Seyfarth Synopsis: New SEC rules aiming to curb insider trading by directors and officers of public companies took effect on February 27, 2023.
On December 14, 2022, the Securities and Exchange Commission (“SEC”) adopted by unanimous vote: (1) final amendments to Rule 10b5-1 (17 CFR § 240.10b5-1) under the Exchange Act of 1934 (the “Exchange Act”) for insider trading plans and (2) new disclosure requirements intended to remove many of the loopholes that allowed corporate insiders to take undue advantage of these trading plans. The adopting release is available here and publication in the Federal Register is available here.
The final rules became effective 60 days after the date the rules were published in the Federal Register, i.e., December 29, 2022. That means the changes to Rule 10b5-1 became effective on February 27, 2023. After that, all Rule 10b5-1 trading plans adopted or modified should comply with the new requirements or the person adopting the plan will not be able to rely on the affirmative defense to Rule 10b-5.
Many observers have pointed out that for the last two decades, officers and directors at U.S. public companies seeking to trade illicitly on inside information had a giant loophole for avoiding SEC restrictions on insider trading. The loophole arose as an unintended consequence of the SEC’s adoption in 2000 of Rule 10b5-1, which created an affirmative defense to Rule 10b-5 for trades made pursuant to a compliant trading plan, but which academic research has shown created a gap in enforcement. By using such plans, SEC enforcement actions were infrequent because the SEC’s chances of success against someone who used such a plan were unlikely.
“Before the change occurred, you could have an executive utilize a $100 million 10b5-1 plan, and there would be no trace in public disclosures that they were utilizing such a plan,” said Daniel Taylor, an accounting professor at the University of Pennsylvania and the co-author of a 2021 study on 10b5-1 abuses that was cited in the SEC’s final rule.
It was reported that some insiders were selling shares less than a month after adopting their plans, sometimes even the same day, or adopting and initiating trading plans right before earnings announcements. Another trick had been to adopt multiple 10b5-1 plans and later selectively cancel the ones that wouldn’t work to the insider’s benefit. Potential abuses of 10b5-1 plans were the subject of a Wall Street Journal article in June 2022 that also was cited in the SEC’s final rule.
The changes to the rule update the conditions that must be met under a 10b5-1 trading plan to trigger the affirmative defense to Rule 10b-5 liability for insider trading.
Cooling Off Period
The amendments adopt cooling-off periods for persons other than issuers before trading can commence under a Rule 10b5-1 plan. Specifically, trading cannot begin under a plan adopted by a director or officer until the later of (a) 90 days after the adoption of the trading plan or (ii) two business day after the disclosure of the company’s financial results in a Form 10-Q or 10-K for the fiscal quarter in which the plan was adopted. The cooling off period is capped at 120 days. For insiders other than officers and directors, the colling off period is 30 days.
Director and Officer Certification
The amendments further provide that directors and officers must include representations in their plans certifying at the time of the adoption of a new or modified Rule 10b5-1 plan that: (1) they are not aware of any material nonpublic information about the issuer or its securities; and (2) 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.
Insiders that report on Forms 4 or 5 will be required to indicate by checkbox that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose the date of adoption of the trading plan. Finally, bona fide gifts of securities that were previously permitted to be reported on Form 5 will be required to be reported on Form 4.
Restrictions on Overlapping and Single Trade Plans
The amendments restrict the use of multiple overlapping trading plans and limit the ability to rely on the affirmative defense for a single-trade plan to one single-trade plan per twelve-month period for all persons other than issuers.
Quarterly Disclosure of Insider Trading Policies
The amendments will require more comprehensive disclosure about issuers’ policies and procedures related to insider trading, including quarterly disclosure by issuers regarding the use of Rule 10b5-1 plans and certain other trading arrangements by its directors and officers for the trading of its securities.
Annual Disclosure of Insider Trading Policies and Procedures
The final rules require disclosure of issuers’ policies and practices around the timing of option grants and the release of material nonpublic information.
Tabular Disclosure of Certain Equity Awards
The rules will require that issuers report on a new table any option awards beginning four business days before the filing of a periodic report or the filing or furnishing of a current report on Form 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 a triggering event.
Transition Periods for New Rules
For most U.S.-listed companies, the new disclosure requirements will become effective April 1, 2023. Section 16 reporting persons will be required to comply with the amendments to Forms 4 and 5 for beneficial ownership reports filed on or after April 1, 2023. Issuers will be required to comply with the new disclosure requirements in Exchange Act periodic reports on Forms 10-Q, 10-K and 20-F (foreign private issuers) 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. However, the final amendments defer by six months the date of compliance with the additional disclosure requirements for smaller reporting companies.
Please reach out either to the authors of this Legal Update {Blog Post} or to your Seyfarth Employee Benefits attorney if you need additional information.