On December 14, 2022, the Securities and Exchange Commission (the “SEC”) adopted amendments to Rule 10b5-1 (“Rule 10b5-1” or the “Rule”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as new disclosure requirements to bolster investor protections against insider trading (collectively, the “Final Rule”). The Final Rule takes into consideration extensive comments on the SEC release of proposed amendments on January 13, 2022 (the “Proposed Amendments”). The full text of the Final Rule can be found here.

Current Rule: 10b5-1 Affirmative Defense

Rule 10b5-1(c)(1) currently provides an affirmative defense (the “Affirmative Defense”) to Rule 10b-5 insider trading liability if a trade was made pursuant to a binding contract, an instruction from an individual to execute the trade for the instructing person’s account, or a written plan. An individual asserting a Rule 10b5-1(c)(1) defense must satisfy the following conditions:

• The person must show that before becoming aware of material nonpublic information, such person had entered into a binding contract to purchase or sell the security, instructed another person to execute the trade for the instructing person’s account, or adopted a written plan for trading securities;
• The person must show that the applicable contract, instruction, or plan:
  • specified the amount of securities to be purchased or sold, the price and date;
  • had a written algorithm, or computer program for determining the amounts, prices, and dates; or
  • did not permit the person to exercise any subsequent influence over how, when, or whether to effect the purchases or sales (and, additionally, that any other person who exercised such influence was not aware of the material nonpublic information while doing so);
• The person must show that the purchase or sale was pursuant to the prior contract, instruction, or plan. (The purchase or sale does not constitute “pursuant” to a contract, instruction, or plan under the Rule if the person who entered into the arrangement altered or deviated from such contract, instruction, or plan, or entered into or altered a corresponding or hedging transaction); and
• The Affirmative Defense is only available if the trading arrangement was entered into “in good faith and not as part of a plan or scheme to evade prohibitions” of the Rule.

Amendments under the Final Rule

The amendments under the Final Rule are intended to strengthen investor protections regarding insider trading and to help shareholders understand when and how insiders are trading securities. Changes to the Rule update the conditions that must be met for the Affirmative Defense.

Mandatory Cooling-Off Periods

Under the current Rule, an individual may adopt a Rule 10b5-1(c)(1) trading arrangement and execute a trade on the same day; there is no cooling-off period requirement. A cooling-off period is the time between when a plan is implemented and when the first trade is executed under the plan, thus minimizing the ability of an insider to benefit from any material nonpublic information.

The Final Rule adopts the following cooling-off periods:

• A cooling-off period for directors and officers of the later of: (i) 90 days following plan adoption or modification; or (ii) two business days following the disclosure of the issuer’s financial results in Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted or modified (with a maximum of 120 days following adoption or modification of the plan) before any trading may begin under the trading arrangement; and
• A cooling-off period of 30 days for persons other than issuers or directors and officers before any trading may commence under a Rule 10b5-1 plan.

This is a deviation from the corresponding provisions in the Proposed Amendments. Under the Proposed Amendments, the SEC sought to implement a minimum 120-day cooling-off period for directors and officers before any trading under the arrangement and a minimum 30-day cooling-off period for issuers. Commenters expressed a wide range of views on the proposed cooling-off periods, especially with respect to issuers that use Rule 10b5-1 plans in connection with share repurchase programs. Although the SEC has not adopted a cooling-off period for issuers at this time, it has indicated that further consideration of a possible cooling-off period is warranted.

Director and Officer Certifications

Although already a part of many Rule 10b5-1 plan templates, the Final Rule requires directors and officers to include a representation in their Rule 10b5-1 plans certifying that, at the time of adoption or modification of a plan, they were: (1) not aware of any material, nonpublic information regarding the issuer or its securities; and (2) adopting the plan in good faith and not to scheme or evade prohibitions of Rule 10b-5. The certification condition is intended to reinforce and remind directors and officers of the obligation to not trade or enter into a trading plan while aware of any material nonpublic information about the issuer or its securities.

Restriction on Multiple Overlapping Plans

Currently, a person is not entitled to the Affirmative Defense for a trade if the person enters into or alters a “corresponding or hedging transaction or position” with respect to the planned transactions. The SEC enacted this requirement to prevent persons from organizing schemes to exploit material nonpublic information by establishing pre-existing hedging trading programs and then executing only the favorable transaction.

The Proposed Amendments sought to eliminate the Affirmative Defense for any trades made by a trader who has established multiple overlapping trading arrangements for open market purchases or sales of the same class of securities. The Final Rule retained the general prohibition on multiple overlapping trading arrangements, but broadened the prohibition by removing the reference to “same class of securities,” so this restriction will apply to contracts, instructions or plans for any class of securities of the issuer. However, the Final Rule includes exceptions that: (i) allow for contracts to be treated as a single “plan” where taken together the contracts otherwise satisfy the conditions of the Rule; (ii) provide that a broker-dealer or other agent executing trades on behalf of the insider pursuant to the Rule 10b5-1 plan may be substituted by a different broker-dealer or other agent so long as the purchase or sale instructions are identical with respect to the prices of securities to be purchased or sold, the dates of purchases or sales, and the amount of securities to be purchased or sold; (iii) allow for two separate Rule 10b5-1 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 (there is a required cooling-off period that runs from the date of termination of the earlier-commencing plan); and (iv) authorize certain “sell-to-cover” transactions to which an insider instructs its agent to sell securities to satisfy tax withholding obligations at the time an award vests.

Restrictions on Single Trade Plans

The Final Rule places a limitation on the ability for anyone, other than the issuer, to rely on an Affirmative Defense for a single-trade plan to one such plan during any consecutive twelve (12) month period.

Good Faith

Under the Final Rule, all persons entering into a Rule 10b5-1 plan must act in good faith with respect to the contract, instruction, or plan.

Enhanced Disclosure Requirements

Lastly, the Final Rule requires the following new disclosures:

• Quarterly disclosure in Forms 10-Q and 10-K whether, during the applicable fiscal quarter (fourth quarter for the Form 10-K), any director or officer has adopted or terminated (i) any contract, instruction or written plan for the purchase or sale of securities of the registrant that is intended to satisfy the Affirmative Defense conditions of Rule 10b5-1(c); and/or (ii) any written trading agreement for the purchase or sale of securities of the registrant that meets the requirements of a non-Rule 10b5-1 plan and provide a description of the material terms (other than terms with respect to price) of the trading arrangement, such as:
  • the name and title of the director or officer;
  • the date on which the insider adopted or terminated the trading arrangement;
  • the duration of the trading arrangement; and
  • the aggregate number of shares to be purchased or sold pursuant to the trading arrangement;
• Annual disclosure (in the proxy statement and customarily incorporated by reference into Part III of the Form 10-K) of whether the issuer has adopted insider trading policies and procedures (and if not, why not), and the filing of such insider trading policies as Exhibit 19 to the Form 10-K;
• Annual narrative discussion (in the proxy statement and customarily incorporated by reference into Part III of the Form 10-K) of  the issuer’s policies and practices on the timing of awards of stock options, SARs and/or similar option-like instruments in relation to the disclosure of material nonpublic information by the issuer, including:
  • how the issuer’s board of directors determines when to grant awards;
  • whether, and if so, how the issuer’s board of directors or compensation committee takes material nonpublic information into account when determining timing and terms of an award; and
  • whether the issuer has timed the disclosure of material nonpublic information for purposes of affecting the value of executive compensation;
• Annual tabular disclosure (in the proxy statement and customarily incorporated by reference into Part III of the Form 10-K) of options awarded to named executive officers if, during the last completed fiscal year, the issuer awarded options to a named executive officer in the period beginning four business days before the filing (or furnishing) of a Form 10-Q, Form 10-K or Form 8-K (disclosing material nonpublic information, subject to a minor exception) and ending one business day after the filing or furnishing of such report;
• For Form 4 and 5 filers, indication by checkbox whether a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c); and
• The reporting of bona fide gifts of equity securities by insiders on Form 4 (rather than the annual Form 5) in accordance with Form 4’s filing deadline (before the end of the second business day following the date of the gift).

Timeline for Compliance; Next Steps

The Final Rule will become effective on February 27, 2023. The amendments to Rule 10b5-1 will not affect the Affirmative Defense for any 10b5-1 plan entered into prior to February 27, 2023, except to the extent the material terms of such plan are modified following the effective date. 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 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 (October 1, 2023 for smaller reporting companies).

In light of the Final Rule, issuers should revisit their insider trading policies and procedures; option award timelines and practices; all existing Rule 10b5-1 (and non-Rule 10b5-1) plans entered into by officers and directors, as well as sign-off procedures and related disclosure controls for the modification of existing plans or the adoption of new plans; and Section 16 filing logistics, especially in light of the accelerated reporting of gifts by insiders.

For additional information related to the Final Rule, or any related securities law topic, please contact one of the authors listed above, or any member of our Securities Law Practice Group.