceptions: 
  
  • A person may have two separate Rule 10b5-1 plans in place at the same time if trading under a later-commencing plan is not authorized to begin until after all trades under the first plan are completed or expire without execution. This may help directors, employees and other traders with long term planning.
  • Rule 10b5-1 plans adopted in connection with tax withholding sell-to-cover programs for equity awards will generally not cause an employee to lose the benefit of the affirmative defense with respect to an otherwise eligible Rule 10b5-1 plan. The plan must only authorize qualified sell-to-cover transactions as are necessary to satisfy tax withholding obligations incident to the vesting of a compensatory award such as restricted stock units or stock appreciation rights and where the insider does not control the timing of such sales.
  • A person may maintain separate 10b5-1 plan contracts with different broker-dealers if the contracts, when taken as a whole, satisfy all of the applicable conditions of Rule 10b5-1. This exception could be helpful where an employee owns shares of the company in one brokerage account but also has shares in an account at the broker that manages the company’s equity program or where a person has shares in brokerage accounts at different brokers. 
• With respect to multiple plans, the final amendments remove the reference in the proposed rule to plans involving the “same class of securities.” Under the final amendments, multiple plans covering any securities of the issuer — including hedging instruments and other contracts — are subject to the limitation.
• The SEC also adopted the proposed limitation on single trade plans to one during any twelve-month period; however, the final amendments do not apply that limitation to issuers. The final amendments also deviate from the proposed rule by excluding from the limitation valid sell-to-cover single trade plans as described in the multiple plan discussion above. 
• The SEC adopted quarterly disclosure requirements for issuers about Rule 10b5-1 plans adopted, materially modified, or terminated by their Section 16 officers and directors. In response to comments on the need to disclose material terms of such plans, the final amendments provide that the pricing terms of such plans need not be disclosed. The final amendments also eliminated the proposed requirement that information about issuer 10b5-1 plans be disclosed.
• Separately from the Rule 10b-5 amendments that are central to the new rules, the SEC has also addressed spring loading of options — a practice of granting options to employees ahead of an expected positive news event, such as a product launch or quarterly results, so that employees can benefit from a lower option exercise price. The final rules include a requirement for annual tabular disclosure of and about option grants made by issuers within a specified period of time prior to the release of material nonpublic information in a Form 10-Q, Form 10-K, or Form 8-K. The final rules eliminated the proposed requirement that grants made proximate to issuer share repurchases be subject to the disclosure.
• As originally proposed, issuers that are not small reporting companies must disclose whether they have adopted insider trading policies and procedures and, if not, explain why that is the case. The final rules deviate from the proposed ones by providing that insider trading policies are to be filed as exhibits to Form 10-K or Form 20-F, as applicable, rather than be described in such filings.

The rules will soon be published in the Federal Register and will become effective 60 days following that publication date. The updated Form 4 and Form 5 filing requirements described below will become effective on April 1, 2023. For issuers that are not smaller reporting companies, the quarterly and annual disclosure requirements will be effective for the first filing that covers the full fiscal periods beginning on or after April 1, 2023. For smaller reporting companies, the quarterly and annual disclosure requirements will be effective for full fiscal periods that begin on or after October 1, 2023.

We have summarized the new approved rules below:

1. Mandatory “cooling-off” periods. A cooling-off (or burn-in) period is the time between the plan’s adoption or material modification and the first trade under the plan. For executive officers (as defined in Exchange Act Rule 16-1(f)) and directors, the SEC adopted a mandatory cooling-off period running from the date of adoption of a plan until the later of 90 days or two business days following the issuer’s disclosure of financial results in a Form 10-Q, Form 10-K, Form 20-F or Form 6-K for the fiscal quarter during which the plan was adopted or modified (subject to a maximum required cooling off period of 120 days). For insiders other than officers and directors, the mandatory cooling off period is 30 days. There is no cooling off period requirement for plans adopted by issuers to trade in their own stock. While many current 10b5-1 plan templates mandate a waiting period, the new parameters for officers and directors will require an update to the language and operation of most form plans. 
2. Good faith representation requirement. As a condition of the availability of Rule 10b5-1’s affirmative defense to insider trading liability, Section 16 officers and directors will need to make representations in the 10b5-1 plan — at the time of its adoption or modification — that the insider is not aware of any material nonpublic information about the issuer or its securities and is adopting or modifying the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5. Most brokerage firms’ Rule 10b5-1 plan templates already require similar undertakings from persons setting up plans. 
3. Restriction on overlapping trading plans. The Commission approved amendments under which Rule 10b5-1’s affirmative defense would be available only if a trader (other than an issuer) has a single plan for trading in any securities of an issuer in place at the same time. This requirement is designed to prevent insiders from picking between multiple plans as they please. There are a number of exceptions to this limitation:
   
   1. A person may have two separate Rule 10b5-1 plans in place at the same time if trading under a later-commencing plan is not authorized to begin until after all trades under the first plan are completed or expire without execution. As noted above, this may help directors, employees and other traders with long term planning.
   2. Rule 10b5-1 plans adopted in connection with tax withholding sell-to-cover programs for equity awards will generally not cause an employee to lose the benefit of the affirmative defense with respect to an otherwise eligible Rule 10b5-1 plan. The plan must only authorize qualified sell-to-cover transactions as are necessary to satisfy tax withholding obligations incident to the vesting of a compensatory award such as restricted stock units or stock appreciation rights and where the insider does not control the timing of such sales.
   3. A person may maintain separate 10b5-1 plan contracts with different broker-dealers if contracts, when taken as a whole, satisfy all of the applicable conditions of Rule 10b5-1. As noted above, this exception could be helpful where an employee owns shares of the company in one brokerage account but also has shares in an account at the broker that manages the company’s equity program or where a person has shares in brokerage accounts at different brokers. 
4. Restriction on single trade plans. Historically, some officers and directors adopted into Rule 10b5-1 plans that provide for only a single trade of the issuer’s securities. Under the final rules, the affirmative defense for such Rule 10b5-1 plans adopted by a person is limited to one single-trade plan within a 12-month period. The limitation does not apply to single-trade plans adopted by issuers or if there is a valid sell-to-cover single trade plan meeting the requirements described above for multiple plans.
5. Good faith requirement. The Rule 10b5-1(c)(1) affirmative defense is only available if a trading arrangement was entered into in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5. Under the final rules, it is also a condition that the person has acted in good faith with respect to the plan. This addition is designed to address situations where a person may try to improperly influence the timing of corporate disclosures to benefit their trades under a Rule 10b5-1 trading arrangement, such as by delaying or accelerating the release of material nonpublic information.
6. Disclosure requirements. The Commission adopted extensive amendments to its disclosure regulations:
   
   1. Rule 10b5-1 Plans. The Rule 10b5-1 amendments require issuers to report in their quarterly reports on Form 10-Q and annual report on Form 10-K the adoption, material modification, and termination of Rule 10b5-1 plans and other types of written trading arrangements by its directors and officers as well as the material terms (other than pricing terms) of such trading arrangements. 
   2. Insider Trading Policies. The new disclosure rules require issuers to indicate in their annual reports and proxy statements whether they have adopted insider trading policies and procedures. If an issuer has not adopted such policies and procedures, it would be required to explain why not. The insider trading policies and procedures must then be filed as an exhibit to Forms 10-K and 20-F, as applicable.
   3. Section 16 Filings. The SEC modified Form 4 so that filers must check certain boxes to indicate whether a purchase or sale was made under a plan that is intended to satisfy the affirmative defense provisions of Rule 10b5-1(c) and the date of adoption of any such plan. In addition, officers and directors are no longer permitted to report gifts of securities on Form 5; such gifts are now subject to the two-day reporting requirements of Form 4.
   4. Option Grant Policies. The final rules require issuers to disclose in their annual reports their grant policies and practices with respect to options and similar awards and how the board takes into account material nonpublic information when determining the timing and terms of awards. The new rules also require issuers to provide annual tabular disclosure showing stock option grants made within the period of four business days before the filing of a periodic report on Form 10-Q or Form 10-K or the filing or furnishing of a Current Report on Form 8-K that discloses material nonpublic information (including earnings information) and ending one business day after a triggering event and the percentage change in the market price of the underlying securities between those two dates.

Public companies should evaluate their Insider Trading Policies in preparation for the public disclosure requirement and to ensure that they facilitate compliance with the new 10b5-1 plan rules. Companies may want to consider establishing a standalone Rule 10b5-1 Plan Policy that sets forth procedures and requirements for the adoption of 10b5-1 plans by company employees and directors.