On December 14, 2022, the SEC adopted amendments that significantly change the requirements for Rule 10b5-1 plans, including by imposing a 90 to 120 day cooling-off period for plans adopted by directors and officers, and introduce new disclosures related to the adoption and termination of trading plans of directors and officers and other matters. We explain how the amendments change the existing Rule 10b5-1 regime and the disclosure framework for trading by company insiders.
The SEC proposed amendments to Rule 10b5-1 and certain related new disclosure requirements on December 15, 2021 (see our related client alert). In general, the final rules follow the initial proposal, but the SEC made several modifications in response to the many comments it received. Chief among these modifications is that, at this time, the SEC decided not to apply most of the Rule 10b5-1 amendments to companies’ own Rule 10b5-1 plans. Doing so would have had significant implications for share repurchase programs conducted pursuant to Rule 10b5-1. The SEC did indicate, however, that it may revisit this topic in the future.
The final amendments to Rule 10b5-1 include:
Related amendments to disclosure rules will require:
For purposes of all amendments to Rule 10b5-1 and most of the new disclosure requirements, “officers” means officers who are required (or, in the case of foreign private issuers, would be required) to file Section 16 trade reports on Forms 4 and 5.
All amendments will become effective 60 days after publication of the final rules in the Federal Register, which we expect will likely put effectiveness in late February or early March of 2023.
The amendments to Rule 10b5-1, which include the new cooling-off periods, will apply to Rule 10b5-1 plans for securities of all domestic and foreign private issuers (including MJDS filers) that are entered into after the effective date of the amended rule. These amendments, except the requirement to act in good faith, do not apply to companies’ Rule 10b5-1 plans.
These amendments will not affect Rule 10b5-1 plans that were entered into before the effective date of the amended rule, except to the extent that such plans are modified after the effective date and the modification is treated as termination of the existing plan and the adoption of a new one (which will be the case for substantive modifications).
The new disclosure requirements will apply to domestic issuers only, except those related to the disclosure and filing of insider trading policies, which will also apply to foreign private issuers (other than MJDS filers). The disclosure requirements are not scaled based on filer status as an emerging growth or smaller reporting company, although smaller reporting companies benefit from a longer transition period as discussed below.
The new quarterly disclosure requirements will apply to Forms 10-Q and 10-K, and annual disclosure requirements will apply to Form 10-K (or 20-F for foreign private issuers) and proxy or information statements, in the first filing that covers the first full fiscal period that begins on or after April 1, 2023 (or October 1, 2023, for smaller reporting companies).
Companies with a calendar fiscal year will thus need to provide the new quarterly disclosures beginning with their quarterly report for the second quarter of 2023. Smaller reporting companies with a calendar fiscal year can delay compliance with quarterly disclosure requirements until their annual report for 2023.
With respect to the new annual disclosures, although the final rules could be read to suggest a longer phase-in, we believe that the SEC intended that those annual disclosures will need to be provided in the Form 10-K, proxy statement or 20-F for the first fiscal year that includes the first fiscal quarter that begins on or after April 1, 2023. We therefore believe that calendar year companies will have to provide the new annual disclosures for the first time in their annual report or proxy statement for 2023, filed in 2024.
Companies with a different fiscal year end will need to provide the new annual disclosures in the Form 10-K or proxy statement for the first fiscal year that includes the first full fiscal quarter that begins on or after April 1, 2023. For example, a company with a June 30 fiscal year end will have to provide the new annual disclosures when it files its Form 10-K or proxy statement for the fiscal year ended June 30, 2023. Conversely, a company with a May 31 fiscal year end would provide the new annual disclosures when it files its Form 10-K and proxy statement for the fiscal year ended May 31, 2024.
Amendments to the Section 16 trade reporting requirements will apply to Forms 4 and 5 filed on or after April 1, 2023.
Rule 10b5-1 plans of directors or officers must provide that trading under the plan will not begin until the later of (a) 90 days after plan adoption or (b) two business days after disclosure of the company’s financial results in a Form 10-Q or 10-K for the fiscal quarter in which the plan was adopted or, for foreign private issuers, in a Form 20-F or 6-K that discloses the company’s financial results for that quarter, all subject to a maximum cooling-off period of 120 days after plan adoption. Earnings releases that are furnished on Form 8-K do not count as disclosure of financial results for this purpose. In certain circumstances, this can extend the cooling-off period beyond 90 days, especially for Rule 10b5-1 plans adopted in the fourth quarter. For these Rule 10b5-1 plans, the cooling-off period may then not end until two business days after the filing of the Form 10-K (or 20-F for foreign private issuers), even if the company otherwise opens its trading window after the fourth quarter earnings release has been issued and before the Form 10-K is filed.
A 30-day cooling-off period will apply to all persons using Rule 10b5-1 plans who are not directors or officers, but no cooling-off period will apply to companies that use Rule 10b5-1 plans for their share repurchases. While the SEC is not adopting a cooling-off period for companies at this time, it indicated that it continues to consider doing so, leaving the door open to further amendments.
The SEC also codified its prior guidance that a modification or change to the amount, price or timing of the purchase or sale of securities (or a formula or algorithm that determines such parameters) qualifies as a termination of the plan and the concurrent adoption of a new plan. Under the new rules, such a modification or change will therefore trigger a fresh cooling-off period.
Directors and officers will have to certify at the time they enter into a Rule 10b5-1 plan that they are not aware of any MNPI and that they are adopting the plan in good faith and not as a scheme to avoid the prohibition on insider trading. In a change from the SEC’s original proposal, however, this certification will take the form of a representation in the Rule 10b5-1 plan itself rather than in a separate document that would have been required to be retained for ten years. The SEC declined to state in the text of the rule that the certifications would not impose an additional liability burden on directors and officers but expressed its belief that it was “sufficiently clear” that the certification itself would not create an independent basis of liability for insider trading.
Overlapping Plans. A person using a Rule 10b5-1 plan (other than a company) will not be permitted to have another plan outstanding or enter into a new plan for purchases or sales of any securities of the company on the open market during the same period.
The SEC did, however, include three important exceptions to this prohibition:
Single Trade Plans. All persons other than the company can only adopt one single-trade Rule 10b5-1 plan in any 12-month period. This covers plans designed to effect the open-market purchase or sale of all securities covered by the plan as a single transaction. Single-trade plans authorizing only sell-to-cover transactions are exempt from this limitation.
For this purpose, a plan is “designed to effect” the purchase or sale of securities as a single transaction when it has the practical effect of requiring such a result. In contrast, a plan is not designed to effect a single transaction where the plan leaves the person’s agent discretion over whether to execute the plan as a single transaction. Similarly, a plan is also not designed to effect the purchase or sale of securities as a single transaction when (a) the plan does not leave discretion to the agent, but instead provides that the agent’s future acts will depend on events or data not known at the time the plan is entered into, such as a plan providing for the agent to conduct a certain volume of sales or purchases at each of several given future stock prices and (b) it is reasonably foreseeable at the time the plan is entered into that the plan might result in multiple transactions.
The SEC did not adopt a prohibition on overlapping plans and single trade plans for companies, but again noted the potential for future action following further consideration.
Rule 10b5-1’s existing condition that a person relying on the rule must have entered into the plan in good faith will be supplemented by a condition that the person must also have acted in good faith with respect to the plan. According to the SEC, this is intended to ensure that MNPI does not factor into the decision to trade under a plan. Unlike the other changes to Rule 10b5-1 adopted by the SEC, this “acting in good faith” condition also applies to companies.
Domestic companies will be required to report the adoption or termination of any Rule 10b5-1 plan or “non-Rule 10b5-1 trading arrangement” with respect to securities of the company by its directors or officers that occurred during the prior fiscal quarter. The disclosure would be included in a Form 10-K or 10-Q covering the period. “Non-Rule 10b5-1 trading arrangements” are effectively securities trading plans, entered into by directors or officers at a time when they did not have MNPI, which comply with the requirements of Rule 10b5-1 as currently in effect (including that the person adopting the plan not be permitted to exercise any influence on trading under the plan), but that do not meet all of the new additional conditions described above now adopted by the SEC (such as the cooling-off period).
The disclosure must identify the following:
This disclosure will not be required in Form 20-F filed by foreign private issuers. A Rule 10b5-1 plan that “expires” in accordance with its own terms should not be considered a termination and, therefore, no disclosure should be required.
Companies, including foreign private issuers other than MJDS filers, will have to annually disclose whether they have adopted insider trading policies and if not, why not. Although the rule requires domestic issuers to include the new disclosure in both their annual reports and proxy statements, in practice we would expect it to be included in a company’s proxy statement and, pursuant to Instruction G to Form 10-K, incorporated by reference into the annual report from a definitive proxy statement filed within 120 days of the end of the fiscal year. Foreign private issuers will need to disclose this information in their annual reports on Form 20-F.
Insider trading policies will need to be filed as exhibits to Forms 10-K and 20-F but will not need to be summarized in the body of the annual reports, as the SEC had originally proposed. Companies that include their insider trading policies in their code of ethics and file the code of ethics as an exhibit to their annual report could satisfy the new disclosure requirement by hyperlinking their disclosure of whether they have insider trading policies and procedures to the code of ethics exhibit. Posting insider trading policies and procedures on the company’s website would not be sufficient.
While domestic companies (other than smaller reporting companies) are already required to disclose option grants pursuant to Item 402(d) of Regulation S-K, pursuant to new Item 402(x) of Regulation S-K, all companies (including smaller reporting companies) must also include in the annual report and proxy or information statement, in a tabular format, disclosure of:
For this purpose, option awards include stock options, stock appreciation rights and similar instruments with option-like features. With respect to each option award, the table would need to disclose the name of the recipient, the number of underlying securities, date of grant, grant date fair market value and exercise price.
In addition, new Item 402(x) will require a narrative description of the company’s policies and practices on option grants in relation to the disclosure of MNPI, including how the board determines when to grant option awards, whether and how it considers the release of MNPI in determining the timing and terms of option awards and whether the company has timed the release of MNPI to affect executive compensation. Companies that do not have such policies will neither be required to adopt them nor explain their absence.
We expect these tabular and narrative disclosures to be included in the proxy statement and incorporated by reference into the annual report on Form 10-K, like other compensation-related information.
Companies must tag the newly-required disclosures discussed above regarding the adoption or termination of trading plans by directors and officers, insider trading policies and option awards timing in inline XBRL language, even though much of this disclosure will be in narrative format. The SEC believes that inline XBRL is well-suited to such disclosures as it is already used in narrative disclosure contexts (such as disclosures of significant accounting policies) and will make disclosures more readily available and easily accessible for market participants for aggregation, comparison, filtering and other analysis. Companies will have to comply with the inline XBRL tagging requirements on the same timeline as they will be required to report the new disclosures.
Section 16 insiders will need to check a new mandatory box in their Form 4 and 5 filings to indicate whether the reported transaction was made pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1. If the box is checked, the form would also need to disclose when the relevant Rule 10b5-1 plan was adopted.
In addition, Section 16 insiders will now need to report the making of bona fide gifts of equity securities on Form 4 and will no longer be permitted to report such transactions on a delayed basis on Form 5. This dramatically accelerates the timing of insiders’ disclosure of gifts, from within 45 days after the end of the company’s fiscal year to before the end of the second business day following the gift transaction. The stated goal of accelerating gift reporting is to combat perceived abuse, such as the backdating of gifts for maximum tax benefits. The acquisition of equity securities pursuant to gifts received by insiders will not be affected and may continue to be reported on Form 5.
The mandatory cooling-off period of 90 to 120 days for directors and officers, while less onerous than the 120 days originally proposed, still has the potential to make Rule 10b5-1 plans less attractive for directors and officers seeking liquidity or diversification. It remains to be seen what impact this will have on the use of Rule 10b5-1 plans, and whether some directors and officers will instead choose to rely more on discretionary transactions without a plan.
We expect that those companies that require insiders to use Rule 10b5-1 plans for any trading in company securities may revisit this requirement.
Overall, we do not believe that the good faith requirement should present a major challenge for companies and insiders as the purpose of the requirement is consistent with mainstream practices employed by companies and the brokers that execute trading under Rule 10b5-1 plans. Companies that have strong policies and procedures with respect to the entry into and documentation of Rule 10b5-1 plans, as well as such companies’ insiders, should not be significantly impacted by the new requirement of acting in good faith. As discussed below, however, the likely increase in scrutiny of the timing of plan modifications and terminations, as well as of timing of MNPI disclosures, will be something for insiders and companies to monitor.
The timing of trading plan modifications and terminations and of disclosures of MNPI is likely to come under greater scrutiny. In the adopting release, the SEC indicated that insiders improperly influencing the timing of corporate disclosures to benefit their own trading under an existing plan (by making pre-planned trades more profitable or less unprofitable) may not be acting in good faith. This could invite greater public and regulatory scrutiny of companies’ decisions about the timing of MNPI releases.
The SEC also suggested that insiders who terminate plans on the basis of MNPI may similarly not be acting in good faith with respect to their Rule 10b5-1 plans, which could result in a loss of the protections of Rule 10b5-1 for trades made under the plan prior to termination. This may invite plaintiffs, SEC staff and the media to challenge decisions by insiders to modify or terminate plans as having been motivated by insiders’ desire to maximize profits or avoid losses, as well as to scrutinize trades made under a Rule 10b5-1 or other trading plan prior to its termination.
Any challenges to decisions about timing of MNPI release or plan modification and termination will be facilitated by the wealth of machine-readable information available under the new disclosure mandates about the precise dates on which directors and officers adopted or terminated their plans, or on which trades under those plans occurred, relative to company releases of MNPI. Companies and their directors and officers should be mindful of this heightened scrutiny.
Separately, disclosure of trading plan terminations by company insiders could lead to market speculation about the reasons for the termination, resulting in stock price volatility. This could be the case especially where the reasons for termination may be legitimate, but the company and the insider may not be at liberty to discuss them, as in the case of termination due to ongoing negotiations of strategic transactions.
Companies should consider that the new tabular disclosure connecting option grants to the release of MNPI may suggest causal links between the two even where none exist and, therefore, invite greater scrutiny of companies’ timing of option awards. The tabular presentation calls only for disclosure of absolute percentage of stock price movements between the day before and the day after the release of the MNPI. This is a fairly crude metric that lacks the context of other relevant factors, such as stock price movements in the broader market or the company’s peers. The new disclosure may therefore create a perception of “spring loading” (granting options in advance of the release of positive MNPI) or “bullet-dodging” (delaying option grants until after the release of negative MNPI). This may require companies to supplement the new table with additional information to provide context for the award timing and avoid implying causation or correlation between MNPI release and option awards where none exists.
We expect that practice in this area will develop over time as companies start to grapple with these new disclosures and gain experience with how investors and markets will react to them. It is also possible that companies may adjust the timing of their option grants where possible to fall outside the time periods that would trigger the disclosure.
The new disclosure requirements and the resulting need to collect, compile and present the relevant information will result in an increased overall compliance and administrative burden for companies as well as for the directors and officers whose plan adoptions and terminations will need to be reported. Companies will also need to review and, as needed, revise their Rule 10b5-1 plan policies for compliance with new rules, as well as ensure that insider trading policies and procedures more broadly are ready for public scrutiny to the extent they had not been previously publicized.
The changes to the requirements for Rule 10b5-1 plans present the first overhaul of these requirements since the rule’s adoption more than twenty years ago. Motivated by concerns about abuse, the changes, especially the long cooling-off period, have the potential to make reliance on Rule 10b5-1 plans by directors and officers less attractive, which may have implications for liquidity, diversification and other aspects of equity-based compensation. The newly-required disclosures about the timing of plan adoptions and terminations as well as the timing of option grants relative to the release of MNPI are likely to invite greater scrutiny of trading, MNPI disclosure and option award decisions.
Special thanks to Kazumasa Watanabe for his contribution to this publication.