February 8, 2023

Volume XIII, Number 39

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February 06, 2023

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SEC Adopts Amendments to Rule 10b5-1 Insider Trading Plans and Related Matters

OVERVIEW

On 14 December 2022, the Securities and Exchange Commission (the SEC) adopted amendments to Rule 10b5-1 of the Securities Exchange Act of 1934 addressing concerns that insiders and issuers have in the past been able to evade the spirit of the rule and trade opportunistically on the basis of material nonpublic information. Additionally, the SEC adopted new disclosure requirements related to:

  • Issuers’ insider trading policies and procedures;

  • Adoption and termination of 10b5-1 plans;

  • Equity compensation to directors and executive officers; and

  • Bona fide gifts of securities.

POTENTIAL LOOPHOLES

The SEC adopted the 10b5-1 amendments to fill gaps in the existing infrastructure that potentially allowed insiders and issuers to trade securities opportunistically on the basis of material nonpublic information. Insiders were previously allowed to adopt multiple overlapping 10b5-1 plans and in practice were able to selectively cancel certain plans based on their relative profitability, possibly on the basis of material nonpublic information. Additionally, there previously was no requirement for any waiting period before commencing trading under a 10b5-1 plan after its adoption. Academic studies have shown that insiders trading pursuant to 10b5-1 plans consistently outperform those not trading under 10b5-1 plans, particularly when an insider’s trades occur shortly after a plan’s adoption.

10B5-1 AMENDMENTS

To curb potential abuses of the 10b5-1 protections, the SEC adopted amendments to:

  • Include cooling-off periods applicable to directors, officers and all other persons other than the issuer;

  • Include a certification condition for directors and officers to the effect that they are not aware of material nonpublic information and are adopting the plan in good faith;

  • Limit the ability of persons other than the issuer to use multiple overlapping 10b5-1 plans;

  • Limit the ability of persons other than the issuer to adopt no more than one single-trade 10b5-1 plan during any consecutive 12-month period; and

  • Add a condition that all persons entering into Rule 10b5-1 plans must act in good faith with respect to that plan.

Under the final rule, directors and officers may not rely on the affirmative defenses under Rule 10b5-1 if a plan allows for trading within 90 days of adoption or within two business days following the disclosure of the issuer’s financial results in an annual or quarterly report for the fiscal quarter in which the plan was adopted, whichever is later. For persons other than directors, executive officers, and the issuer, the cooling-off period is at least 30 days following adoption of a 10b5-1 plan. Lastly, while there will be no required cooling-off period for issuers trading in their own securities under a 10b5-1 plan, the SEC noted in the adopting release that it is continuing to consider whether regulatory action is needed to mitigate any risk of investor harm from the misuse of 10b5-1 plans by the issuer, such as in the share repurchase context.

NEW DISCLOSURE REQUIREMENTS

Under the existing rules, there is no requirement for issuers or insiders to disclosure the use of 10b5-1 trading plans. In addition to the amendments related to the adoption of 10b5-1 plans noted above, the SEC sought to improve transparency with respect to trades made by insiders and issuers pursuant to these plans. The amendments also require:

  • Quarterly disclosure by issuers regarding the use of 10b5-1 plans and other trading arrangements by an issuer’s directors and officers;

  • Annual disclosure regarding an issuer’s insider trading policies and procedures in new Item 408 of Regulation S-K and corresponding amendments to Forms 10-Q and 10-K;

  • Tabular and narrative disclosures in new Item 402(x) of Regulation S-K regarding awards of options, stock appreciation rights, and other similar instruments to insiders shortly before and immediately after the release of material nonpublic information;

  • Issuers to apply Inline XBRL tags to the information specified by new Items 402(x), 408(a), and 408(b)(1);

  • Reporting of dispositions of equity securities by bona fide gifts on Form 4, rather than on Form 5; and

  • Adding a mandatory Rule 10b5-1(c) checkbox to Forms 4 and 5.

With all of these disclosure amendments, the SEC hopes to increase transparency regarding the use of 10b5-1 plans, issuers’ insider trading policies and procedures, and their policies and practices with respect to awards of options, stock appreciation rights, and other similar instruments close in time to the release of material nonpublic information.

IMPLEMENTATION TIMELINE

The final rules will go into effect on 13 February 2023, 60 days following publication of the amendments in the Federal Register. Issuers will be required to comply with the new disclosure requirements in financial reports and information statements that cover the issuer’s first full fiscal period ending on or after 1 April 2023.

CONCLUSION

The amendments were a long time in the making. The Council of Institutional Investors, which represents pension funds, endowments and other financial entities, has said that it has been pressing the SEC on 10b5-1 reform for over 10 years. There are legitimate concerns, raised in comments to the initial SEC proposals, that these amendments may impose additional costs on issuers and stifle some legitimate usages of 10b5-1 plans. The additional disclosure requirements will increase legal costs associated with the adoption of 10b5-1 plans.

Additionally, the limitations on the use of 10b5-1 plans by directors and executive officers may make the equity compensation they receive more difficult to sell and therefore less valuable, meaning issuers may have to increase equity compensation packages to attract and retain qualified directors and executive officers. However, the potential for increased costs to issuers was outweighed by the value of increased investor and market confidence that issuers and corporate insiders are operating on a level-playing field. Ultimately, the amendments were passed by a unanimous vote of the SEC’s five commissioners, signaling bipartisan support for the need to bring 10b5-1 rules up to date.

NEXT STEPS

Compliance with the new rules will require additional diligence on the part of issuers to ensure that they and their insiders affirmatively do not hold material nonpublic information when adopting or modifying a 10b5-1 plan. Issuers will need to make sure that accurate records are kept regarding the use of 10b5-1 plans and the procedures and the trades thereunder for inclusion in quarterly and annual reports. Additionally, the new rules may impact how a company designs its equity incentive compensation packages and the timing of awards. 

Jeffrey K. Pititto also contributed to this article.

Copyright 2023 K & L GatesNational Law Review, Volume XII, Number 354
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About this Author

Erin L. Fogarty Partner K&L Gates
Partner

Erin Fogarty is a partner in the firm's corporate/securities practice. She represents companies and investment funds in public and private offerings of debt, equity and convertible securities and advises them on compliance with the reporting requirements of the federal securities laws, Sarbanes-Oxley and NYSE and NASDAQ rules and regulations as well as providing general corporate representation. She also advises financial sponsors and strategic buyers and sellers in connection with mergers, acquisitions, joint ventures and similar transactions.

305-539-3385
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