Employees, officers, and directors frequently seek to trade company securities, whether such securities are awarded as equity compensation, are required to be purchased to serve on the board, or otherwise. However, such trades carry significant risk for insiders who trade while aware of material nonpublic information (MNPI). These trades are subject to the same insider-trading prohibitions under section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act) and Rule 10b‑5 thereunder that apply to all market participants, even when the insider’s motivation for trading is entirely legitimate.
A well-structured Rule 10b5‑1 trading plan helps to mitigate this risk. Under Rule 10b5‑1(c) of the Exchange Act, trades executed under a compliant written plan are deemed not to have been made “on the basis of” MNPI, thereby providing an affirmative defense against insider-trading claims. For companies with equity-compensation programs, these plans are an essential compliance tool.
Key requirements for a valid Rule 10b5‑1 plan
To qualify for the affirmative defense, a Rule 10b5‑1 plan must satisfy several key requirements, including the following:
-
Adoption timing. The written trading plan must be adopted or modified before the person becomes aware of MNPI, and the plan must (i) specify the amount, price, and date of trades; (ii) provide a written formula or algorithm for determining those parameters; or (iii) eliminate the person’s ability to exercise subsequent influence over trading decisions.
-
Good-faith requirement. The plan must be entered into in good faith and not as part of a plan or scheme to evade insider-trading prohibitions of section 10(b) of the Exchange Act and Rule 10b-5 and Rule 10b5-1. The person must continue to act in good faith with respect to the plan throughout its duration.
-
Director and officer certifications. Directors and officers must include a representation certifying that at the time of adoption or modification, (i) they are not aware of any MNPI about the issuer or its securities, (ii) they are adopting or modifying the plan in good faith, and (iii) the plan is not a part of a plan or scheme to evade the prohibitions of Rule 10b-5.
-
Cooling-off periods. Directors and officers may not execute trades until a “cooling-off period” has elapsed. This period is the later of (i) 90 days following plan adoption or modification and (ii) two business days following disclosure of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified, subject to a maximum of 120 days after adoption or modification. For traders who are not directors or officers, the cooling-off period is 30 days following plan adoption or modification.
-
No overlapping plans. With limited exceptions, persons other than the issuer may not maintain multiple overlapping plans. The rule also provides that a person may not use more than one single-trade plan during any consecutive 12-month period.
-
No subsequent modifications. To preserve the plan’s protection, a trader must not alter or deviate from the plan or enter into or modify any corresponding or hedging transaction or position.
Sell-to-cover transactions
One common application of these requirements involves “sell-to-cover” transactions. When an insider sells shares to satisfy tax-withholding obligations arising from equity-award vesting, the amount sold may reflect a good-faith calculation of the insider’s expected effective tax obligation (and is not necessarily limited to the minimum withholding amount under applicable tax rules). Recent SEC staff guidance in the Compliance and Disclosure Interpretations for the Exchange Act Rules confirms this interpretation, reinforcing that a compliant Rule 10b5‑1 plan can cover sell-to-cover activity so long as the plan satisfies the rule’s requirements at adoption or modification.
How plan implementation works
Adopting a Rule 10b5‑1 plan requires coordination among several parties. The insider typically works with legal counsel to enter into the plan at a time when the insider does not possess MNPI and designates a broker-dealer to execute trades on a predetermined basis. After the plan takes effect and any applicable cooling-off period has expired, the broker executes trades automatically without further direction from the insider. The company’s role is to preclear the plan through a designated compliance representative, confirm that the plan satisfies the rule’s requirements, and monitor ongoing plan activity. This structure ensures that trading decisions are made at a time when the insider does not possess MNPI and that execution occurs mechanically, reinforcing the affirmative defense.
Action items for companies
Given the potentially serious consequences of noncompliance with insider-trading prohibitions under applicable securities laws, and the protection afforded by a valid Rule 10b5‑1 plan, companies with equity-compensation programs should evaluate the role that Rule 10b5‑1 plans may play in their insider-trading compliance programs for directors, executive officers, and other insiders who are likely to engage in securities transactions. Action items include the following:
-
Facilitating plan adoption. Encourage directors, executive officers, and other insiders who are likely to trade company securities to adopt Rule 10b5‑1 plans.
-
Establishing a governance framework. Implement a written policy that addresses eligibility requirements, plan-adoption windows, mandatory cooling-off periods, and limitations on overlapping or single-trade plans consistent with the SEC’s amended rules. This may take the form of a stand-alone trading-plan policy or an addendum to the company’s existing insider-trading policy.
-
Maintaining internal procedures. Develop procedures for preclearing individual plans, monitoring plan activity, and ensuring compliance with stock-exchange listing requirements and SEC disclosure obligations, including the quarterly disclosures under Item 408(a) of Regulation S‑K and annual disclosures regarding insider-trading policies under Item 408(b) of Regulation S‑K.
-
Reminding insiders of Form 4 requirements. Directors and officers should be aware that Form 4 filings include a checkbox indicating whether a reported transaction was made under a Rule 10b5‑1 plan, enhancing the visibility of plan-based trading activity.
As companies continue to refine their insider-trading compliance frameworks, careful implementation and oversight of Rule 10b5‑1 plans remain essential to mitigating litigation risk and providing insiders with confidence that their planned transactions will withstand regulatory scrutiny.
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.
[View Source]
