We previously blogged here about the proposed Securities and Exchange Commission (SEC) amendments to Rule 10b5-1 trading plans. As the amendments have now been unanimously adopted, below are some answers to frequently asked questions on the new rules.
Q1: When do the new rules become effective?
The final rules will become effective 60 days following the publication of the adopting release in the Federal Register. The clock is officially running because the release was published in the Federal Register on Thursday, December 29, 2022. That means the changes to Rule 10b5-1 will become effective on February 27, 2023.
In addition to the Rule 10b5-1 amendments, the SEC adopted new disclosure requirements and changes to Section 16 forms. The compliance dates for those changes are as follows:
- Section 16 reporting persons will be required to comply with the updated Form 4 and Form 5 filing requirements (discussed below) on or after April 1, 2023.
- Issuers that are smaller reporting companies (SRCs) will 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 disclosures in the first filing that covers the first full fiscal period beginning on or after October 1, 2023.
All other issuers will 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 disclosures in the first filing that covers the first full fiscal period that begins on or after April 1, 2023.
Q2: What happens to existing 10b5-1 plans?
The adopting release provides that the amendments to Rule 10b5-1(c)(1) will not affect the affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the revised rule’s effective date (February 27, 2023), except to the extent that such a plan is modified or changed with respect to the amount, price or timing of the purchase or sale after the effective date of the final rules. In that case, the modification or change would be equivalent to adopting a new trading arrangement. Thus, amended Rule 10b5-1(c)(1) would be the applicable regulatory affirmative defense that would be available for that modified arrangement.
Q3: What new conditions do the amendments add to the current Rule 10b5-1 affirmative defense?
The amendments add five new conditions to the Rule 10b5-1 affirmative defense, which are briefly summarized below:
Cooling-Off Periods for Insiders
Directors and Section 16 Officers: Under the new rules, if the insider is a Section 16 officer or director of the issuer, then no trades can be made under a 10b5-1 plan until the later of: (1) 90 days after the adoption or modification of the plan, or (2) two business days following the disclosure of the issuer’s financial results in a Form 10-Q or Form 10-K for the completed fiscal quarter in which the plan was adopted or modified or, for foreign private issuers, in a Form 20-F or Form 6-K that discloses the issuer’s financial results (but, in any event, this required cooling-off period is subject to a maximum of 120 days after adoption of the contract, instruction, or plan).
The new rules treat any modification of the price, amount or timing of a transaction according to a 10b5-1 plan (including changes to a related trading formula or algorithm) as a cancellation of the existing plan and adoption of a new plan, which will trigger a new cooling-off period.
Persons Other than Directors and Officers: If the person is not a director, officer or issuer, then no trades can be made under the plan until the expiration of a cooling-off period 30 days after the adoption or modification of such plan.
Sidebar: The SEC decided not to include any cooling-off period requirements for issuer 10b5-1 plans (i.e., stock repurchase plans). However, they noted in the release that further consideration of such a requirement is warranted.
Restrictions on Single Trade Plans
For a person other than the issuer to rely on the 10b5-1 defense for a single-trade plan, such a person cannot have relied on the defense for another single-trade plan within the last 12 months (i.e., an insider can only rely on the 10b5-1 defense for a single trade plan once within any consecutive 12-month period).
Restrictions on Overlapping Plans
The new rules state that persons (other than the issuer) adopting a 10b5-1 plan must not have another outstanding qualifying 10b5-1 plan, contract or instruction during the relevant period. The SEC has, however, made exceptions for overlapping plans that meet the following criteria:
- Contracts with multiple brokers to execute trades pursuant to a single Rule 10b5-1 plan that covers securities held in different accounts (i.e., treated as a single “plan”).
- A later commencing plan that will only begin trading after all trades of the earlier plan are completed/expired without cancellation.
- “Sell-to-cover” plans designed to fund tax withholding obligations in connection with award-vesting events.
Director and Officer Certifications
For directors and Section 16 officers, the new amendments require a personal certification by such director or officer stating that, on the date of the adoption of the plan, the following is true about the insider:
- They are not aware of any material nonpublic information of the security or issuer.
- 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.
Good Faith Conditions
The new amendments add the condition that the person who entered into the Rule 10b5-1 plan “has acted in good faith with respect to” the contract, instruction, or plan. The SEC stated that this requirement would help ensure that traders do not engage in opportunistic trading in connection with Rule 10b5-1 plans and will help deter corporate insiders from improperly influencing the timing of corporate disclosures to benefit their trades under such a plan. The adopting release states, “Indeed, a corporate insider would not be operating a Rule 10b5-1 plan in good faith if the 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 a Rule 10b5-1 plan more profitable (or less unprofitable). In such a scenario, notwithstanding that the Rule 10b5-1 plan may have been adopted or entered into in good faith, the corporate insider would not be entitled to the affirmative defense.”
Q4: What are the new disclosure requirements?
In addition to the additional Rule 10b5-1 conditions noted in the previous question, the amendments also contemplate other disclosures for issuers and Section 16 reporting persons, including:
- Quarterly disclosure of Rule 10b5-1 plans.
- Insider trading policy disclosure on an annual basis.
- Additional executive compensation tabular disclosure when stock options and option-like instruments are granted close in time to the release of material nonpublic information.
- Additional Section 16 disclosures.
- Inline XBRL tagging of the required insider trading policy and stock option disclosure.
Reporting companies generally will now be required to disclose in their periodic reports (i.e., 10-Qs and 10-Ks) any adoption, termination or modification of a 10b5-1 plan by any Section 16 officer or director during the last completed quarter. A description of the material terms of such a plan is required, which include the name and title of the director or officer, date of adoption or termination, duration, and an aggregate number of securities to be sold or purchased. Terms with respect to price are not required.
Also, companies will be required to annually disclose in their Form 10-Ks and proxy statements whether they have adopted insider trading policies and procedures, and if not, to explain why not. A copy of such policies must be filed as an exhibit to Form 10-K. As a result, issuer insider trading policies will now become public documents, which was previously not the case for most companies (currently, most public companies do not voluntarily disclose their insider trading policies). Moreover, in a change from the proposed text included in the SEC’s proposing release, the adopting release makes clear that this insider trading policy disclosure (and exhibit) requirement applies not only to insider trading policies applicable to directors, officers and employees but also to any such policies applicable to trading in securities by the registrant itself.
Additionally, new Item 402(x) of Regulation S-K will require companies to discuss their policies and practices on the timing of awards of options in relation to the disclosure of material nonpublic information, including how the board determines when to grant such awards (for example, whether such awards are granted on a predetermined schedule); whether the board or compensation committee takes material nonpublic information into account when determining the timing and terms of such an award, and, if so, how the board or compensation committee takes material nonpublic information into account when determining the timing and terms of such an award; and whether the registrant has timed the disclosure of material nonpublic information to affect the value of executive compensation. For companies subject to the CD&A, this narrative disclosure could be included in the CD&A, which may already discuss these topics to some extent.
The new amendments will also require the inclusion of a new executive compensation table when stock options are awarded close in time to the release of material nonpublic information. Specifically, tabular disclosure of certain grant information will be if, during the last completed fiscal year, the registrant awarded options to a named executive officer in the period beginning 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 (other than a current report on Form 8-K disclosing a material new option award grant under Item 5.02(e) of that form), and ending one business day after the filing or furnishing of such report. The options grant tabular disclosures will be required in both annual reports and proxy statements on Schedule 14A.
In addition to the new requirements for reporting companies, Section 16 filers will be required to report bona fide gifts on a Form 4 within two business days (as opposed to reporting on a Form 5 as the current rules allow). Moreover, Forms 4 and 5 will also include a checkbox to indicate whether the transaction made was pursuant to a 10b5-1 plan, and the reporting person will need to disclose the date of the adoption of such plan.
Q5: What should we be doing now?
The following are recommended action items to help prepare for the new rules:
- Review the company’s existing insider trading policies for whether amendments are needed, particularly regarding trading windows, pre-clearance procedures, treatment of gifts, and any consequences of noncompliance with such policies.
- Sidenote: With respect to the treatment of gifts, the adopting release reflects a more overt and aggressive SEC position. For example, commentary in the SEC’s adopting release (see footnote 257) confirms 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.” Moreover, the adopting release (on page 113) states that “in [the SEC’s] view, the terms ‘trade’ and ‘sale’ in Rule 10b5-1(c)(1) include bona fide gifts of securities.”
- Review any existing Rule 10b5-1 policies and practices the company has in place. While not all companies currently have these policies, those that do will likely find amendments are necessary (e.g., implementing longer cooling-off periods, etc.). Companies that do not have such policies may want to consider implementing them.
- Educate directors and Section officers about the new amendments. While many Section 16 reporting persons already voluntarily disclose gifts on Form 4 (rather than waiting for Form 5), the amendments will now mandate two-business day reporting.
- Review any existing equity grant policies and practices for whether amendments are needed. For example, new Item 402(x) of Regulation S-K will require companies to discuss their policies and practices on the timing of awards of options in relation to the disclosure of material nonpublic information by the registrant, among other items. Moreover, changes to practices may be warranted to avoid triggering the new executive compensation tabular disclosure for equity awards close in time to the release of material nonpublic information.
If you have a question not answered above, please email the authors directly or, if applicable, contact your primary Bass, Berry & Sims relationship attorney.