Our Securities Group analyzes the Securities and Exchange Commission's attempt to address Rule 10b5-1's affirmative defenses that could allow insiders to take advantage of the liability protections against insider trading.
- Officers and directors would be subject to a 120-day cooling-off period
- The proposed rules would introduce several new disclosure requirements
- Interested parties have 45 days to submit comments
On December 15, 2021, the Securities and Exchange Commission (SEC) proposed amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 that would:
- Add new conditions to the availability of the affirmative defense under Rule 10b5-1(c)(1).
- Create new disclosure requirements relating to insider trading policies and the adoption of 10b5-1 plans by issuers, officers, and directors.
- Create new disclosure requirements relating to the timing of certain equity awards for executive and director compensation.
- Update Forms 4 and 5 to require the identification of transactions made pursuant to Rule 10b5-1 plans and the disclosure of all gifts of securities on Form 4.
Background
Section 10(b) of the Exchange Act prohibits the use of "any
manipulative or deceptive device or contrivance" in connection
with the purchase or sale of a security. Rule 10b5-1 stipulates
that the sale or purchase of a security is made on the basis of
material nonpublic information if the person making the purchase or
sale was aware of the material nonpublic information at the time of
the trade.
Rule 10b5-1(c) established an affirmative defense to insider
trading liability in circumstances where the trade was made
pursuant to a trading agreement that was established at a time the
trader was not aware of the material nonpublic information. Rule
10b5-1 also offers an affirmative defense for non-natural persons
engaged in trading.
Despite the current requirements, there is a market perception
among some investors that the Rule 10b5-1 affirmative defenses
allow insiders to take advantage of the liability protections
against insider trading. In response to these concerns, the SEC
proposed rule and form amendments to address certain practices
associated with Rule 10b5-1 trading agreements, grants of options,
and the gifting of securities.
Highlights of the Proposed Amendments
Cooling-off period
Officers (as that term is defined for purposes of the Section 16
reporting rules under Exchange Act Rule 16a-1(f)) and directors
entering into a Rule 10b5-1 trading arrangement would be subject to
a 120-day mandatory cooling-off period from the day the arrangement
is adopted before any trading can start under the
arrangement.
In addition, issuers that structure a share repurchase plan as a
Rule 10b5-1(c)(1)(i) trading arrangement, including stock
repurchasing plans, would be subject to a 30-day mandatory
cooling-off period from the day the arrangement is adopted before
any trading can start under the arrangement.
Modifications to existing Rule 10b5-1 trading arrangements would be
treated as equivalent to creating a new trading arrangement,
triggering a new mandatory cooling-off period.
Written certifications
To maintain the availability of a Rule 10b5-1 affirmative
defense, officers and directors would be required to provide a
certification to the issuer that they are not aware of material
nonpublic information about the issuer or security at the time they
adopt a 10b5-1 trading arrangement and that the arrangement was
adopted in good faith and not as a part of a plan or scheme to
avoid the prohibitions of Section 10(b) and Rule 10b-5. The
proposed rules would require that an officer or director seeking to
rely on the affirmative defense retain a copy of the certification
for 10 years.
No overlapping plans
The affirmative defense under Rule 10b5-1(c)(1), which provides
a defense for liability if the trade was made pursuant to a trading
agreement, would not apply to multiple overlapping Rule 10b5-1
trading arrangements for open market trades in the same class of
securities. This would not apply to transactions made directly with
the issuer.
Limitations on single-trade plans
The affirmative defense under Rule 10b5-1(c)(1) would only be
available for one single-trade plan during any 12-month
period.
New disclosure requirements
The proposed rules would introduce several new disclosure requirements.
- An issuer would be required to provide in its quarterly reports on Form 10-Q or annual report on Form 10-K whether, during the quarterly period covered by the report, the issuer, or any officer or director who is required to file reports under Section 16, adopted or terminated a Rule 10b5-1(c) trading plan.
- An issuer would be required to disclose in its Form 10-K or Form 20-F whether or not it has adopted insider trading policies and, if they do maintain such policies, to describe them. If the issuer does not have an insider trading policy, it would be required to provide justification for not having a policy.
- Section 16 reporting persons would be required to indicate on the applicable Form 4 or Form 5 whether a sale or purchase reported on that form was made pursuant to a Rule 10b5-1(c) trading arrangement. Filers would also be required to provide the date of adoption of the trading arrangement and would have the option to provide additional relevant information about the reported transaction.
- To increase transparency around the timing of certain compensatory stock awards, an issuer would be required to include tabular disclosure of each option award granted within 14 calendar days 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 nonpublic information; the market price of the underlying securities the trading day before disclosure of the material nonpublic information; and the market price of the underlying securities the trading day after disclosure of the material nonpublic information. This disclosure would be required in annual reports on Form 10- K, as well as in proxy statements and information statements related to the election of directors, shareholder approval of new compensation plans, and solicitations of advisory votes to approve executive compensation.
Section 16 reporting of gifts
Gift transactions by Section 16 filers would no longer be
eligible for delayed reporting on Form 5 and, instead, would be
required to be reported on Form 4 within two business days
following the transaction.
Next Steps
Interested parties have 45 days to submit comments to the SEC
electronically or via mail. We anticipate significant comments from
both issuers and investors to these proposed rules.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.