(Article from Registered Funds Regulatory Update, January 2023)
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On December 14, 2022, the SEC adopted amendments to Rule 10b5-1 under the Exchange Act and added related new disclosure requirements in an effort to address concerns about perceived abuse of the rule and to impose additional disclosure requirements on issuers. Among other things, Rule 10b5-1 provides an affirmative defense to insider trading liability, when certain conditions are met, for trades that occur pursuant to a written plan adopted at a time when the trader was not aware of any material nonpublic information. Notably, the vote adopting the new rules was unanimous, reflecting a general consensus on the need for Rule 10b5-1 reform. The amendments introduce new conditions to being able to utilize the affirmative defense against insider trading liability contained in the rule, including prescribed cooling-off periods, additional certifications, limitations on overlapping plans, limitations on single-trade plans and an amended good faith condition. The new conditions other than the amended good faith condition were not applied at this time to issuer share repurchases. In addition, the new disclosure rules will, among other things, require quarterly disclosure by issuers regarding the use of Rule 10b5-1 plans and other trading arrangements by their directors and officers and annual disclosure by issuers regarding their insider trading policies and procedures.
New Conditions Impacting Rule 10b5-1 Plans
The five new conditions that must be met to be able to rely on Rule 10b5-1’s affirmative defense are summarized as follows.
Cooling-Off Periods. If the insider is a director or officer of the issuer, then no trades can be made under the plan until the later of (i) 90 days after the adoption or modification of the plan, and (ii) two business days following the disclosure of the issuer’s financial results in a periodic report (Forms 10-K or 10-Q) for the fiscal quarter in which the plan was adopted or modified, subject to a maximum cooling-off period of 120 days. For most plans, the required cooling-off period will generally be 90 days; however, for plans adopted in the fourth fiscal quarter, given the later deadline for Form 10-K filings, it is possible that the cooling-off period would need to be extended to the second part of the rule. If the insider is a person other than the issuer, director, or officer, no trades can be made under the plan until 30 days after its adoption or modification.
Additional Certifications. If the insider is a director or officer of the issuer, the plan must include a certification by the insider that, on the date of the plan’s adoption, the insider is (i) not aware of any material nonpublic information about the security or the issuer, and (ii) adopting the plan in good faith and not as part of a plan or scheme to evade Rule 10b-5’s prohibitions.
Limitations on Overlapping Plans. If the insider is a person other than the issuer, such insider cannot have any other plan outstanding, other than pursuant to one of the following exceptions:
- A series of separate contracts with multiple broker-dealers or other agents can be treated as a single plan if the contracts, when taken as a whole, meet all of the applicable conditions of Rule 10b-5.
- A later-commencing plan that does not authorize trades to begin until after all trades under the earlier-commencing plan are completed or expire is permitted. This exception is not available, however, in certain circumstances where the earlier-commencing plan is terminated rather than expiring under its terms.
- A plan authorizing an agent to sell only such securities as are necessary to satisfy tax-withholding obligations arising exclusively from the vesting of a compensatory award that does not otherwise allow the insider to exercise control over the timing of such sales is permitted.
Limitations on Single Trade Plans. If the insider is a person other than the issuer and is seeking to rely on the affirmative defense for a single-trade plan, such insider cannot have relied on the affirmative defense for another single-trade plan within the last 12 months.
Amended Good Faith Condition. For all types of insiders, the amended good faith condition requires the insider to have acted in good faith with respect to the plan more broadly, not just in connection with entering into the plan.
Additional Disclosure Requirements
As part of its rulemaking, the SEC adopted several new disclosure requirements. Disclosure requirements regarding the adoption, modification, termination, and material terms of officer and director trading arrangements under Item 408(a) of Regulation S-K apply to annual and quarterly reports on Forms 10-K and 10-Q or amendments to them, but will not apply to registered investment companies, which do not file reports on Forms 10-K and 10-Q. These changes are summarized below.
Quarterly Reporting of Director and Officer Trading Arrangements. Companies will be required to disclose whether any director or officer adopted or terminated any Rule 10b5-1 plans or other pre-planned trading arrangements during the company’s last fiscal quarter. In relation to such disclosure, companies will be required to provide a description of certain material terms of the plans or trading arrangements at issue.
Disclosure of Insider Trading Policies and Procedures. Under the new rules, companies will be required to disclose on an annual basis whether they have adopted insider trading policies and procedures governing the purchase, sale, and/or disposition of the company’s securities by directors, officers, and employees, or the registrant itself, that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, as well as any applicable listing standards. If a company has not adopted such policies and procedures, it must explain why it has not done so. Companies that have adopted such policies and procedures must file them as an exhibit to the related annual report or proxy statement.
Disclosure of Option Grants and Similar Equity Instruments Made Close in Time to the Release of Material Nonpublic Information. Companies will specifically be required to provide narrative disclosure regarding their policies and practices on timing of awards of stock options and other similar option-like instruments in relation to their disclosure of material nonpublic information. Companies will also be required to provide tabular disclosure of awards made in the four business days before a periodic or current report filing that discloses material nonpublic information and ending one business day after such filing.
Identification of Rule 10b5-1 Plan Transactions on Forms 4 and 5 and the Reporting of Gifts on Form 4. Forms 4 and 5 will be updated for filers to identify if a reported transaction is pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1. Additionally, gifts will now be required to be reported on Form 4.
The final rules will become effective 60 days following publication of the release in the Federal Register.
Insider Trading Arrangements and Related Disclosures, SEC Release Nos. 33-11138
(Nov. 2, 2022), available at: https://www.sec.gov/rules/final/2022/33-11138.pdf.