On December 14, 2022, the United States (U.S.) Securities and Exchange Commission (SEC) finalized amendments to the disclosure requirements and investor protections concerning insiders trading in company stock proposed one year ago. The final rules add new conditions to adopting and implementing insider trading plans under SEC Rule 10b5-1 and create new disclosure requirements, including the filing of a company’s insider trading policy as an Exhibit to Form 10-K.
Rule 10b5-1 Trading Plans
A written trading plan under Rule 10b5-1 provides corporate insiders, including directors and officers, with an affirmative defense against insider trading liability. The plan must be established in good faith, at a time when the individual is unaware of material nonpublic information (MNPI) and can be a useful defense if the trades made pursuant to the plan are executed at a time when the individual is aware of MNPI.
The amendments to Rule 10b5-1 add new conditions to the affirmative defense against insider trading liability, including:
- Time Between Plan Adoption and the First Trade. The rule requires a cooling-off period before any trading can commence under a 10b5-1 plan. For directors and Section 16 officers, the final rule was revised from a strict 120 days in the proposing release to:
- 90 days following plan adoption or modification of a plan or
- two business days following the filing of a Form 10-K or 10-Q (Form 20-F or 6-K for foreign private issuers) for the quarter in which the plan was adopted or modified but not to exceed 120 days following plan adoption or modification
For other persons, the cooling-off period is 30 days, and plans entered into by companies to buy or sell their own stock will not be subject to a cooling-off period. A new cooling-off period will be triggered by a modification to the amount, price or timing of a purchase or sale (including changes to related formulas or algorithms) under an existing plan, as the SEC treats this as a cancellation of the existing plan and the adoption of a new plan.
- While a 30 day cooling-off period has become the standard, this longer period for Section 16 officers and directors will be a longer period before trading for most officers and directors that enter into 10b5-1 plans and will require additional planning to take advantage of this defense against insider trading.
- Required Section 16 Officer or Director Certification. Officers and directors will be required to certify that they are not aware of MNPI at the time of the adoption or modification of a Rule 10b5-1 trading plan, and that they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5. They will also be obligated to act in good faith with respect to the plan.
- Although this is a new requirement, most 10b5-1 plans already contain this representation and all participants are accustomed to providing this representation. The act in good faith requirement will allow for easier SEC enforcement for example, if an insider uses their influence over the timing of corporate disclosures to make a trade more profitable or to avoid or reduce a loss.
- No Overlapping 10b5-1 Plans. The rule eliminates the affirmative defense if there are multiple overlapping 10b5-1 trading arrangements. However, a person can maintain two 10b5-1 trading plans at the same time so long as trading under the later-commencing plan is not authorized to begin until after all trades under the earlier-commencing plan are completed or expire without execution. The first trade under the later plan may not occur until the cooling-off period has been established from the date of termination of the earlier plan. In addition, an employee might also have separate sell-to-cover trading plans to cover employee vesting events outside the control of the employee such as Restricted Stock Unit (RSU) or Performance Sharing Unit (PSU) vesting (not for option exercises).
- This is welcome news for smaller cash-strapped companies as it will not negatively impact the decision that a company makes when determining whether or not to move from options to RSUs.
- Impact on Single Trade Plans Under 10b5-1. The rule limits the availability of the affirmative defense for a trading arrangement designed for a single trade to only one plan in any 12-month period except for companies using the plans to repurchase stock in the open market or for sell-to-cover trading plans as discussed above.
New Company Disclosure Requirements
- Quarterly Reporting of Trading Arrangements. Form 10-Q or Form 10-K will need to disclose whether or not a Section 16 officer, director or the company adopted, modified (in certain circumstances) or terminated any 10b5-1 plan or certain other pre-planned trading arrangements in the quarter, including the name and title of the director or officer, date of adoption or termination, the duration of the plan or arrangement and the aggregate number of securities to be traded (pricing information is not required to be disclosed).
- Disclosure of Insider Trading Policies and Procedures. The company’s Form 10-K (or Form 20-F for foreign filers) will need to disclose whether it has adopted insider trading policies and procedures concerning the purchase, sale or other disposition of the company’s securities by its directors, officers and employees. The company would then be required to disclose those policies and procedures as an Exhibit to the Form 10-K. Conversely, a company would also need to explain why it did not adopt insider trading policies and procedures.
- New Proxy Table for Certain Option Grants and Narrative Disclosure of Option Grant Policies Pursuant to new Item 402(x) of Regulation S-K. The rule adds a new executive compensation table disclosing any options or stock appreciation rights granted beginning four business days before the filing of Form 10-Q, 10-K or 8-K that discloses material nonpublic information, including earnings information, (other than a Form 8-K that discloses a material new option award grant under Item 5.02(e)) and ending one business day after the report filing or 8-K triggering event requiring the disclosure for each named executive officer (NEO) with the following information:
- Grant date
- Number of securities underlying the award
- Exercise price
- Grant date fair value
- Percentage change in the closing market price of the common stock between the trading day ending immediately prior to the disclosure of MNPI and the trading day immediately following the disclosure of the MNPI
The rule also requires narrative disclosure of a company’s option grant practices with specific information regarding how the board determines the timing of option grants and how the board or compensation committee takes MNPI into account when making option grants. This disclosure is intended to provide shareholders with a full and complete picture of any spring-loaded or bullet-dodging option grants made during the fiscal year. These disclosures would apply to smaller reporting companies and emerging growth companies as well, which are generally subject to less extensive executive compensation disclosure requirements than other reporting companies.
- SEC Form 4 and 5 Changes. The rule requires that Section 16 officers and directors check a box on the SEC Forms 4 and 5 as to whether a transaction was made under a Rule 10b5-1 trading plan. These individuals will also have to report gifts of company stock at the same time as sales, within two business days, which is significantly earlier than the current requirements to file by Form 5 within 45 days after the end of the year.
The 10b5-1 trading plan compliance rules will become effective 60 days after the new rules are published in the Federal Register. Companies should review their 10b5-1 policies now to get ready for these changes.
The Form 4 and Form 5 rule changes go into effect on April 1, 2023. Companies should alert their Section 16 officers and directors of the change in the timing of gift disclosures and make sure that they have compliance procedures in place to capture these transactions. Companies should also consider whether they need to revise their insider trading policies to cover gift transactions.
The new disclosure requirements for insider trading policies and the new named executive officer table and narrative for certain option grants will not be effective for some time. Companies will be required to comply with these new disclosure requirements in the first filing that covers the first full fiscal period that begins on or after April 1, 2023 (2025 filings for calendar year-end companies). Compliance by smaller reporting companies will be delayed by six months to cover the first full fiscal period that begins on or after October 1, 2023.
There are no SEC rules or regulations requiring that public companies have insider trading policies. However, given the SEC’s continued focus in this area, companies should carefully review their insider trading policies and procedures or adopt such policies and procedures if they do not yet exist. Companies should review their option grant practices to ensure they meet best practices as well and consider avoiding grant dates that would require the disclosure of this additional table in future proxy statements.