A Closer Look at the Rule 10b5-1 Amendments Adopted by the SEC
- The U.S. Securities and Exchange Commission (SEC) has adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 and new disclosure requirements to enhance investor protections against insider trading on the basis of material nonpublic information (MNPI).
- The new and amended rules, while intended to improve investor confidence in the securities markets, impose significant new requirements on the ability of insiders to take advantage of the safe harbor offered by Rule 10b5-1.
- This Holland & Knight alert provides an in-depth look at the amendments and disclosure requirements adopted by the SEC.
The U.S. Securities and Exchange Commission (SEC), in a rare unanimous vote, adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) and new disclosure requirements to enhance investor protections against insider trading. Adopted on Dec. 14, 2022, the amendments:
- add new conditions to the availability of the affirmative defense under Rule 10b5-1(c)(1), including cooling-off periods for sales of issuer securities by directors, officers and other persons other than issuers
- create new disclosure requirements under Item 408 of Regulation S-K regarding issuers' insider trading policies and procedures, as well as the adoption and termination (including modification) of Rule 10b5-1 and certain other trading arrangements by directors and officers
- create new disclosure requirements under Item 402 of Regulation S-K for executive and director compensation regarding certain equity compensation awards made close in time to the issuer's disclosure of material nonpublic information (MNPI)
- update Forms 4 and 5 to require filers to identify transactions made pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose all bona fide gifts of securities on Form 4
The new and amended rules are intended to improve investor confidence in the securities markets, and by extension enhance liquidity and capital formation, while continuing to provide appropriate flexibility to traders who would like to plan securities transactions in advance when they are not aware of MNPI. To achieve these goals, the rules are designed to significantly reduce opportunities for corporate insiders to misuse Rule 10b5-1 to trade on MNPI. Further, the amendments are intended to increase transparency regarding the use of Rule 10b5-1 plans, issuers' insider trading policies and procedures, and their policies and practices with respect to awards of options and/or similar option-like instruments close in time to the release of MNPI.
The rules will become effective on Feb. 27, 2023. Persons required to report under Section 16 will be required to comply with the amendments to Forms 4 and 5 for reports filed on or after April 1, 2023. Issuers will be required to comply with the new disclosure 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 April 1, 2023. The final amendments defer by six months, or until Oct. 1, 2023, the date of compliance with the additional disclosure requirements for smaller reporting companies.
The net effect of the new rules is to increase the requirements necessary for corporate insiders to avail themselves of the affirmative defense under Rule 10b5-1 and increase both investor and SEC scrutiny of trades by insiders pursuant to the rule. Issuers will need to ensure that their insider trading policies are consistent with the new rule's requirements, that they have adequate reporting systems to capture information now required to be disclosed in a timely fashion and that Rule 10b5-1 plans of their insiders are fully compliant. Increased scrutiny facilitated by the new rules will likely increase the possibility of both SEC enforcement and private actions, making the cost of a failure to comply quite high.
For a detailed description of the new and amended rules see the "Rule Amendments" and "New Disclosure Requirements" sections below. For a redline of the Rule 10b5-1 amendments against the existing rule and the text of new Items 408 and 402, as well as the amendments to Forms 4 and 5 and Rule 16a-3, see Appendix A.
In August 2000, the SEC adopted Rule 10b5-1, which, in part, provides an affirmative defense to insider trading liability under Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5 in circumstances where 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 MNPI (Rule 10b5-1 affirmative defense).
Since the adoption of the Rule 10b5-1 affirmative defense, courts, commentators and members of Congress have expressed concern that traders have sought to benefit from its liability protections while trading securities opportunistically on the basis of MNPI. Furthermore, some academic studies have found that corporate insiders trading pursuant to Rule 10b5-1 plans consistently outperform the trading of corporate insiders not conducted under such plans. These studies have raised concerns that corporate insiders may be trading under Rule 10b5-1 in ways that harm investors and undermine the integrity of the securities markets. Practices that have raised public concern include corporate insiders adopting multiple overlapping plans and subsequently selectively canceling certain trades under such plans while they are aware of MNPI (allowing such insiders to buy or sell securities under the plans that provide the most advantageous price) or commencing trades pursuant to a new plan shortly after the adoption of such plan (in some cases on the day of adoption, which, when combined with comparatively larger trades made closer in time to adoption of a plan, suggests that those trades may be on the basis of MNPI).
To address such concerns, in December 2021, the SEC proposed amendments to Rule 10b5-1 and related disclosure requirements to enhance investor protections concerning insider trading.
Under amended Rule 10b5-1(c)(1)(ii)(A), to be eligible for the Rule 10b5-1 affirmative defense, a contract, instruction or plan must have been entered into in good faith and persons availing themselves of such defense must have acted in good faith with respect to such contract, instruction or plan.
The addition of an "acted in good faith" condition is intended to address concerns from the time that Rule 10b5-1 was first adopted that corporate insiders may take actions after adopting a Rule 10b5-1 plan to benefit from MNPI that the insider acquires after establishment of the plan.
Under amended Rule 10b5-1(c)(1)(ii)(B), a director or officer who adopts or modifies a Rule 10b5-1 plan will not be able to rely on the Rule 10b5-1 affirmative defense unless the plan provides that trading under the plan will not begin until the later of:
- 90 days after the adoption of the Rule 10b5-1 plan, and
- two business days following the disclosure of the issuer's financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted 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, the required cooling-off period is subject to a maximum of 120 days after adoption of the plan)
The addition of a cooling-off period is intended to deter opportunistic trading that may be occurring under the current rule and, by extension, to increase investor confidence that directors and officers are not using Rule 10b5-1 plans for such purposes. The purpose of a cooling-off period is to provide a separation in time between the adoption of the plan and the commencement of trading under the plan so as to minimize the ability of an insider to benefit from any MNPI.
Director and Officer Certifications
Under amended Rule 10b5-1(c)(1)(ii)(C), if a director or officer of the issuer of the securities adopts a Rule 10b5-1 plan, as a condition to the availability of the Rule 10b5-1 affirmative defense, such director or officer will be required to include a representation in the plan certifying that at the time of the adoption of a new or modified Rule 10b5-1 plan such director or officer is:
- not aware of MNPI about the issuer or its securities, and
- adopting the contract, instruction or plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5
The addition of a certification condition is intended to reinforce directors' and officers' cognizance of their obligation not to trade or enter into a trading plan while aware of MNPI about the issuer or its securities, that it is their responsibility to determine whether they are aware of MNPI when adopting Rule 10b5-1 plans, and that the Rule 10b5-1 affirmative defense requires them to act in good faith and not to adopt such plans as part of a plan or scheme to evade the insider trading laws.
Restrictions on Multiple Overlapping Plans
Under amended Rule 10b5-1(c)(1)(ii)(D), persons (other than issuers) may not have another outstanding (and may not subsequently enter into any additional) contract, instruction or plan that would qualify for the Rule 10b5-1 affirmative defense for purchases or sales of any class of securities of the issuer on the open market during the same period. The foregoing condition is subject to three limited exceptions (i.e., 1) a series of separate contracts that qualify to be treated as a "single plan," 2) a later-commencing contract, instruction or plan that is not authorized to begin until after all trades under the earlier-commencing contract, instruction or plan are completed or expired, and 3) an outstanding or additional contract, instruction or plan that qualifies as an eligible sell-to-cover transaction1).
Under amended Rule 10b5-1(c)(1)(ii)(E), with respect to single-trade plans2, a person (other than the issuer) will be able to rely on the Rule 10b5-1 affirmative defense for only one single-trade plan during any 12-month period and such defense will be available for a single-trade plan only if the person had not, during the preceding 12-month period, adopted another single-trade plan that also qualified for the Rule 10b5-1 affirmative defense.
The addition of the above limitations are intended to address the concerns about an insider's use of multiple overlapping plans, or the selective alteration or cancellation of a Rule 10b5-1 plan, to achieve a particular trading outcome when an insider is aware of MNPI.
New Disclosure Requirements
Under new Item 408(a), registrants are required to:
- disclose whether, during the registrant's last fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report), any director or officer has adopted or terminated any:
- contract, instruction or written plan for the purchase or sale of securities of the registrant that is intended to satisfy the Rule 10b5-1 affirmative defense (Rule 10b5-1 trading arrangement), and/or
- written trading arrangement for the purchase or sale of securities of the registrant that meets the requirements of a non-Rule 10b5-1 trading arrangement as defined in Item 408(c) (non-Rule 10b5-1 trading arrangement), and
- indicate whether the trading arrangement is a Rule 10b5-1 trading arrangement or non-Rule 10b5-1 trading arrangement and provide a description of the material terms of such arrangement other than terms with respect to the price at which the individual executing the respective trading arrangement is authorized to trade, such as the:
- name and title of the director or officer
- date of adoption or termination of the trading arrangement
- duration of the trading arrangement, and
- aggregate number of securities to be sold or purchased under the trading arrangement
Such disclosure is intended to better allow investors, the SEC and other market participants to observe how directors and officers use Rule 10b5-1 plans and other non-Rule 10b5-1 trading arrangements. The information also will add important context to other disclosures of trades by directors and officers, such as in Forms 4 and 5, and may aid investors in obtaining a more accurate valuation of the issuer's shares and making more informed investment decisions. Furthermore, this information will provide investors with valuable information about the specific uses of such arrangements, which could bring focus to the particular arrangements and deter potential abuses.
Under new Item 408(c), a trading arrangement with respect to a director or officer would be a "non-Rule 10b5-1 trading arrangement" where the director or officer asserts that, at a time when they were not aware of MNPI about the security or the issuer of the security, such person:
- adopted a written arrangement for trading the securities, and
- the trading arrangement:
- specified the amount of securities to be purchased or sold, as well as the price at which and the date on which the securities were to be subsequently purchased or sold
- included a written formula or algorithm, or computer program, for determining the amount of securities to be purchased or sold and the price at which the securities were to be purchased or sold, or
- did not permit the covered person to exercise any subsequent influence over how, when or whether to effect purchases or sales (provided, in addition, that any other person who, pursuant to the trading arrangement did exercise such influence must not have been aware of MNPI when doing so)
In adopting the non-Rule 10b5-1 trading arrangement disclosure requirement, the SEC recognizes that Rule 10b5-1 provides affirmative defenses, but that corporate insiders may assert other defenses to liability under Section 10(b). Absent this disclosure requirement, directors and officers may be more likely to choose to trade in reliance on alternative defenses to liability other than this affirmative defense in order to avoid the disclosure requirements for Rule 10b5-1 plans, as well as avoiding the other requirements of the affirmative defense. Thus, the non-Rule 10b5-1 trading arrangement disclosure is intended to be useful to investors for largely the same reasons that disclosure of plans that fully satisfy Rule 10b5-1 is useful.3
Under new Item 408(b) and Item 16J in Form 20-F, registrants will be required to disclose whether they have adopted insider trading policies and procedures governing the purchase, sale and other dispositions of their securities by directors, officers and employees, or the registrant itself that are reasonably designed to promote compliance with insider trading laws, rules and regulations, and any listing standards applicable to the registrant. If a registrant has not adopted such insider trading policies and procedures, it must explain why it has not done so.
These disclosures will be required in annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C. Pursuant to new Item 16J in Form 20-F, foreign private issuers (FPIs) will be required to provide analogous disclosure in their annual reports on that form.
Pursuant to related amendments to Item 601 of Regulation S-K and Form 20-F, if the registrant has adopted insider trading policies and procedures, it must file such policies and procedures as an exhibit to Forms 10-K and Form 20-F, as applicable. If all of the registrant's insider trading policies and procedures are included in its code of ethics and the code of ethics is filed as an exhibit, such inclusion would satisfy the exhibit filing requirement.
Such disclosure is intended to help an investor understand whether or not an issuer insider trading policy actually prevents the unlawful communication of and trading on MNPI. This disclosure is likely to increase investor and SEC scrutiny of insider trades and raise the stakes for potential failures to comply fully with the Rule 10b5-1 affirmative defense through SEC enforcement and private actions by investors (similar to private enforcement of violations of Section 16(b)).
Disclosure Regarding Option Grants Made Close in Time to the Release of MNPI
Under new Item 402(x)(1), registrants will be required to discuss:
- their policies and practices on the timing of awards of stock options, stock appreciation rights (SARs) and/or similar option-like instruments in relation to the disclosure of MNPI by the registrant, including how the board determines when to grant such awards (for example, whether such awards are granted on a predetermined schedule)
- whether, and if so, how, the board or compensation committee takes MNPI into account when determining the timing and terms of an award, and
- whether the registrant has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation
Under new Item 402(x)(2), if, during the last completed fiscal year, stock options, SARs and/or similar option-like instruments were awarded to a named executive officer (NEO) within a period starting 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 MNPI (including earnings information), other than a current report on Form 8-K disclosing a material new option award grant under Item 5.02(e), and ending one business day after a triggering event, the issuer must provide the following information concerning each such award for the NEO on an aggregated basis in the tabular format set forth in the rule:
- name of the NEO
- grant date of the award
- number of securities underlying the award
- per-share exercise price
- grant date fair value of each award computed using the same methodology as used for the registrant's financial statements under generally accepted accounting principles, and
- 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 MNPI
The purpose of the new table is to highlight for investors options award grants that may be more likely than most to have been made at a time that the board of directors was aware of MNPI affecting the value of the award. Again, the likely effect of this disclosure will be to increase investor scrutiny of issuers' equity grant practices and may increase private actions with respect thereto.
Reporting of Trading on Forms 4 and 5
Under the revisions to Forms 4 and 5, filers will indicate by check mark whether a transaction was made pursuant to a contract, instruction or written plan for the purchase or sale of equity securities of the issuer that is intended to satisfy the Rule 10b5-1 affirmative defense. Filers are instructed to also provide the date of adoption of the Rule 10b5-1(c) plan in the "Explanation of Responses" portion of the form.
The new checkbox is intended to help investors and the public better understand how trading plans that rely on the revised Rule 10b5-1(c) affirmative defense are being used by corporate insiders, including whether they are being used to engage in opportunistic trading. The checkbox is also intended to provide transparency into the use of Rule 10b5-1 plans to help deter potential misuse of those plans, which would complement the cooling-off period.
Reporting of Gifts on Forms 4
Under amended Rule 16a-3, Section 16 reporting persons will be required to report dispositions of bona fide gifts of equity securities on Form 4 (rather than Form 5) in accordance with Form 4's filing deadline (i.e., before the end of the second business day following the date of execution of the transaction).
The amendments are intended to address concerns that the lengthy reporting deadline currently allowed by reporting bona fide gifts on Form 5 (within 45 days after the issuer's fiscal year end) may allow Section 16 reporting persons to engage in the problematic practices involving gifts of equity securities, such as making stock gifts while in possession of MNPI or backdating stock gifts in order to maximize the tax benefits associated with such gifts. The shortened reporting deadline by way of the filing of such gifts on Form 4 is intended to help investors, other market participants and the SEC better evaluate the actions of Section 16 filers and the context in which they make gifts of equity securities.
How We Can Help
If you have any questions regarding the Rule 10b5-1 disclosure regulations or any other executive compensation disclosure issues, please contact one of the members of Holland & Knight's Public Companies and Securities Team or Executive Compensation and Benefits Team.
1 Sales of securities used to generate funds to cover the withholding taxes associated with equity vesting and elections under 401(k) plans or employee stock purchase plans that may be structured as Rule 10b5-1 plans.
2 Plans designed to effect the open market purchase or sale of the total amount of the securities subject to the plan as a single transaction.
3 For example, an insider may have overlapping plans or a plan that does not have a cooling-off period. Because any such plan would not satisfy all requirements for a Rule 10b5-1 plan, it would be considered a non-Rule 10b5-1 trading arrangement.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.