SEC Adopts Broad Amendments to Rule 10b5-1 Protections and Section 16(a) Reporting

The rule amendments and form revisions discussed in this alert are collectively referred to as the “Rules.” This alert describes the Rules and how they compare to existing practices and provides practical advice for issuers and other insiders.

The Rule 10b5-1 Affirmative Defense

Because the federal securities laws do not specify the elements of insider trading, liability for trading based on material nonpublic information is generally premised on violations of the antifraud provisions of the Exchange Act (i.e., Section 10(b) and Rule 10b-5 thereunder). In 2000, in an attempt to provide greater clarity regarding the scope of insider trading prohibitions, the SEC adopted Rule 10b5-1, which provides that a person trades “on the basis of” MNPI “if the person making the purchase or sale was aware of the [MNPI] when the person made the purchase or sale.”

The rule also provided an affirmative defense to liability when a trade was executed pursuant to a written plan or binding contract adopted when the trader was not aware of MNPI. The plan must specify the amount, price and timing of the trade, and be insulated from any further influence by the trader. To qualify for the rule’s affirmative defense, the trader must strictly comply with these requirements and enter into the trading arrangement “in good faith and not as part of a plan or scheme to evade the prohibitions.” Rule 10b5-1(c)(1)(ii).

Although Rule 10b5-1 plans are often associated with corporate officers and directors, the affirmative defense is available to any person or entity that complies with the rule, including private equity funds and investment managers. Additionally, the rule’s protections extend to all types of securities (i.e., beyond equities) and are not limited to publicly traded securities.

Paradigm Shift: Rule 10b5-1 Trading Plans

Cooling-Off Periods

In a significant change to existing practice, when the Rules become effective, directors, officers and other persons (but not issuers) will be required to observe a cooling-off period between the adoption and modification of a 10b5-1 plan and the initiation of transactions in securities under the plan. The Rules impose two different cooling-off periods: one period for directors and officers (defined using the familiar “Section 16 director and officer” definition in Rule 16a-1(f)), and a separate period for all other persons. The cooling-off periods are:

• For directors and officers, subject to a maximum of 120 days, the later of:

-  90 days following the adoption of the 10b5-1 plan;

-  Two business days following the date of disclosure in a periodic report of financial results for the quarter in which the 10b5-1 plan was adopted or modified; and

• For other persons who are not directors or officers, 30 days following the date of adoption of the 10b5-1 plan.

The SEC did not impose a cooling-off requirement for issuers.

The Rules effectively impose a trading blackout period for directors and officers under a newly adopted or modified 10b5-1 plan for at least 90 days and before earnings results are disseminated to the public in a Form 10-Q or 10-K (or for foreign private issuers, a Form 20-F or 6-K).

The Rules treat a modification or change to a 10b5-1 plan as a termination of the plan followed by a subsequent adoption of a new 10b5-1 plan if the modification or change affects the amount, price or timing of the purchase or sale of securities (or to the formula, algorithm or program that controls the amount, price or timing of the purchase or sale of securities) under the 10b5-1 plan. Any modification to a 10b5-1 plan with these effects will trigger the applicable cooling-off period. There is no financial hardship exception.

No Multiple-Overlapping Plans

In a significant policy shift, the Rules will prohibit persons (other than issuers) from maintaining more than one active 10b5-1 plan, with certain limited exceptions (such as to satisfy sell-to-cover tax obligations incident to certain equity compensation). The Rules are aimed broadly at extinguishing the practice of activating multiple 10b5-1 plans and then selectively cancelling certain of the plans to achieve favorable trading outcomes, which the SEC has viewed with disfavor. While the Rules allow insiders to contract with multiple broker-dealers or agents to execute their 10b5-1 plan, each individual contract must meet the applicable conditions of Rule 10b5-1, and the contracts will remain collectively subject to the Rule. As a result, the trading instructions provided within each distinct broker contract must, in the aggregate, collectively meet the requirements of the Rules. The termination or modification of a single contract with a broker will be treated as a modification (i.e., termination and adoption of a new plan) of the 10b5-1 plan and trigger the cessation of trading during the applicable cooling-off period. The Rules do permit substitution of brokers, provided that the substitute broker implements the same trading instructions that were applicable to the substituted broker. Additionally, the Rules allow persons to maintain two separate 10b5-1 plans if trading under the later-commencing plan does not begin until after all trades under the earlier-commencing plan are completed or expire without execution. In this case, the later-commencing plan is treated as the adoption of a new plan and still triggers the applicable cooling-off period before trading may commence under the later 10b5-1 plan.

Limitations on Single-Trade Plans

The Rules limit persons (other than issuers) to one 10b5-1 plan “designed to effect” a single transaction in any 12-month period. The “designed to effect” qualification clarifies that certain 10b5-1 plans will not be deemed a single transaction plan if: (1) such plan leaves an insider’s agent discretion over whether to execute the instructions in the 10b5-1 plan or instructs that the plan be executed depending on events or information not known when the plan is entered into, and (2) it is reasonably foreseeable that the 10b5-1 plan’s trading instructions will result in multiple transactions.

Director and Officer Certifications

When directors and officers adopt a new or modified 10b5-1 plan, the Rules will require them to certify that they:

• Are not aware of material nonpublic information about the issuer or its securities; and
• Are adopting the plan in good faith and not as part of a scheme to evade the prohibitions of Rule 10b-5.

The certifications are required to be in the 10b5-1 plan representations rather than documented separately. Directors and officers are not required to maintain records of the certifications for any specific length of time; however, the burden of establishing the requirements of the Rule 10b5-1 affirmative defense falls on the director or officer, so maintenance of these records is critical.

Effectiveness

The cooling-off periods, director and officer certifications and limitations on single-trade and overlapping 10b5-1 plans discussed in this section will apply to all 10b5-1 plans adopted or modified on or after February 27, 2023. 10b5-1 plans already in effect on the effective date of the Rules will be permitted to continue unaltered as long as they are not modified or amended to change the amount, price or timing of transactions under the plan.

New Annual and Periodic Report Disclosure

The Rules will require increased disclosure relating to the use of 10b5-1 plans, issuers’ insider trading policies and increased disclosure of equity grants made shortly before or after MNPI is disclosed to the public in the compensation discussion and analysis section (CD&A). The newly required disclosure in annual and periodic reports includes:

• For annual reports:

-  Narrative disclosure of an issuer’s policies and practices regarding the timing of equity awards in relation to the disclosure of MNPI, including how the board determines when to grant such awards and whether the board or compensation committee takes MNPI into account when determining the timing and terms of an award, and whether the issuer has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation;

-  Tabular disclosure for awards made in the four business days before and one business day after the filing of a periodic report or filing or furnishing of a current report that discloses MNPI, including a column that discloses the percentage change in the market value of the securities underlying the awards between those dates;

-  Disclosure of whether the issuer has adopted insider trading policies and procedures reasonably designed to promote compliance with insider trading laws and applicable exchange listing standards; and

-  Disclosure of an issuer’s insider trading policy as an exhibit to their Form 10-K or 20-F, or if they do not have such a policy, an explanation of why they do not.

• For quarterly reports:

-  Whether, during the preceding fiscal quarter, any director or officer has adopted a 10b5-1 plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and any non-Rule 10b5-1 trading arrangement (as defined in Item 408(c)); and

-  A description of the material terms of any Rule 10b5-1 or non-Rule 10b5-1 trading plan other than pricing terms, including the name and title of the director or officer, date of plan adoption or termination, plan duration, the aggregate number of securities to be sold or purchased under the plan and whether the plan is intended to be a 10b5-1 plan, or not to be a Rule 10b5-1 plan.

Compliance with these new disclosure requirements will be required in any periodic report or proxy or information statement covering the full fiscal period that begins on or after April 1, 2023, and for smaller reporting companies, the full fiscal period that begins on or after October 1, 2023, (i.e., for calendar year companies, the Form 10-Q filed for the second quarter of 2023).

Exhibits contained in Forms 10-K and 20-F are subject to the certifications of Section 302 of the Sarbanes-Oxley Act, meaning that principal executive and financial officers are certifying the accuracy of the description of their company’s insider trading policy. This potentially exposes these officers to liabilities for irregular or inconsistent implementation of such policies within their companies. Companies should ensure that procedures and controls are in place to ensure compliance with all aspects of their insider trading policy. If a company has not adopted an insider trading policy, it should strongly consider doing so.

Forms 4 and 5: Revisions and Gift Reporting

Forms 4 and 5 will be updated to include a checkbox indicating whether a particular transaction was “intended to satisfy the affirmative defense conditions” of Rule 10b5-1(c). While many insiders already voluntarily report this information in footnotes to their beneficial ownership reports, the Rules will require this information to be reported by selecting this new checkbox.

The Rules will also require any bona fide gift of an issuer’s registered equity securities (or their derivatives) to be reported within two business days of the transaction. Previously, reporting of gifts could be delayed until the annual Form 5 deadline (though many insiders voluntarily reported them earlier). Going forward, insiders should coordinate closely with their compliance counsel to ensure gifts are reported on time. Compliance with the checkbox and gift reporting requirements will be required for all Forms 4 and 5 filed on or after April 1, 2023.

Practical Advice: Time to Review Rule 10b5-1 Plans, Insider Trading Policies and Equity Grant Practices

It is important that issuers and affected individuals analyze and revise their practices and procedures to ensure compliance with the updated rules, certifications and disclosure requirements. Issuers should:

• Review or adopt a compliant insider trading policy, including procedures to ensure observation of cooling-off periods by insiders;
• Adopt procedures to monitor the timing of equity grants in relation to the public disclosure of MNPI, and consider whether to adopt a policy that avoids issuing equity grants between four business days before and one business day after the public disclosure of MNPI (including in earnings releases);
• Review employee benefit plans and related documents for compliance with cooling-off periods, certification requirements and the limitations on single-trade or overlapping 10b5-1 plans;
• Adopt disclosure controls and procedures for the updated narrative and tabular disclosure surrounding equity grants and 10b5-1 plan adoptions; and
• Adopt procedures for the timely reporting of gifts on Form 4.

Other affected individuals should review and revise as necessary their 10b5-1 plans to observe the applicable cooling-off periods and certification requirements, as well as for compliance with the limitations on single-trade and overlapping plans, gift reporting and other applicable rules discussed in this alert.