SEC Seeks to Crack Down on Insider Trading Abuses by Corporate Executives with the Adoption of New Disclosures and Trading Restrictions
On December 14, 2022, the U.S. Securities and Exchange Commission (“SEC”) unanimously voted to adopt amendments to Rule 10b5-1 plans, adding new disclosure requirements aimed at curtailing abuses of insider trading by corporate executives. The proposed amendments were first introduced in January 2022 to help fill perceived regulatory gaps in the rule as originally written and require more transparency around trading by company insiders. The final amendments, which are the first since the rules’ adoption in 2000, are intended to prevent executives from putting a plan in place, and immediately trading in circumstances where they had access to confidential information.
Background of Rule 10b5-1
Corporate executives, directors and other insiders frequently have access to non-public market-moving information, making it difficult for them to sell company shares without the risk of facing claims of insider trading.
In 2000, Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Exchange Act”) was created to provide officers, directors, public company insiders, and businesses with an affirmative defense to insider trading claims, even if they were in possession of material nonpublic information (“MNPI”) at the time of their stock trades, provided that the trades were made pursuant to a plan adopted when they did not possess MNPI. These written plans allow executives—whose compensation is often tied up in company shares—to trade in a company’s stock on a pre-determined date, without running afoul of SEC rules.
Amendments to the Rule
The amendments to the rule end a controversial practice in which executives can sell stock days after creating a plan, which research suggests leads to abnormal returns, raising suspicion that they may have acted on inside information.
The amendments impose a 90-day cooling-off period between when the plan is created or modified and when executives can trade, which makes it harder for executives to create or modify a plan informed by insider information. While executives can still trade outside of this window, they cannot take advantage of this affirmative defense to insider trading accusations. Executives will also have to certify that they are not making the trade on the basis of MNPI.
According to the SEC’s Rule 10b5-1 fact sheet, for corporate insiders to avail themselves of the affirmative defense to insider trading under Rule 10b5-1(c)(1), they must abide by the following new requirements:
- A cooling-off period for officers and directors of at least 90 days (but not more than 120 days) after a plan is adopted or modified, or two business days after certain periodic financial reports are disclosed, whichever is later
- A cooling-off period of 30 days for persons other than directors, officers, or the issuer
- Prohibition on overlapping trading plans (i.e. a corresponding hedging transaction or position)
- Limit of one single-trade plan in a 12-month period
- Certifications by directors and managers adopting a new plan or modifying an existing plan that they are not aware of MNPI about the company or its securities and that they are adopting the plan in good faith
- Insider obligation to act in good faith
Moreover, the amendments impose several new disclosure requirements for issuers about officers’ and directors’ use of these plans, and related policies, and procedures with respect to trading by company insiders, as well as the granting of spring-loaded options to executives:
- Quarterly disclosure of Rule 10b5-1 plans
- Annual disclosure of insider trading policies and procedures, or an explanation by the registrant why it has not adopted such policies and procedures
- Disclosure of option grant timing
- Amendments to Forms 4 and 5 related to the use of a plan
- Tagging disclosures using inline XBRL
- Form 4 gift disclosure
Effective Dates
The final rule will become effective 60 days following publication of the adopting release in the Federal Register.
- Section 16 reporting persons will have to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed beginning on April 1, 2023
- Companies must comply with the new disclosure requirements in Forms 10-Q, 10-K, and 20-F and in any proxy or information statements in the first filing that covers the first full fiscal period that begins on or after April 1, 2023
- Smaller reporting companies must provide the new disclosures in the first filing that covers the first fiscal period that beings on or after October 1, 2023
The amendments to Rule 10b5-1(c)(1) will not affect the affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the revised rule’s effective date. If an existing plan is modified after the effective date of the final rules, the modification would be equivalent to adopting a new trading arrangement, and the amended Rule 10b5-1(c)(1) would apply, including a new cooling-off period.
Recommended Actions
Corporate insiders are best protected from regulatory scrutiny when they sell company shares pursuant to Rule 10b5-1 plans. While the rules ultimately adopted by the SEC are far less strict than initially proposed, the amendments and new disclosure requirements create many new obligations for public companies, their directors, officers, and employees, as well as brokerage firms that execute Rule 10b5-1 plans.
Public companies should align these changes with their insider trading and stock options policies and procedures. Companies should carefully consider their controls and procedures that underlay the determination that a 10b-5-1 plan can appropriately be put into place by its executives and board members. At the same time, those executives and board members should be conscious of the fact that every trade they make – even if is subject to a 10b5-1 plan – will receive heightened scrutiny as will every subsequent modification or termination of their 10b5-1 plans. While not specifically required by the amendments to the rule, anyone putting in place a 10b5-1 plan should consider not only the strict requirements of the rule but the appearances surrounding the establishment of the plan itself and trades pursuant to the plan. Appearances matter and are often difficult to address when a plan or a trade is being viewed in hindsight. In this regard, while not specifically required, it is worth considering whether to delay any trading until the plan has been in place for at least six months to avoid the kinds of concerns, or even appearance of such concerns, that the amendments are intended to address. Such measures are the best evidence of good faith and create an additional factual buffer to the allegation that the director or executive had access to MNPI.
Given the SEC’s demonstrated interest in Rule 10b5-1 compliance, companies, corporate executives and brokerage firms should proceed cautiously and seek guidance from experienced counsel when implementing, modifying, or executing 10b5-1 plans. Moreover, as the SEC will now require registrants to disclose insider trading policies and procedures or explain why such policies have not been adopted, registrants may wish to consult with experienced counsel regarding a review of their insider trading policies, or adopting such insider trading policies, in advance of the final rule’s effective date.
For further information, please contact:
Danielle Giffuni, Crowell & Moring
dgiffuni@crowell.com
