SEC amends Rule 10b5-1 and revamps affirmative defense to insider trading charges


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Since its enactment in 2000, the Rule has provided an affirmative defense to an insider trading charge if the company insider can show that they entered into a binding contract, adopted a written plan, or instructed another person to purchase or sell a security (i.e., a 10b5-1 plan). The 10b5-1 plan must provide instructions for execution of the trade, such as directions for determining when, how many, and at what price the securities should be purchased or sold, and must not permit the company insider to make subsequent decisions over how, when, or if purchases or sales should be effected.² Over the years Courts, Congress, and others have raised concerns that bad actors could trade on MNPI and skirt liability by asserting the affirmative defense, and that investors and regulators do not have sufficient information about companies’ insider trading arrangements, incentives, and governance practices, which can affect shareholder value.³ The latest amendments are intended to fill these gaps and increase investor confidence in the markets. What’s new? The amended Rule will include, among other changes, (1) implementation of a “cooling-off period” for trading under 10b5-1 plans; (2) required certifications about knowledge of MNPI and good faith; (3) changes to how 10b5-1 plans may be used; and (4) new disclosure requirements for registrants and individuals.⁴ Cooling-off period: A cooling-off period is an established amount of time between the adoption of a 10b5-1 plan and when trading can begin. Cooling-off periods currently are voluntary—so theoretically company insiders that possess MNPI can adopt a 10b5-1 plan and start trading under the plan that same day. To deter company insiders from being able to invoke the affirmative defense while engaging in opportunistic trading on the basis of MNPI, the new Rule will require a mandatory cooling-off period before trading can begin. For officers and directors, the cooling-off period must be either 90 days following adoption or modification of a 10b5-1 plan or two business days following the disclosure of the issuer’s financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted, whichever is later (resulting in a mandatory cooling-off period of 90 to 120 days). For persons other than officers and directors, the cooling-off period is 30 days following adoption or modification of the 10b5-1 plan. 10b5-1 Certifications: The updated Rule will require officers and directors to certify at the time they enter into or modify a 10b5-1 plan that (1) they are not aware of MNPI about the issuer or its securities; and (2) they are adopting the contract, instruction, or plan “in good faith and not as part of a plan or scheme to evade the prohibitions” of Rule 10b-5. Permitted Use of 10b5-1 Plans: The Rule will change how company insiders can use 10b5-1 plans. Currently, company insiders can adopt multiple 10b5-1 plans covering the same time period and then later selectively trade on or terminate plans (potentially on the basis of newly-obtained MNPI). The amended Rule will prohibit persons other than issuers from having multiple overlapping plans in place. Further, the Rule will only allow company insiders (other than issuers) to rely on the affirmative defense to one single-trade plan in any 12-month period. In addition, changes to the amount, price, or timing of transactions in an existing plan will be considered to be a new plan under the Rule. Disclosure Requirements: The amended Rule will impose several new disclosure requirements on registrants. Companies will need to disclose, among other information: whether any director or officer adopted or terminated a 10b5-1 plan during the last fiscal quarter, as well as a description of the material terms of such plans in their quarterly reports; whether they have adopted insider trading policies and procedures that are reasonably designed to promote compliance with securities laws in their annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C. P; and the timing of certain equity compensation awards to named executive officers close in time to the release of MNPI, in periodic reports or in the filing of Form 8-K that discloses MNPI. In addition, company insiders who report transactions using Forms 4 or 5 will need to indicate using a checkbox whether the transaction was intended to satisfy the affirmative defense requirements and disclose the date that the plan was adopted. What’s next? The amended Rule will go into effect on February 27, 2023. Plans that were entered into prior to the effective date are “grandfathered” and can be used as support for the affirmative defense, unless the plan is modified after the effective date. Issuers will be required to comply with the new disclosure requirements in their first filing of the full fiscal period beginning on or after April 1, 2023.⁵ Even though the amended Rule has not yet taken effect, issues relating to misuse of 10b5-1 plans are already on the SEC’s radar. In September 2022, two C-suite executives settled allegations relating to the use of 10b5-1 plans to trade on the basis of MNPI and materially misleading statements about revenue for combined civil penalties of $756,834. The executives purportedly avoided losses of approximately $300,000 by selling 96,000 shares pursuant to 10b5-1 plans shortly before the company announced lower-than-expected revenue, which caused the company’s stock to decline. The SEC found that the two executives violated Section 10(b) of the Exchange Act because they adopted the 10b5-1 plans when they already knew of the revenue and earnings issues and impending disclosures.⁶ What should companies do? There are several proactive measures companies may consider before the Rule comes into effect: Revise the language in the company’s 10b5-1 plan template to include (1) information about the requisite cooling-off period; and (2) certifications that the company insider is not aware of MNPI regarding the issuer or securities, and that they are adopting the plan in good faith; Consider whether policies and procedures should be updated to protect officers, directors, and others who may possess MNPI (e.g., by explicitly specifying the minimum cooling-off period in a policy or requiring internal approval of 10b5-1 plans by the chief legal officer); Train or otherwise communicate to officers, directors, and others who may possess MNPI or be responsible for complying with the additional disclosure requirements to ensure they understand the effects of the amendments; and Prepare to file the additional disclosures and ensure templates include all newly required information. _____________ 1 The SEC proposed the amendments and solicited comment on December 15, 2021. For more information on the proposed amendments, see Cynthia Krus, Stephani Hildebrandt, and Krystyna Blokhina Gilkis, SEC proposes shake-up for Rule 10b5-1 trading plans, Corporate Secretary (Feb. 28, 2022). 2 The amendments do not affect the Rule’s affirmative defense for persons that are not “natural persons,” which can be invoked if the person making the trade was not aware of MNPI and had implemented reasonable policies and procedures to ensure that such trading would not violate rules prohibiting trading on MNPI. See Rule 10b5–1(c)(2) [17 CFR 240.10b5–1(c)(2)]. 3 See, e.g., “Waters and McHenry Introduce Bipartisan Legislation to Curb Illegal Insider Trading,” U.S. House Committee on Financial Services, (Jan. 18, 2019) (stating Rule 10b5-1 “currently allows corporate insiders to avoid accusations of illegal insider trading”); Letter from Senators Elizabeth Warren, Sherrod Brown and Chris Van Hollen (Feb. 10, 2021) (stating “the plans’ lack of transparency, damage investors and risk undermining public confidence”). 4 The amended Rule also includes updates relating to structured data requirements and requirements for reporting on gifts. For more information on the amended Rule see SEC Press Release 2022-222 (Dec. 14, 2022) and the SEC’s Fact Sheet, Rule 10b5-1: Insider Trading Arrangements and Related Disclosures. 5 Smaller Reporting Companies, as defined in Securities Act Rule 405 and Exchange Act Rule 12b-2, have until August 27, 2023 to comply with the new disclosure requirements. 6 Sheng Fu and Ming Xu, SEC Administrative Proceeding, File No. 3-21118 (Sept. 21, 2022). If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work. The materials on the Eversheds Sutherland website are for general information purposes only and do not constitute legal advice. While reasonable care is taken to ensure accuracy, the materials may not reflect the most current legal developments. Eversheds Sutherland disclaims liability for actions taken based on the materials. 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The Securities and Exchange Commission (SEC) has unanimously adopted amendments to Rule 10b5-1 (the Rule), which prohibits the purchase or sale of securities on the basis of material nonpublic information (MNPI) in violation of Section 10(b) of the Securities and Exchange Act of 1934.¹ The amendments will restrict when company insiders may invoke the Rule’s affirmative defense to insider trading and impose additional disclosure requirements.

Since its enactment in 2000, the Rule has provided an affirmative defense to an insider trading charge if the company insider can show that they entered into a binding contract, adopted a written plan, or instructed another person to purchase or sell a security (i.e., a 10b5-1 plan). The 10b5-1 plan must provide instructions for execution of the trade, such as directions for determining when, how many, and at what price the securities should be purchased or sold, and must not permit the company insider to make subsequent decisions over how, when, or if purchases or sales should be effected.²

Over the years Courts, Congress, and others have raised concerns that bad actors could trade on MNPI and skirt liability by asserting the affirmative defense, and that investors and regulators do not have sufficient information about companies’ insider trading arrangements, incentives, and governance practices, which can affect shareholder value.³ The latest amendments are intended to fill these gaps and increase investor confidence in the markets.

What’s new?

The amended Rule will include, among other changes, (1) implementation of a “cooling-off period” for trading under 10b5-1 plans; (2) required certifications about knowledge of MNPI and good faith; (3) changes to how 10b5-1 plans may be used; and (4) new disclosure requirements for registrants and individuals.⁴

Cooling-off period: A cooling-off period is an established amount of time between the adoption of a 10b5-1 plan and when trading can begin. Cooling-off periods currently are voluntary—so theoretically company insiders that possess MNPI can adopt a 10b5-1 plan and start trading under the plan that same day. To deter company insiders from being able to invoke the affirmative defense while engaging in opportunistic trading on the basis of MNPI, the new Rule will require a mandatory cooling-off period before trading can begin. For officers and directors, the cooling-off period must be either 90 days following adoption or modification of a 10b5-1 plan or two business days following the disclosure of the issuer’s financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted, whichever is later (resulting in a mandatory cooling-off period of 90 to 120 days). For persons other than officers and directors, the cooling-off period is 30 days following adoption or modification of the 10b5-1 plan.
10b5-1 Certifications: The updated Rule will require officers and directors to certify at the time they enter into or modify a 10b5-1 plan that (1) they are not aware of MNPI about the issuer or its securities; and (2) they are adopting the contract, instruction, or plan “in good faith and not as part of a plan or scheme to evade the prohibitions” of Rule 10b-5.
Permitted Use of 10b5-1 Plans: The Rule will change how company insiders can use 10b5-1 plans. Currently, company insiders can adopt multiple 10b5-1 plans covering the same time period and then later selectively trade on or terminate plans (potentially on the basis of newly-obtained MNPI). The amended Rule will prohibit persons other than issuers from having multiple overlapping plans in place. Further, the Rule will only allow company insiders (other than issuers) to rely on the affirmative defense to one single-trade plan in any 12-month period. In addition, changes to the amount, price, or timing of transactions in an existing plan will be considered to be a new plan under the Rule.
Disclosure Requirements: The amended Rule will impose several new disclosure requirements on registrants. Companies will need to disclose, among other information:

whether any director or officer adopted or terminated a 10b5-1 plan during the last fiscal quarter, as well as a description of the material terms of such plans in their quarterly reports;
whether they have adopted insider trading policies and procedures that are reasonably designed to promote compliance with securities laws in their annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C. P; and
the timing of certain equity compensation awards to named executive officers close in time to the release of MNPI, in periodic reports or in the filing of Form 8-K that discloses MNPI.

In addition, company insiders who report transactions using Forms 4 or 5 will need to indicate using a checkbox whether the transaction was intended to satisfy the affirmative defense requirements and disclose the date that the plan was adopted.

What’s next?

The amended Rule will go into effect on February 27, 2023. Plans that were entered into prior to the effective date are “grandfathered” and can be used as support for the affirmative defense, unless the plan is modified after the effective date. Issuers will be required to comply with the new disclosure requirements in their first filing of the full fiscal period beginning on or after April 1, 2023.⁵

Even though the amended Rule has not yet taken effect, issues relating to misuse of 10b5-1 plans are already on the SEC’s radar. In September 2022, two C-suite executives settled allegations relating to the use of 10b5-1 plans to trade on the basis of MNPI and materially misleading statements about revenue for combined civil penalties of $756,834. The executives purportedly avoided losses of approximately $300,000 by selling 96,000 shares pursuant to 10b5-1 plans shortly before the company announced lower-than-expected revenue, which caused the company’s stock to decline. The SEC found that the two executives violated Section 10(b) of the Exchange Act because they adopted the 10b5-1 plans when they already knew of the revenue and earnings issues and impending disclosures.⁶

What should companies do?

There are several proactive measures companies may consider before the Rule comes into effect:

Revise the language in the company’s 10b5-1 plan template to include (1) information about the requisite cooling-off period; and (2) certifications that the company insider is not aware of MNPI regarding the issuer or securities, and that they are adopting the plan in good faith;
Consider whether policies and procedures should be updated to protect officers, directors, and others who may possess MNPI (e.g., by explicitly specifying the minimum cooling-off period in a policy or requiring internal approval of 10b5-1 plans by the chief legal officer);
Train or otherwise communicate to officers, directors, and others who may possess MNPI or be responsible for complying with the additional disclosure requirements to ensure they understand the effects of the amendments; and
Prepare to file the additional disclosures and ensure templates include all newly required information.

_____________

1 The SEC proposed the amendments and solicited comment on December 15, 2021. For more information on the proposed amendments, see Cynthia Krus, Stephani Hildebrandt, and Krystyna Blokhina Gilkis, SEC proposes shake-up for Rule 10b5-1 trading plans, Corporate Secretary (Feb. 28, 2022).

2 The amendments do not affect the Rule’s affirmative defense for persons that are not “natural persons,” which can be invoked if the person making the trade was not aware of MNPI and had implemented reasonable policies and procedures to ensure that such trading would not violate rules prohibiting trading on MNPI. See Rule 10b5–1(c)(2) [17 CFR 240.10b5–1(c)(2)].

3 See, e.g., “Waters and McHenry Introduce Bipartisan Legislation to Curb Illegal Insider Trading,” U.S. House Committee on Financial Services, (Jan. 18, 2019) (stating Rule 10b5-1 “currently allows corporate insiders to avoid accusations of illegal insider trading”); Letter from Senators Elizabeth Warren, Sherrod Brown and Chris Van Hollen (Feb. 10, 2021) (stating “the plans’ lack of transparency, damage investors and risk undermining public confidence”).

4 The amended Rule also includes updates relating to structured data requirements and requirements for reporting on gifts. For more information on the amended Rule see SEC Press Release 2022-222 (Dec. 14, 2022) and the SEC’s Fact Sheet, Rule 10b5-1: Insider Trading Arrangements and Related Disclosures.

5 Smaller Reporting Companies, as defined in Securities Act Rule 405 and Exchange Act Rule 12b-2, have until August 27, 2023 to comply with the new disclosure requirements.

6 Sheng Fu and Ming Xu, SEC Administrative Proceeding, File No. 3-21118 (Sept. 21, 2022).

If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.

The materials on the Eversheds Sutherland website are for general information purposes only and do not constitute legal advice. While reasonable care is taken to ensure accuracy, the materials may not reflect the most current legal developments. Eversheds Sutherland disclaims liability for actions taken based on the materials. Always consult a qualified lawyer for specific legal matters. To view the full disclaimer, see our Terms and Conditions or Disclaimer section in the footer.