Rule 10b5-1, adopted in 2000, has for the past two decades provided a safe harbor from insider trading by permitting directors, officers and other company insiders to trade company securities while in possession of material non-public information using a “10b5-1 plan” that is put in place when the insider does not have material non-public information. Since the adoption of Rule 10b5-1, the use of 10b5-1 plans by public company directors and officers, as well as issuers, has become widespread.
However, critics point to data suggesting that insiders trading under 10b5-1 plans consistently outperform those who trade outside of such plans, implying that insiders are gaming the system. Rule 10b5-1 has been on the SEC’s agenda following recent public remarks by SEC Chair Gary Gensler in June and July 2021 noting that 10b5-1 plans have exposed potential gaps in the insider trading enforcement regime. With proposed amendments published on December 15, 2021, the SEC is calling for greater transparency to investors about trading arrangements of issuers and insiders, issuer insider trading restrictions and insider compensation and incentives.
The SEC also proposed new rules calling for enhanced disclosure of corporate share buybacks, which includes buybacks structured as a 10b5-1 plan. See our separate post about this topic for more information.
Summary of proposed amendments
The proposed amendments focus on (1) adding new requirements for 10b5-1 plans and (2) creating disclosure obligations in connection with 10b5-1 plans and executive compensation.
If adopted, the proposed amendments would mark a significant change from current practice. For issuers, this means revisiting core policies and practices for 10b5-1 plans, insider trading more generally and executive compensation, as well as building the new disclosure requirements into current and periodic reporting processes. For insiders, the new requirements may fundamentally change their approach to financial, estate and tax planning as well as the use of 10b5-1 plans for such purposes. In both instances, the new required disclosures allow for enhanced scrutiny and potential enforcement or litigation risk.
The table below summarizes the proposed amendments by topic. Except where indicated, references to “directors and officers”, refer to those directors and officers subject to Section 16 of the Exchange Act.
| Topic | Proposed amendment |
10b5-1 Plan Requirements | ||
1. | 120 day / 30 day cooling off period |
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2. | Director / officer certifications |
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3. | Limits on the number of 10b5-1 plans |
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4. | Clarification that 10b5-1 plans must be operated in good faith | In addition to being entered into in good faith, 10b5-1 plans must be operated in good faith (i.e., a trader must not cancel or modify their plan to evade the prohibitions of the rule or use their influence to affect the timing of corporate disclosures to increase the profitability or reduce the loss of a trade). |
Quarterly and annual report disclosures | ||
5. | Quarterly disclosure of trading plans |
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6. | Annual report / proxy statement disclosure of insider trading policies |
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7. | Annual report / proxy statement disclosure of option awards (including stock appreciation rights and similar instruments) |
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Section 16 filings | ||
8. | Reporting of trades under plans on Form 4 and Form 5 and bona fide gifts on Form 4 for all required filers (including directors, officers and beneficial owners of more than 10% of an issuer’s registered equity securities) |
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Key takeaways
120 day cooling off period and limits on the number of plans
In proposing the 120-day cooling off period for directors and officers, the SEC explained that 120 days would span an entire quarter, which would prevent such insiders from capitalizing on any material non-public information for the upcoming quarter. This duration also follows recommendations from the SEC Investor Advisory Committee (the “IAC”) in September 2021. In our experience, the cooling off period is significantly longer than that followed by even the most conservative issuers. If the proposed amendments are adopted, most issuers will have to adjust their policies accordingly.
The SEC has also proposed limiting the number of overlapping plans and single-trade plans as an additional deterrent to timing trades to occur around the dates on which an issuer might release material non-public information. Coupled with the cooling off period, limiting the number of plans would mean that directors and officers must observe the full 120-day cooling off period between adopting, cancelling or modifying a plan and making a trade under a new plan and there would be no ability to use overlapping plans to effectively shorten the cooling off period.
For directors and officers looking to use 10b5-1 plans for financial, estate or tax planning purposes, the 120-day cooling off period in particular means such insiders would have to start planning ahead far in advance if they intend to rely on a 10b5-1 plan for such purposes and may be limited in their ability to use 10b5-1 plans for event-specific liquidity needs.
Quarterly disclosure of trading plans
The proposed amendments do not go as far as the IAC recommendations from September 2021, which would have required disclosures on Form 8-K upon the adoption, modification or cancellation of any trading plan. However, the proposed amendments, if adopted, will have implications for issuers beyond the additional disclosure obligations. For example, issuers may need to implement new processes to ensure thorough review, vetting and tracking of all trading plans (whether in accordance with Rule 10b5-1 or otherwise) in order to disclose their material terms (see Item 5 in the chart above for the specific disclosures required) on a quarterly basis. Notably, there is no proposed requirement to file the trading plans or to disclose a plan’s pricing terms.
Annual report disclosure of insider trading policies
The SEC acknowledges in its proposing release that insider trading policies differ between companies and notes that the proposed amendments do not prescribe what such policies are intended to cover. However, the SEC advises issuers to “endeavor to provide detailed and meaningful information from which investors can assess the sufficiency of their insider trading policies and procedures” when formulating their insider trading policy disclosures. The SEC also sets out subject areas that, in their view, investors may find useful such as (i) the issuer’s process (and documenting of such process) for analyzing whether directors, officers, employees or the issuer itself (when conducting open market share repurchases) have material non-public information, (ii) the issuer’s process for documenting and approving requests to trade securities, (iii) the issuer’s process for enforcing its insider trading policies and (iv) the issuer’s policies regarding gifts and other dispositions that are not traditionally purchases or sales.
It has historically been relatively uncommon for companies to make their insider trading policies publicly available. Issuers will want to revisit and/or refresh their insider trading policies in advance of being required to provide annual report disclosure about them. In particular, issuers should consider whether their existing insider trading policies adequately cover the vetting, clearance and enforcement processes, as well as gift policies that the SEC listed as example subject areas to cover in insider trading disclosures, as described above. As part of Item 10 in Part III of Form 10-K, the insider trading policy disclosures would also be covered by the accompanying SOX 302 certifications of the issuer’s CEO and CFO as to accuracy of the annual report. As a consequence of the new disclosure requirement, we expect more active benchmarking of insider trading policies to take place going forward, resulting in the increased standardization of such policies.
Annual report disclosure of option awards
The additional disclosure requirements regarding option awards (including stock appreciation rights and similar instruments) follows renewed focus by the SEC on equity awards that are made in contemplation of or shortly before the release of positive material non-public information (i.e., “spring-loaded” equity awards). In November 2021, the SEC issued new guidance on estimating the fair value of “spring-loaded” equity awards, which we expect will result in the significant curtailing of such awards given the unanswered question of what methodology companies should apply when determining fair value or any adjustment to fair value. For further discussion of this new guidance, see our previous post about this topic. The proposed amendments require disclosure of option awards made to named executive officers during the 14-day period 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 non-public information (including disclosure of the option exercise price as well as the market price of the underlying securities before and after the release of the material non-public information contained in the periodic report or current report).
This 14-day period may give practitioners some insight as to what the SEC is contemplating constitutes the “shortly before” the planned release of material non-public information timeframe in relation to spring-loaded equity awards. Issuers should review their equity grant practices, as even routine annual grants made within this period will fall under the SECs new accounting guidance and require disclosure under the proposed rules.
In addition, the inclusion of issuer share repurchases as one of the events triggering disclosure reflects the SEC’s increased scrutiny of share repurchases following criticism that the share price increase that often occurs in connection with issuer share repurchases can be used to enhance executive compensation and insider stock value. See also our separate post about the SEC’s proposed new rules calling for enhanced disclosure of corporate share buybacks.
The additional disclosure regarding an issuer’s policies and practices on the timing of option grants will also make it more difficult for issuers to make grants that do not follow these policies and practices because any deviation will impact the same disclosure for subsequent years. A version of this requirement, which focused on disclosing whether an issuer had a plan or practice to time option grants with the release of material non-public information and information taken into account by the board or compensation committee when determining whether to make such grants, was included in the rules related to the Compensation Discussion and Analysis so many issuers have already included similar disclosure in their proxy statements.
Reporting gifts on Form 4
While the existing rules allow a gift of equity securities to be disclosed on Form 5, which is required to be filed within 45 days of the end of the year during which the gift was made, the proposed amendments would require disclosure of any such gift within two business days on Form 4. In the proposing release, the SEC takes issue with insiders gifting equity securities while in possession of material non-public information and explained that the timelier disclosure of gifts would help investors and the SEC itself better evaluate the actions of insiders. Given the significant increase in recent years of gifting equity securities to trusts for estate and tax planning purposes, the proposed amendment would impose an additional filing requirement for insiders but will also cause insiders to revisit the timing (and possibly feasibility) of such gifts, which may also impact tax deductions and charitable giving. In addition, given that the SEC also mentioned policies on gifting securities as an area investors may find useful for purposes of the proposed insider trading policy disclosure in annual reports, issuers may also consider revisiting their own policies for permitting insiders to gift securities during periods when insiders may have material non-public information.
Director and officer certifications
While the SEC clarifies in its proposing release that the director and officer certifications are not intended to be an independent basis of liability for directors or officers under Section 10(b) and Rule 10b-5 under the Exchange Act, this will be an area of future enforcement interest if the proposed amendments are adopted, as the certification that 10b5-1 plans have been adopted in good faith may provide the SEC with an additional hook to take action against any directors and officers who succumb to any temptation to delay bad news or otherwise time corporate disclosures in a manner that results in personal gains under 10b5-1 plans.
