SEC Adopts Final Rules Regarding 10b5-1 Trading Plans and Disclosures for Executive Officer Equity Grants and Gifts

On December 14, 2022, the SEC adopted final rules (available here) amending Rule 10b5-1, largely as proposed.  Rule 10b5-1(c) provides an affirmative defense to insider trading liability under Rule 10b-5 where the trading person can show that a trade is made pursuant to a contract, instruction or plan (a “10b5-1 plan”) entered into at a time when the person was not in possession of material nonpublic information, that specifies the amount of securities to be sold and the pricing and timing parameters of such sales, and over which the person does not exercise any subsequent influence.  The amendments address areas where the SEC sees the potential for abusive practices by imposing mandatory cooling-off periods, eliminating the use of multiple or overlapping 10b5-1 plans, and requiring significantly more disclosures regarding trading by issuers and insiders (under 10b5-1 plans and otherwise).   

Under the final amendments: 

• the conditions of the affirmative defense under Rule 10b5-1 will require not only that the seller entered into the 10b5-1 plan in good faith, but also that such person “has acted in good faith with respect to” the 10b5-1 plan;
• 10b5-1 plans by Section 16 officers and directors will be required to include a mandatory cooling-off period between adoption of the plan and the first trade thereunder of the later of (i) 90 days, and (ii) two business days following the filing of the Form 10-Q or 10-K (or 6-K or 20-F) covering the fiscal quarter in which the plan was adopted, and in any event ending no later than 120 days after the adoption of the plan;
• 10b5-1 plans by persons other than Section 16 officers and directors will be required to include a mandatory 30-day cooling‑off period between the adoption of a plan and the first trade thereunder;
• 10b5-1 plans by issuers will not require a cooling-off period;
• most modifications of a plan will trigger a new cooling-off period, but the SEC has clarified that 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, will not trigger a new cooling-off period;
• other than for issuers, the Rule 10b5-1 affirmative defense will not be available for multiple or overlapping trading plans (which are plans allowing trades in the same period), or more than one single-trade plan in any 12 month period (with exceptions in both cases for sell-to-cover plans solely to satisfy tax withholding obligations on vesting of equity awards);
• when adopting a 10b5-1 plan, Section 16 officers and directors will be required to include representations in the 10b5-1 plan certifying that they are not aware of any material nonpublic information, and they are adopting the plan in good faith and not as part of a scheme to evade the insider trading laws;
• Form 4 will include a new check box to mark for trades made pursuant to a 10b5-1 plan;
• issuers will be required to disclose, on a quarterly basis, information regarding the adoption and termination of 10b5-1 trading plans and other trading plans by its officers and directors;
• issuers will be required to disclose whether they have adopted an insider trading policy and if not, why not, and to file such policy as an exhibit to their annual report;
• issuers will be required to provide new annual quantitative disclosures regarding equity award grants made within the period commencing four business days prior to and ending the business day after the issuer’s disclosure of material nonpublic information (including earnings releases, quarterly and annual reports and other current reports on Form 8-K); and
• gifts by insiders will need to be disclosed within two business days on Form 4 (instead of on a Form 5 due 45 days after the company’s year-end).

The amendments will become effective February 27, 2023.  The amendments will not affect the availability of the affirmative defense under an existing 10b5-1 plan that was entered into prior to the effective date.  Compliance with the new Form 4 and Form 5 requirements will be required commencing April 1, 2023, though gifts by Section 16 insiders will need to be reported on Form 4 commencing February 27, 2023.  Issuers will be required to comply with the new disclosure requirements in Exchange Act periodic reports on Forms 10-Q, 10-K, 20-F and 6-K 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. For example, for companies whose fiscal year is the calendar year, this means the quarterly reporting on 10b5-1 plans would commence in the second quarter Form 10-Q filed in 2023, while the new annual Item 402(x) disclosure would commence in the annual report or proxy filed in 2025 following the end of the 2024 fiscal year.  Smaller reporting companies will have an additional six months to comply with these disclosure requirements. 

Amended Good Faith Requirement

To address the concern that insiders may be in a position to take actions after adopting a 10b5-1 plan to benefit from material nonpublic information acquired after the 10b5-1 plan adoption, the SEC is amending the conditions of the affirmative defense of Rule 10b5-1(c) to require not only that the seller entered into the 10b5-1 plan in good faith, but also that such person “has acted in good faith with respect to” the 10b5-1 plan. The SEC offered as an example the scenario where a corporate insider, while aware of material nonpublic information, directly or indirectly induces the issuer to publicly disclose that information in a manner that makes their trades under an existing 10b5-1 plan more profitable (or less unprofitable).

Cooling-Off Periods

The amendments will require 10b5-1 plans to include cooling-off periods between the entry into the plan and the first trade thereunder.  While the initial proposal contemplated a 120-day cooling-off period for Section 16 officers and directors, a 30‑day cooling-off period for issuers, and no cooling-off period for other entities and persons, the final rules instead will require cooling-off periods as follows:

1. for Section 16 officers and directors, the later of (i) 90 days, and (ii) two business days following the filing of the Form 10-Q or 10-K (or 6-K or 20-F) covering the fiscal quarter in which the plan was adopted (not to exceed 120  days after the adoption of the plan);
2. for all other persons other than the issuer, 30 days; and
3. for issuers, no cooling-off period, though the SEC advised that it may reconsider this issue later.

These cooling-off periods will also apply to trades occurring after modifications of the plan; however, the SEC has clarified that 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, will not trigger a new cooling-off period.  The cancellation of a trade will be deemed to be the termination of the plan and adoption of a new one, and require the observance of the cooling-off period before any new trades could occur under a subsequent plan. 

Limitations on the Use of Multiple or Overlapping Plans and Single-Trade Plans; Exception for “Sell to Cover” Plans

To reduce the potential abuse of multiple and overlapping 10b5-1 plans and the potential to circumvent the cooling-off periods, the amendments limit sellers other than issuers to just one 10b5-1 plan covering sales of any class of the issuer’s securities at a time.   The SEC has clarified that overlapping trading plans are those that allow trades in the same period (i.e., trading plans that are consecutive will be permitted).  If, at the time the plan is entered into, a seller has other outstanding plans, or subsequently enters into additional plans, allowing for sales in the same time period, then none of the plans will be eligible for the Rule 10b5‑1(c) affirmative defense.  The SEC has clarified that this prohibition will not impede (i) the ability to have multiple brokers execute trades pursuant to a single 10b5-1 plan, (ii) the substitution of brokers so long as the instructions remain identical, including with respect to the price, dates and amount of securities to be sold or (iii) transactions in securities through participation in employee stock ownership plans or dividend reinvestment plans.

The SEC also clarified that this prohibition will not impede “sell to cover” plans providing for the sale of shares solely to cover tax withholding obligations in connection with vesting of equity awards such as restricted stock units or restricted share awards that may overlap with other trading plans (the reason for the exception is that the insider does not exercise control over the timing of such sales). As a result, the exception for overlapping plans that are “sell-to-cover” plans does not extend to plans involving exercise of stock options because the insider controls the timing of the exercise. 

In addition, the amendments limit sellers to just one “single trade” 10b5-1 plan (where the plan is designed to effect the purchase or sale of all the securities in one transaction) in any 12-month period (though, here too, the SEC has exempted “sell to cover” plans from this restriction).

Certifications

Section 16 officers and directors will be required to make representations in the 10b5-1 plan certifying that:

• they are not aware of material nonpublic information about the issuer or its securities; and
• they are adopting the contract, instruction or plan in good faith and not as part of a plan or scheme to evade the prohibitions of Exchange Act Section 10(b) and Exchange Act Rule 10b-5.

Disclosures

The amendments will require a number of additional disclosures by issuers and insiders.

10b5-1 Plans

New Item 408(a) of Regulation S-K will require issuers to disclose, on a quarterly basis, in their Form 10-Q or Form 10-K:

• whether any Section 16 officers or directors have adopted or terminated any 10b5-1 plan or any other pre-planned written trading arrangement; and
• with respect to any such plan or trading arrangement, a description of the material terms thereof other than pricing terms, including:
  • the name and title of the Section 16 officer or director, if applicable;
  • the date of adoption or termination;
  • the duration;
  • the aggregate amount of securities to be sold or purchased; and
  • whether the trading arrangement is intended to qualify for the affirmative defense of Rule 10b5-1 or not.

Trading Policies

New Item 408(b) of Regulation S-K will require issuers to disclose annually in their Annual Reports on Form 10-K or 20-F and proxy and information statements on Schedule 14A and 14C:

• whether they have adopted insider trading policies regarding trading by Section 16 officers, directors and employees;
• if they have not done so, to explain why not; and

Issuers who  have adopted a policy will be required to file it as an exhibit to their Annual Report on Form 10-K or 20-F. 

Timing of Equity Award Grants

In order to address the SEC’s previously expressed concern regarding the timing of grants of stock options, which have an exercise price based on the fair market value of the underlying stock at the time of grant, in proximity to the release of material nonpublic information, the final rules also include new Item 402(x) of Regulation S-K, that will require in the annual meeting proxy and/or Annual Report on Form 10-K general disclosure regarding the issuer’s policies and practices on the timing of certain equity grants (stock options, SARs or similar instruments with option-like features) in relation to the disclosure of material nonpublic information. In addition, there are specific disclosures regarding any such equity award granted to named executive officers (that is, the individuals for whom executive compensation disclosure is required in the annual proxy statement) within four business days before or one business day after 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 contains material nonpublic information (reduced from the 14-day period before and after such publication initially proposed).  Issuers will be required to present, in tabular format, the following information on a grant-by-grant basis for stock options, SARs or similar instruments with option-like features:

• the name of the executive officer;
• the grant date;
• the number of securities underlying the award;
• the per-share exercise or strike price of the award;
• the grant date fair value of the award; and
• the percentage change in the 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.

Identifying 10b5-1 Plan Sales on Form 4

To help investors and the public “better discern whether Rule 10b5-1 trading arrangements are being used to engage in opportunistic trading on the basis of inside information,” Section 16 filers will be required to indicate, by ticking a new box on the Form 4 or 5, whether the reported transaction is being made pursuant to a 10b5-1 plan and the date of adoption or modification of the plan.  Filers will continue to have the opportunity to provide additional relevant disclosures about the transaction in the footnotes and remarks section of the filing.

Gifts by Insiders

Historically, Section 16 insiders have been permitted to report gifts of securities on a delayed basis on a Form 5 due within 45 days following the issuer’s year end.  Motivated by concerns that the delays in reporting gifts under Section 16 create the potential for abuse regarding the timing and valuation of such gifts, the SEC has revised the reporting rules so that any gift by a Section 16 insider will be required to be reported on Form 4 within two business days of the gift.

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