What You Need to Know About the SEC’s Amendments to Enhance Investor Protections Concerning Insider Trading

13 minute read | December.16.2022

During an open meeting held December 14, 2022, the SEC voted unanimously in favor of adopting changes to the rules governing insider trading defenses, including amendments to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), new required disclosure regarding Rule 10b5-1 trading arrangements and insider trading policies and procedures, as well as amendments regarding the disclosure of the timing of certain equity compensation awards and reporting of gifts on Form 4. A version of these rules was first proposed by the SEC during December of last year.

The SEC announcement, fact sheet, and final rule text are available here, here and here, respectively.

Key Takeaways:

The new rules, which will be effective no later than 60 days after publication of the release in the Federal Register, will, among other things:

  • Require insider trading policies and procedures be filed as exhibits to Forms 10-K and 20-F, respectively, beginning with the first filing that covers the first full fiscal period beginning on or after April 1, 2023;
  • Require quarterly disclosure by domestic companies of their insiders’ use of 10b5-1 trading plans and annual tabular and other disclosure by domestic companies regarding option grants made close in time to the release of material nonpublic information (“MNPI”);
  • Impose new conditions to establish an affirmative defense to insider trading violations by use of a Rule 10b5-1 trading plan, including mandatory cooling-off periods before any trading can commence, a prohibition on multiple overlapping plans, and required certifications from directors and officers;
  • Require Form 4 and 5 filers indicate by checkbox if a reported transaction was pursuant to a 10b5-1 plan; and
  • Require contemporaneous reporting of “bona fide” gift transactions by Section 16 reporting persons.

While many of these changes are consistent with best practices, among other things, the length of cooling-off periods and contemporaneous gift reporting will be major changes for directors and officers.

Disclosure of Insider Trading Policies and Procedures by Companies

New S-K Item 408(b) requires annual disclosure by companies regarding whether or not (and if not, why not) the company has adopted insider trading policies and procedures that govern the purchase, sale, or other disposition of the registrant’s securities by directors, officers, and employees that are reasonably designed to promote compliance with insider trading laws, rules, and regulations. In a change from the proposed rules, the new rules provide that insider trading policies and procedures will also need to be provided in Form 10-K filings as an exhibit.[1]

Very few companies make their insider trading policies public today, so the exhibit filing requirement will likely cause many companies to consider refreshing their policies in advance of the filing. The SEC also specifically noted that investors may be interested in certain information about procedures that may not currently be detailed in some companies’ policies: specifically, “information on the issuer’s process for analyzing whether directors, officers, employees, or the issuer itself when conducting an open-market share repurchase have MNPI; the issuer’s process for documenting such analyses and approving requests to purchase or sell its securities whether through Rule 10b5-1 plans or otherwise; and/or how the issuer enforces compliance with any such policies and procedures it may have.” Accordingly, with a view to disclosure, companies might evaluate existing procedures and consider whether their policies should be augmented, and in the case of some companies, formally documented in writing.

Disclosure Regarding Use of 10b5-1 Plans

New S-K Item 408(a) will require Form 10-Q[2] and 10-K[3] disclosure by companies regarding the use of Rule 10b5-1 plans and certain other trading arrangements by their directors and officers. The disclosure must include a description of material terms such as the name and title of the director or officer, the date the arrangement was adopted or terminated, the duration of the arrangement, and the number of securities to be purchased or sold pursuant to the arrangement. This quarterly disclosure is not applicable to FPIs.

Disclosure Regarding Option Grants Made Close in Time to the Release of MNPI

New Item 402(x) of Regulation S-K will require companies to discuss their policies and practices on the timing of option grants and similar stock appreciation-based equity instruments in relation to disclosure of MNPI. It will also require companies to report on a new table[4] in their proxy statement or Form 10-K, any stock options or similar equity instruments granted to a “named executive officer” beginning four business days before the filing of a periodic report or the filing or furnishing of a current report on Form 8-K that discloses MNPI, including earnings information (other than a Form 8-K that discloses a material new award under Item 5.02(e)), and ending one business day after a triggering event.

The new table is intended to highlight for investors award grants that may be more likely to have been made at a time the board was aware of MNPI affecting the value of the equity award.

New Requirements for 10b5-1 Plans

Rule 10b5-1(c)(1) provides an affirmative defense to Section 10(b) and Rule 10b-5 liability for insider trading conducted pursuant to a pre-established trading plan under certain conditions. Addressing concerns that corporate insiders have used 10b5-1 plans to trade on the basis of MNPI, the SEC amended Rule 10b5-1(c)(1) to: (i) apply a cooling-off period between entering into a plan and making the first trade under the plan for persons other than the company; (ii) impose a certification requirement on directors and officers; (iii) limit the ability of individuals to use multiple overlapping Rule 10b5-1 plans; (iv) limit the use of single-trade plans by individuals to one plan in any 12-month period; and (v) add a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to that plan.

Cooling-Off Periods for Persons Other Than the Company

“Trading plans must provide for a waiting period between the date that a trading plan is adopted, or modified, and the date of the first transaction under the plan. The length of the waiting period depends on who is adopting the plan, but for directors and officers the cooling-off period will generally last at a minimum through two business days following the filing of a 10-Q or 10-K for the quarter in which the plan was adopted. 

The final rules provide that to rely on the Rule 10b5-1 affirmative defenses, a 10b5-1 plan adopted or modified by a director or “officer” (here, defined as Section 16 officers)[5] must provide that trading will not begin until the later of (i) 90 days after the adoption or modification of the plan or (ii) two business days following the disclosure of the company’s financial results in a Form 10-Q or Form 10-K (or in a Form 20-F or Form 6-K that discloses such information for foreign private issuers (“FPIs”)).[6] In any event, the period is capped at a maximum of 120 days after the adoption of the plan. Note that the final rules broadly define “modification” for purposes of triggering a new cooling-off period. See “Modifications and Treatment of Existing 10b5-1 Plans” below.

If the person adopting the 10b5-1 plan is neither the company nor a director or officer, the cooling-off period is 30 days after adoption of the plan. The rules do not require cooling-off periods for 10b5-1 plans adopted by companies.

Director and Officers Certifications

“Directors and officers must include a representation in the plan certifying that at the time of the adoption: (1) they are not aware of any MNPI and (2) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Exchange Act Rule 10b-5.”

While Rule 10b5-1(c) has always required that plans be entered into in good faith and at a time when the individual did not possess MNPI, this certification requirement was described by the SEC in the release as a reminder to individuals of those obligations. While many companies and brokers already require similar representations be delivered when adopting a plan, the new certifications must be included in the 10b5-1 plan document, as separate delivery of similar representations to companies or brokers will not be sufficient.

Directors and officers are encouraged to consult with counsel to assist them in understanding the meaning of the terms “material” and “nonpublic information.”[7]

Restricted Use of Multiple Overlapping Trading Arrangements

“If another qualifying arrangement is outstanding, no person (other than the company) can enter into an arrangement and qualify for the affirmative defense under Rule 10b5-1(c)(1).”

The rule prohibits individuals from having multiple overlapping 10b5-1 plans, but allows the following:

  • An individual can use multiple broker-dealers to execute trades under separate contracts, and the series of separate contracts may be treated as a single “plan” if the contracts, when taken as a whole, meet all the applicable conditions and are subject to the provisions of Rule 10b5-1(c)(1). As long as the instructions are identical, a broker-dealer or other agent can be substituted without such substitution being deemed a modification of the arrangement (modifications to the amount, price, or timing of the purchase or sale of the securities underlying an arrangement are deemed a termination of the arrangement. See “Modifications and Treatment of Existing 10b5-1 Plans” below).
  • A person can have one additional plan as long as trading is not authorized to begin under the later plan until after all trades under the earlier plan are completed or expire. The later plan also must not allow for trades before the cooling-off period that would apply if the existing plan were deemed terminated on the date the later plan was entered into, to prevent the use of multiple plans for circumventing cooling-off periods.
  • The restriction on multiple overlapping plans will not apply to sell-to-cover transactions (transactions which authorize an agent to sell only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of an equity compensation award) structured as Rule 10b5-1 plans.

Restrictions on Single-Trade Arrangements for Persons Other Than the Company

The final rules provide that any person, other than the company, who enters into an arrangement designed to effect an open-market purchase or sale as a single arrangement[8] may only take advantage of the affirmative defense for one such plan in each 12-month period.

Amended Good-Faith Condition

In addition to the rule’s existing requirement that a plan must be entered into in good faith, the new rules provide that any person relying on the plan must also act “in good faith with respect to” the plan. This would sweep in good-faith requirements for actions such as modifications and terminations.

Modifications and Treatment of Existing 10b5-1 Plans

“Any modification or change to the amount, price, or timing of the purchase or sale of the securities underlying an arrangement terminates the existing plan and is treated as the adoption of a new plan .”

Pursuant to new Rule 10b5-1(c)(1)(iv), any modification or change to the amount, price, or timing of the purchase or sale of the securities underlying an arrangement constitutes a termination of the existing plan and the adoption of a new plan. Even modifications that do not directly change the amount, price, or timing of purchases and sales executed under the plan, but have the effect of doing so, will result in termination of the original plan and adoption of a new plan. Note that this will impose the same requirements (including a new cooling-off period) and certifications on the person entering into the plan as required upon entering into a wholly new plan pursuant to the amendments discussed above.

While the SEC clarified in its release that the amendments to Rule 10b5-1(c)(1) would not affect the affirmative defense available to existing plans entered into before the rule’s effective date, this change may impact some existing plans.

Form 4 and Form 5 Changes

New Form 4 and Form 5 Checkbox for Trades Under 10b5-1 Plans

check box example

Starting on April 1, 2023, Form 4 and Form 5 will require the above checkbox to indicate whether a transaction reported on that form was made pursuant to a plan intended to satisfy the conditions of Rule 10b5-1(c). If checked, filers will also be required to provide the date of adoption of the Rule 10b5-1(c) plan in the “Explanation of Responses” portion of Form 4 and Form 5.

Gift Reporting

“Starting on February 27, 2023, Section 16 reporting persons must report gifts of securities on Form 4 rather than Form 5.”

Section 16 reporting persons will be required to report dispositions of securities by “bona fide gifts”[9] on Form 4 before the end of the second business day following the execution of the transaction. Currently, Section 16 reporting persons may delay reporting any “bona fide gift” of equity securities until the filing of Form 5, which is due on or before the 45th day after the end of the company’s fiscal year.

Dispositions of securities by “bona fide gifts” remain exempt from the operation of Section 16(b), pursuant to Rule 16b-5.

While this disclosure applies to all gifts, the SEC also clarified in the adopting release that the affirmative defense of Rule 10b5-1(c)(1) is still available for bona fide gifts of securities made under a Rule 10b5-1 plan.

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We will continue to monitor developments under these new requirements. If you have any questions regarding these new rules, please contact one of the listed authors of this article, or your regular Orrick contact.

[1] If all of a company’s insider trading policies and procedures are included in its code of ethics (as defined in Item 406(b)) and the code of ethics is filed as an exhibit pursuant to Regulation S-K, Item 406(c)(1), a hyperlink to that exhibit accompanying the company’s disclosure as to whether it has insider trading policies and procedures would satisfy this component of the disclosure requirement.

[2] At Form 10-Q, Part II, Item 5 – Other Information.

[3] At Form 10-K, Part II, Item 9B – Other Information.

[4] The table will include the name of the named executive officer and, on an award-by-award basis (i) the grant date of the award; (ii) number of securities underlying the award; (iii) the per-share exercise price of the award; (iv) grant date fair value of the award; and (v) the percentage change in the market price of the underlying securities between the closing market price of the security one trading day prior to and the trading day beginning immediately following the disclosure of MNPI.

[5] See Exchange Act Rule 16a-1(f). These persons are commonly known as “Section 16 officers” because they must file with the SEC beneficial ownership reports under Section 16 of the Exchange Act.

[6] Note that the dissemination of an earnings release prior to the filing of a 10-Q or 10-K will not cut short the cooling-off period, as many commenters had hoped. The SEC specifically stated, “We disagree with commenters who suggested that there cannot be material nonpublic information contained in a Form 10-Q or similar filing when the issuer has already announced its earnings results.”

[7] In the adopting release, the SEC clarified it will continue to rely on existing definitions of “material” and “nonpublic” as established by case law: “Information is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available…. Information is nonpublic until the information is broadly disseminated in a manner sufficient to ensure its availability to the investing public generally, without favoring any special person or group.”

[8] A plan is not “designed to effect” a single transaction where the plan leaves agent discretion over whether to execute the contract, instruction, or plan as a single transaction.

[9] A “bona fide gift” is a gift that is not required or inspired by any legal duty or that is in any sense a payment to settle a debt or other obligation, and is not made with the thought of reward for past services or hope for future consideration.