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Corporate Compliance

United States: Renewed Focus on Rule 10b5-1 Trading Plans

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In brief

The Securities and Exchange Commission (SEC) adopted final rules relating to Rule 10b5-1 in December 2022, which went into effect on February 28, 2023. The amendments introduce new restrictions on 10b5-1 plans, as well as disclosure requirements to address insider trading and improve public reporting on corporate insiders’ transactions.

With the new rules impacting both reporting companies and persons wishing to avail of themselves of the affirmative defense, internal legal and compliance departments must be familiar with and ready to implement the changes brought by the new rules.

To further highlight the importance of the rules governing 10b5-1 plans, the first criminal prosecution tied to the rule was recently filed by the US Attorney’s Office for the Central District of California and later by the SEC, in which cases the insider allegedly entered into a 10b5-1 trading plan while in possession of material non-public information.

Contents

  1. Key takeaways
  2. Changes to Rule 10b5-1 Plans
  3. Review of Existing Plans and Instructions
  4. New disclosure requirements
  5. More information

Key takeaways

  • New conditions for the availability of the Rule 10b5-1 affirmative defense, including cooling-off periods for directors, officers, and persons other than issuers, which applies to new plans adopted, or existing plans amended, after February 27, 2023.
  • Issuers are required to comply with the new disclosure requirements in Exchange Act periodic reports and in any proxy statements in the first filing covering the issuer’s first fiscal period beginning on or after April 1, 2023.
  • Smaller reporting companies have until the first fiscal period on or after October 1, 2023 before they are required to comply with the additional disclosure requirements.
  • Section 16 reporting persons are required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023 (although the Form 4 filing obligation triggered by gifts of securities became effective on February 27, 2023).

Issuers should review and update their insider trading policies in light of the final rule amendments and increased disclosure requirements, including adding requirements that 10b5-1 trading plans must be pre-approved and that gifts of securities are subject to the pre-approval process.

Changes to Rule 10b5-1 Plans

The new amendments add significant conditions to the accessibility of the affirmative defense for corporate insiders to insider trading liability under Rule 10b5-1, including:

  • A requirement that all persons entering into a Rule 10b5-1 plan must act in good faith in relation to the plan.
  • A new cooling-off period for directors and Section 16 officers before trading pursuant to a Rule 10b5-1 plan, which ends on the later of 90 days after the date of adoption or two trading days after the filing of the Form 10-Q or 10-K for the period in which the plan was adopted, but in no event more than 120 days.
  • A new cooling-off period of 30 days for persons other than issuers, directors, or officers.
  • A new limitation to the use of overlapping trading plans for anyone other than issuers.
  • A new requirement for directors and officers to include a representation in their Rule 10b5-1 plan certifying, at the time that the plan is passed, that (1) it is adopted in good faith and (2) that they are not otherwise in possession of material non-public information about the issuer or its securities.
  • A new limitation on the ability to rely on the affirmative defense for a single-trade plan to one single-trade plan per twelve-month period for all persons other than issuers.

Trading plans adopted on or after February 27, 2023 must satisfy amended Rule 10b5-1 rules in order to benefit from the affirmative defense. Existing trading plans can be kept in place after February 27, but an existing trading plan that is modified on or after February 27 to change the amount, price, or timing of trades will need to comply with amended Rule 10b5-1 in order to benefit from the affirmative defense.

Review of Existing Plans and Instructions

Under the new rules, insiders may not have multiple contracts, instructions or plans outstanding that would qualify for the affirmative defense under the amended Rule 10b5-1, unless the plans qualify for one of the amended rule’s limited exceptions for overlapping plans.

As a result, if a person with an existing plan (or multiple existing plans) that do not fit under the limited exceptions wishes to adopt a new plan, that person would need to either terminate the existing plan(s) or provide that trading under the new plan is not authorized to begin until after all trades under the existing plan(s) are completed or expired.

Further, it is common practice for public companies to adopt “sell-to-cover” instructions for RSU vesting events held by insiders in which the agent or broker acting as share plan administrator is instructed to sell securities in order to satisfy tax withholding obligations at the time an award vests. It is important to review such instructions and plans in light of the amended rules, as such instructions could potentially be viewed as an overlapping plan with any newly adopted 10b5-1 plan. An existing sell-to-cover instruction can overlap if it qualifies as an “eligible sell-to-cover-transaction”, which the SEC has defined as one that “authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations incident to the vesting of a compensatory award, such as restricted stock or stock appreciation rights, and the insider does not otherwise exercise control over the timing of such sales.”  If an insider’s existing sell-to-cover instruction meets this definition, the insider may adopt a new Rule 10b5-1 plan that benefits from the affirmative defense without needing to terminate the insider’s existing sell-to-cover instruction. If, however, such existing instructions include sales based on other financial variables beyond satisfying tax withholdings, such as the ability for the insider to elect a higher withholding rate than statutorily required, such instruction would be as an overlapping plan.

It is important to note that the SEC did not extend the “eligible sell-to-cover” exception to include sales incident to the exercise of option awards. The SEC notes that options exercises could create a risk of opportunistic trading. Option exercises occur at the discretion of the insider, and such decisions could occur when the insider later obtains material non-public information.

New disclosure requirements

The new amendments also include extensive updates to disclosure regulations regarding insider trading plans and policies, option grant policies, and Section 16 filings, including the following requirements:

  • Quarterly disclosure by issuers of Rule 10b5-1 insider trading plans and other trading arrangements implemented, modified, or terminated by an issuer’s officers and directors.
  • Annual disclosure by issuers indicating whether they have adopted insider trading policies and procedures, and if not, explaining why.
  • Annual reporting by issuers of their grant policies related to options and similar awards, including a new table that must disclose, among other information, any stock option grants made within four business days before the filing of a periodic report or the filing of a report on Form 8-K that discloses material non-public information (such as an earnings release) or within one business day after such filing.
  • Updated requirement to report gifts of securities on Form 4 that could previously be reported on Form 5.

A new “check-the-box” requirement on Forms 4 that requires issuers to indicate whether a reported transaction was proposed to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose the date of adoption of the trading plan.
Issuers are required to comply with the new disclosure requirements in Exchange Act periodic reports and in any proxy statements in the first filing covering the issuer’s first fiscal period beginning on or after April 1, 2023. Smaller reporting companies have until the first fiscal period on or after October 1, 2023 before they are required to comply with the additional disclosure requirements.

Section 16 reporting persons are required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023.

More information

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Author

Jeremy Moore is a member of the Firm's North America Transactional Practice Group based in the Houston office.

Author

Roger Bivans is a seasoned lawyer focused on strategic transactions, including domestic and multinational mergers and acquisitions, carve-out and joint venture transactions, capital markets transactions, securities regulation and corporate governance matters and general commercial transactions. He is recognized by Chambers USA for Corporate/M&A. A frequent speaker on securities regulation, he is the current Dallas chapter president of the Society for Corporate Governance and moderator of the DFW Securities Law Discussion Group. Mr. Bivans previously served as a surface warfare officer in the United States Navy.

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Francesca Gottardi is an associate in the Corporate & Securities and Mergers & Acquisitions practice groups of Baker McKenzie's Houston office. She has previously worked as a law clerk at General Electric. Francesca has published research on international law and human rights. She has also taught the courses "Law, Politics, and Society," and "International Human Rights" at the University of Cincinnati (OH).

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Anelis Villarreal is an associate in Baker McKenzie’s Houston office and is a member of the North America Transactional Practice Group. Anelis began her career with the Firm as a summer associate in 2019. Anelis’ work spans a variety of subgroups within the broader Transactional practice.

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Sarah J. Rodrigue is an associate in the Firm's North America Transactional Practice Group based in the Houston office. Ms. Rodrigue regularly advises on a wide variety of corporate and securities matters including public and private securities offerings, mergers and acquisitions and other strategic cross-border transactions and investments. Sarah began her career with the Firm as a summer associate in both 2018 and 2019.

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