U.S. SEC Proposes Amendments Regarding Rule 10b5-1 Plans and Related Disclosures
U.S. SEC Proposes Amendments Regarding Rule 10b5-1 Plans and Related Disclosures
On December 15, 2021, the U.S. Securities and Exchange Commission (the SEC) proposed amendments to the affirmative defense in Rule 10b5-1(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and proposed a number of changes to disclosure requirements applicable to issuers and insiders. The SEC described the proposed amendments as intended to address “critical gaps in the SEC’s insider trading regime and to help shareholders understand when and how insiders are trading in securities for which they may at times have material nonpublic information.”
If adopted after a 45-day comment period, these proposed amendments would:
Adopted over 20 years ago, Rule 10b5-1 provides an affirmative defense against allegations of insider trading by companies and their insiders engaging in transactions in the company’s stock, even while in possession of material nonpublic information at the time of trading, through plans that are set up in advance. Over the years, academic studies have suggested that insiders with Rule 10b5-1 plans may achieve better returns than those not trading pursuant to Rule 10b5-1 plans. Those studies, as well as situations where insiders appeared to conduct questionable transactions under Rule 10b5-1 plans, have created negative perceptions about the use of Rule 10b5-1 plans by issuers and insiders.
In 2007, Linda Chatman Thomsen, then the Director of the SEC’s Division of Enforcement, delivered a speech highlighting concerns about the use of Rule 10b5-1 plans. At the time, she said that the SEC would probe issues associated with the use of Rule 10b5-1 trading plans by insiders, and those warnings by the SEC Staff continued for a few years after that speech. Citing academic studies, Thomsen noted that executives who trade within a Rule 10b5-1 plan outperformed their peers who trade outside such a plan. In response, she noted that “[w]e and others are looking at the disclosures surrounding 10b5-1 plans. We’re looking at multiple and seemingly overlapping 10b5-1 plans and at asymmetrical disclosure around plans — that is, disclosure of entry into a 10b5-1 plan, without timely disclosure of related plan modifications or terminations.”
In 2013, the Council of Institutional Investors (the “CII”) submitted a rulemaking petition to the SEC, expressing concerns about Rule 10b5-1 plans. The CII requested that the SEC consider issuing interpretive guidance or adopting amendments to Rule 10b5-1 that would require Rule 10b5-1 plans to be adopted with the additional protocols or guidelines that the CII believed would curb the potential for abuse of Rule 10b5-1 trading plans.
Following recent legislative efforts to compel the SEC to act on Rule 10b5-1 plans, in June 2021 SEC Chair Gary Gensler said that Rule 10b5-1 plans had led to “real cracks in our insider trading regime” and announced that he had asked the SEC Staff to provide recommendations on how the SEC might “freshen up” Rule 10b5-1. Gensler indicated that the Staff would look into possible reforms to Rule 10b5-1. Gensler’s comments were followed by recommendations to amend Rule 10b5-1 from the SEC’s Investor Advisory Committee.
In the Proposing Release, the SEC states:
We share the concern about the prevalence of trading practices by corporate insiders and issuers that suggest the misuse of material nonpublic information. We also understand that some issuers have engaged in a practice of granting stock options and other equity awards with option-like features to executive officers and directors in coordination with the release of material nonpublic information. In addition, there is research indicating that some corporate insiders may be opportunistically timing gifts of securities while aware of material nonpublic information relating to such securities. These practices can undermine the public’s confidence and expectations of honest and fair capital markets by creating the appearance that some insiders, by virtue of their positions, do not play by the same rules as everyone else.
Rule 10b5-1(c)(1) establishes an affirmative defense to Rule 10b-5 liability for a trade if the trade was made pursuant to a binding contract, an instruction to another person to execute the trade for the instructing person’s account, or a written plan. A person asserting a Rule 10b5-1(c)(1) defense must satisfy several conditions:
Rule 10b5-1(c)(1) states that a purchase or sale is not pursuant to a contract, instruction, or plan if, among other things, the person who entered into the arrangement altered or deviated from the contract, instruction, or plan, or entered into or altered a corresponding or hedging transaction or position with respect to the securities. The rule also provides that the affirmative defense of a trading arrangement is only available if the trading arrangement was entered into “in good faith and not as part of a plan or scheme to evade the prohibitions” of the rule.
Currently, Rule 10b5-1(c)(1) does not impose any waiting period between the date on which the trading arrangement is adopted and the date of the first transaction to be executed under the trading arrangement, although in practice many insiders include a waiting period in their Rule 10b5-1 plans. Rule 10b5-1 plan guidelines that issuers adopt as part of their insider trading prevention programs often require waiting periods, although the term of the waiting period that is prescribed varies.
The SEC proposes to amend Rule 10b5-1(c)(1) to add as a condition to the availability of the affirmative defense:
Under the proposed amendments, for directors and officers subject to Exchange Act Section 16 reporting, and for issuers, the Rule 10b5-1(c)(1) affirmative defense would only be available for a trading arrangement that includes a cooling-off period that delays transactions under the trading arrangement for at least 120 or 30 days (whichever is applicable) after the date of adoption of any new or modified trading arrangement. The proposed amendments also include a note clarifying that a “modification” of an existing Rule 10b5-1(c)(1) trading arrangement, including cancelling one or more trades, would be deemed equivalent to terminating the plan in its entirety, and the cooling-off period would therefore apply after a “modification” before any new trades could commence.
The SEC notes in the Proposing Release that applying a cooling-off period to directors and officers is appropriate “because such individuals are more likely than others to be aware of material nonpublic information in the general course of events, and also more likely to be involved in making or overseeing key corporate decisions that have the potential to affect the issuer’s stock price, including decisions about the timing of the disclosure of such information.” The SEC also indicates that it is appropriate to apply a cooling-off period to issuers because it addresses concerns that issuers may conduct stock buybacks while they are aware of material nonpublic information.
The SEC proposes to amend Rule 10b5-1(c)(1)(ii) to impose a certification requirement as a condition to the affirmative defense. Under the proposed amendment, if a director or officer of the issuer of the securities adopts a Rule 10b5-1 trading arrangement, as a condition to the availability of the affirmative defense, such director or officer would be required to promptly furnish to the issuer a written certification at the time of the adoption of a new/modified trading arrangement.
The certification would require a director or officer to certify at the time of the adoption of the trading arrangement:
In the Proposing Release, the SEC indicates that the proposed certification requirement “is intended to reinforce directors’ and officers’ cognizance of their obligation not to trade or adopt a trading plan while aware of material nonpublic information, that it is their responsibility to determine whether they are aware of material nonpublic information when adopting Rule 10b5-1 plans, and that the affirmative defense under Rule 10b5-1 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.”
The proposed amendment includes an instruction that a director or officer seeking to rely on the affirmative defense should retain a copy of the certification for a period of ten years. The proposed amendment would not require a director, officer, or the issuer to file the certification with the SEC. The SEC indicates that the proposed certification would not be an independent basis of liability for directors or officers under Exchange Act Section 10(b) and Rule 10b-5. Rather, the SEC indicates in the Proposing Release that “the proposed certification would underscore the certifiers’ awareness of their legal obligations under the federal securities law related to the trading in the issuer’s securities.”
Restricting Multiple Overlapping Rule 10b5-1 Trading Arrangements and Single-Trade Arrangements
In the Proposing Release, the SEC indicates that it is “concerned that a person could circumvent the proposed cooling-off period by setting up multiple overlapping Rule 10b5-1(c)(1) trading arrangements, and deciding later which trades to execute and which to cancel after they become aware of material nonpublic information but before it is publicly released.” As a result, the SEC proposes to amend Rule 10b5-1(c)(1) to eliminate the affirmative defense for any trades by a trader who has established multiple overlapping trading arrangements for open market purchases or sales of the same class of securities. Under the proposed amendment, the affirmative defense would not be available for trades under a trading arrangement when the trader maintains another trading arrangement, or subsequently enters into an additional overlapping trading arrangement, for open market purchases or sales of the same class of securities.
The SEC indicates that the proposed amendment would not apply to transactions directly with the issuer, such as acquiring shares through participation in employee stock ownership plans or dividend reinvestment plans.
The SEC also proposes to amend Rule 10b5-1(c)(1)(ii) to limit the availability of the affirmative defense for a trading arrangement designed to cover a single trade, so that the affirmative defense would only be available for one single-trade plan during any 12-month period. Under this proposed amendment, the affirmative defense would not be available for a single-trade plan if the trader had, within a 12-month period, purchased or sold securities pursuant to another single-trade plan. The SEC cites in support of this amendment recent research which indicates that single-trade plans are consistently loss avoiding and often precede stock price declines.
Rule 10b5-1 affirmative defense is only available if a trading arrangement was entered into in good faith and not as part of a plan or scheme to evade the prohibitions of the rule. The SEC proposes to amend Rule 10b5-1(c)(1)(ii) to add the condition that a contract, instruction, or plan be “operated” in good faith. In the Proposing Release, the SEC indicates that to further require that the trading arrangement be operated in good faith “would help deter fraudulent and manipulative conduct and enhance investor protection throughout the duration of the trading arrangement.” The SEC also indicates that the proposed amendment is intended to make clear that “the affirmative defense would not be available to a trader that cancels or modifies their plan in an effort to evade the prohibitions of the rule or uses their influence to affect the timing of a corporate disclosure to occur before or after a planned trade under a trading arrangement to make such trade more profitable or to avoid or reduce a loss.”
Other than disclosure currently required by Form 144 (which requires a seller to disclose the date of adoption of a Rule 10b5-1 plan or providing an instruction in accordance with the rule), there are presently no mandatory disclosure requirements concerning the use of Rule 10b5-1 trading arrangements or other trading arrangements by issuers or insiders, although some issuers and insiders elect to provide disclosure when entering into Rule 10b5-1 plans or conducting transactions under Rule 10b5-1 plans. Further, issuers are not required to disclose information about their insider trading policies or procedures.
The SEC is proposing a new Item 408 under Regulation S-K and corresponding amendments to Forms 10-Q and 10-K to require:
The SEC is also proposing new Item 16J to Form 20-F to require annual disclosure of a foreign private issuer’s insider trading policies and procedures. In addition, the SEC is proposing amendments to Forms 4 and 5 to require insiders to identify whether a reported transaction was executed pursuant to a Rule 10b5-1(c) trading arrangements.
As proposed, Item 408(a) of Regulation S-K would require issuers to disclose:
Proposed Item 408(b) of Regulation S-K would require issuers to disclose whether the issuer has adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of the issuer’s securities by directors, officers, and employees or the issuer itself that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the issuer. If the issuer has not adopted such insider trading policies and procedures, the issuer must explain why it has not done so, and if the issuer has adopted insider trading policies and procedures, it must disclose such policies and procedures. These disclosures would be required in an issuer’s annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C. Foreign private issuers would also be required to provide analogous disclosure in their annual reports pursuant to a new Item 16J of Form 20-F.
The SEC is proposing to require that issuers tag the information specified by Item 408 in Inline XBRL in accordance with Rule 405 of Regulation S-T and the EDGAR Filer Manual. The proposed requirements would include block text tagging of narrative disclosures, as well as detail tagging of quantitative amounts disclosed within the narrative disclosures. In the Proposing Release, the SEC indicates that “[r]equiring Inline XBRL tagging of the disclosures provided pursuant to Item 408 would benefit investors by making the disclosures more readily available and easily accessible to investors, market participants, and others for aggregation, comparison, filtering, and other analysis, as compared to requiring a non-machine-readable data language such as ASCII or HTML.”
In December 2020, the SEC proposed, among other things, amendments to Form 4 and Form 5 to add a checkbox to these forms that would permit filers, at their option, to indicate whether a transaction reported on the form was made pursuant to a contract, instruction, or written trading plan for the purchase or sale of equity securities of the issuer that satisfies the conditions of Rule 10b5-1(c). In the December 2020 Proposing Release, the SEC noted that many Form 4 and Form 5 filers voluntarily provide additional disclosure in these forms stating that a reported transaction satisfied the affirmative defenses conditions of Rule 10b5-1(c). The SEC indicated that the checkbox option would provide filers with a more efficient method to disclose this information.
The SEC is now proposing to add a Rule 10b5-1(c) checkbox as a mandatory disclosure requirement on Forms 4 and 5. This checkbox would require a Form 4 or Form 5 filer to indicate whether a sale or purchase reported on that form was made pursuant to a Rule 10b5-1(c) trading arrangement. Filers would also be required to provide the date of adoption of the Rule 10b5-1 trading arrangement, and would have the option to provide additional relevant information about the reported transaction.
In the Proposing Release, the SEC indicates that requiring this disclosure on Forms 4 and 5 would provide greater transparency around the use of Rule 10b5-1 plans and would be consistent with the primary purpose of Exchange Act Section 16, and would provide information that could be used by issuers to comply with their Item 408 disclosure obligations.
In addition, the SEC is proposing to add a second, optional checkbox to both Form 4 and Form 5. This optional checkbox would allow a filer to indicate whether a transaction reported on the form was made pursuant to a pre-planned contract, instruction, or written plan that is not intended to satisfy the conditions of Rule 10b5-1(c).
Based on a concern that existing disclosure requirements do not provide investors with adequate information regarding an issuer’s policies and practices on stock option awards timed to precede or follow the release of material nonpublic information, the SEC proposes to add a new paragraph (x) to Item 402 of Regulation S-K that would require tabular disclosure of (i) each option award (including the number of securities underlying the award, the date of grant, the grant date fair value, and the option’s exercise price) granted within 14 calendar days before or after the filing of a periodic report, an issuer share repurchase, or the filing or furnishing of a Current Report on Form 8-K that contains material nonpublic information; (ii) the market price of the underlying securities on the trading day before disclosure of the material nonpublic information; and (iii) the market price of the underlying securities on the trading day after disclosure of the material nonpublic information. In the Proposing Release, the SEC states that the proposed amendments “are intended to provide shareholders a full and complete picture of any spring-loaded or bullet-dodging option grants during the fiscal year.” The SEC also proposes to require that issuers tag the information required by Item 402(x) in Inline XBRL in accordance with Rule 405 of Regulation S-T and the EDGAR Filer Manual.
Under current requirements, Section 16 reporting persons are required to report any bona fide gift of equity securities registered under Exchange Act Section 12 on Form 5. Exchange Act Rule 16a-3(f) provides that every person who, at any time during an issuer’s fiscal year, was subject to Section 16 of the Exchange Act must file a Form 5 within 45 days after the issuer’s fiscal year end to disclose certain beneficial ownership transactions and holdings not reported previously on Forms 3, 4, or 5. The acquisition and disposition of bona fide gifts are eligible for delayed reporting on Form 5 pursuant to Rule 16a-3(f)(1).
In the Proposing Release, the SEC indicates that it has “become aware that the length of the filing period for Form 5 may allow insiders to engage in problematic practices involving gifts of securities, such as insiders making stock gifts while in possession of material nonpublic information, or backdating a stock gift in order to maximize a donor’s tax benefit.”
The SEC proposes to amend Exchange Act Rule 16a-3 to require the reporting of dispositions of bona fide gifts of equity securities on Form 4 before the end of the second business day following the date of execution of the transaction, which would be significantly earlier than what is required under current requirements.
The SEC’s proposed amendments are subject to a relatively short comment period of 45 days following publication of the Proposing Release in the Federal Register. We expect that given the priority placed by the SEC on addressing these issues, the SEC will act quickly to consider commenters’ suggestions and adopt final rules.
 Release No. 33-11013, Rule 10b5-1 and Insider Trading (Dec. 15, 2021), available at https://www.sec.gov/rules/proposed/2021/33-11013.pdf (the “Proposing Release”).
 Opening Remarks Before the 15th Annual NASPP Conference, Linda Chatman Thomsen (Oct. 10, 2007), available at https://www.sec.gov/news/speech/2007/spch101007lct.htm.
 Rulemaking petition regarding Rule 10b5-1 Trading Plans, File No. 4-658 (Jan. 2, 2013), available at https://www.sec.gov/rules/petitions/2013/petn4-658.pdf.
 Recommendations of the Investor Advisory Committee Regarding Rule 10b5-1 Plans, SEC Investor Advisory Committee (Sept. 9, 2021), available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/20210916-10b5-1- recommendation.pdf.
 Rule 144 Holding Period and Form 144 Filings, Release No. 33-10991 (Dec. 22, 2020), available at https://www.sec.gov/rules/proposed/2020/33-10911.pdf (the “December 2020 Proposing Release”).