On December 14, 2022, the SEC adopted final rules amending Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), which provides an affirmative defense to insider trading for trades made under a written plan adopted when not aware of material nonpublic information (“MNPI”). The final rules add several new conditions for the availability of the affirmative defense and require new quarterly and Form 4 disclosures regarding the Rule 10b5-1 trading arrangements of officers and directors subject to Section 16 of the Exchange Act (“officers and directors”). The rules also require annual disclosure of insider trading policies, as well as of options or option-like instruments granted proximate to the release of MNPI, and require prompt reporting of gifts on Form 4, rather than on Form 5.
With the rule’s effective date quickly approaching, companies and insiders should consider any necessary changes to existing and planned personal trading plans, insider trading policies, corporate-approved forms of 10b5-1 trading plans, company disclosures and Form 4 reporting practices, including a close evaluation of the potential impact of the new rules on transactions by employees and directors under company equity compensation and benefit plans. Although companies often structure purchases and sales of stock under company plans to occur in open window periods, thereby reducing potential insider trading risk, it is not possible to guarantee that trading windows will remain open when scheduled or that certain insiders won’t otherwise have MNPI. Companies and insiders take different approaches to addressing these risks and should now consider whether any changes are warranted.
- Companies that have mitigated potential insider trading risk by designing their equity or benefit plan processes so that sell-to-cover tax withholding arrangements, employee investment elections or other plan transactions may qualify for the affirmative defense of Rule 10b5-1 should bear in mind the new conditions under the rule and the newly required disclosures of the Rule 10b5-1 trading plans of officers and directors.
- Companies and insiders that rely on alternative defenses to insider trading liability for transactions under company plans or that wish to continue to rely on the prior Rule 10b5-1 should determine whether such plans of their officers and directors must be disclosed as “non-Rule 10b5-1 trading arrangements” under the new rules.
The timeline for compliance is short – the new conditions apply for Rule 10b5-1 plans adopted on or after February 27, 2023 (with grandfathering for previously-adopted plans), and the new disclosures are required commencing with the filing that covers the first full fiscal period that begins on or after April 1, 2023.
New Conditions of Rule 10b5-1
Companies that intend for purchases or sales of securities under company plans to qualify for the amended Rule 10b5-1 need to build compliance with the following new conditions into their plans or processes, in addition to existing Rule 10b5-1 requirements:
Cooling-off Periods. The amended Rule 10b5-1 requires a “cooling-off period” between plan adoption (or modification) and the time that trading starts, which (i) for officers and directors is the later of (A) 90 days after adoption of the plan or (B) two business days following the filing of Form 10-Q or 10-K for the fiscal quarter in which the plan was adopted, up to a maximum of 120 days; and (ii) for persons other than officers or directors (or the issuer) is 30 days after adoption of the plan. To comply with this condition:
- Companies that facilitate the sale of shares to cover tax withholdings due in connection with the vesting of restricted stock or restricted stock units (a “sell-to-cover”) would need to ensure that the required cooling-off period has been met between the award holder’s entry into the Rule 10b5-1 sell-to-cover arrangement and when the first sale occurs. If an award agreement is intended to qualify as a Rule 10b5-1 plan, then for grants on or after February 27, 2023, companies should assess whether the cooling-off period can be met before the first potential vesting date (including any accelerated vesting date), and if not, determine whether an alternative withholding method will be feasible for such vesting date or consider setting up a separate 10b5-1 arrangement to cover all future awards.
- Companies operating ESPPs or other plans that allow for the elective purchase of company stock, would need to consider whether the applicable cooling-off period may be met between the time of plan enrollment or any change to an existing enrollment and the time that shares are purchased under the plan.
MNPI Representations. Officers and directors adopting a Rule 10b5-1 plan must certify in the plan that, at the time of adoption, they: (i) are not aware of MNPI about the issuer or its securities, and (ii) are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Exchange Act Rule 10b-5.
- Companies intending for purchases or sales of company stock under equity or benefit plans to qualify for the new Rule 10b5-1 should consider whether it is necessary and feasible to build the required certifications into plan enrollment or grant acceptance procedures.
Prohibition on Multiple Overlapping Plans. An insider that wishes to rely on the affirmative defense cannot have more than one Rule 10b5-1 trading plan for open market purchases or sales of the issuer’s securities at any one time. Fortunately, there are several exceptions to this prohibition, including two which are specifically relevant to company plans:
- A sell-to-cover arrangement is not considered an overlapping plan as long as it authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations incident to the vesting of a compensatory award (such as restricted stock or restricted stock units), and the award holder does not otherwise exercise control over the timing of such sale (an “eligible sell-to-cover”). This exception does not apply to a sale to cover taxes on an option exercise.
- Plans not involving open market transactions, such as employee benefit plans, ESOPs, or DRIPs, as well as typical U.S.-style ESPPs are excepted – but by implication the prohibition would apply to the extent such plans provide for open market purchases and are intended to qualify for the new Rule 10b5-1.
Limitations on Single-Trade Arrangements. An insider may rely on the Rule 10b5-1 affirmative defense for only one single-trade plan for an open market trade in any 12-month period.
- Employee plans are not generally designed as single trade plans, making this limitation largely inapplicable to such plans, but in any event, it does not apply to eligible sell-to-cover transactions or to plans not involving open market transactions as is the case for many employee benefit plans.
Good Faith Requirement. The final rules introduce an operational compliance requirement, in that as well as entering into a Rule 10b5-1 plan in good faith, a person must “act in good faith with respect to” the plan.
- Among other possible consequences, the requirement to operate the plan in good faith could mean that the affirmative defense is jeopardized if a planned transaction is cancelled when in possession of MNPI, potentially impacting the timing of plan withdrawals and changes in restricted stock or restricted stock unit withholding method.
New 10b5-1 Disclosure Requirements
With the intent of making it easier for investors to assess whether corporate insiders are misusing MNPI, the final rules mandate new disclosures of Rule 10b5-1 trading arrangements and also of non-Rule 10b5-1 trading arrangements of officers and directors. The definition of “non-Rule 10b5-1 trading arrangement” broadly captures arrangements that qualified for the prior Rule 10b5-1, with the result that companies will need to consider whether transactions by directors and officers under existing equity or benefit plans may be considered subject to this new disclosure requirement.
Quarterly Disclosure of Trading Plans. Regulation S-K Item 408(a) requires issuers to disclose, quarterly in Forms 10-Q or 10-K whether and when, in the applicable fiscal quarter, any officer or director has adopted or terminated a Rule 10b5-1 plan or a non-Rule 10b5-1 trading arrangement, and to provide the duration, securities covered and other material terms of the plan (other than pricing terms).
- As these new disclosures are required for the first full fiscal period that begins on or after April 1, 2023, companies should ensure they have processes to track and disclose the adoption or termination of covered trading arrangements by their directors and officers before such reporting period, including any arrangements in connection with equity awards or other employee plans.
Mandatory Form 4 and 5 Checkbox. Officers and directors must indicate, in a checkbox on Form 4 and 5, whether the disclosed transactions are intended to satisfy the affirmative defense requirements of Rule 10b5-1 and, if so, the date the 10b5-1 plan was adopted.
- As Section 16 filers have typically included footnote disclosure when a transaction, including a sell-to-cover, has been made under a 10b5-1 plan, this new checkbox is the least onerous of the new requirements, but will need to be done for Form 4s and Form 5s filed on or after April 1, 2023.
Transactions under company equity and benefit plans may have insider trading implications, and companies intending for those transactions to be protected by Rule 10b5-1 need to act quickly to ensure that they develop an approach to the new requirements by February 27, 2023, the effective date of the final rule.
The final 10b5-1 rule shows the SEC’s significant focus on insider trading and use of 10b5-1 plans and non-Rule 10b5-1 plans so it is a good time for all companies to take an inventory of plans that allow for the purchase or sale of company securities to assess the impact of the rules and applicable disclosures, regardless of whether they intend for transactions under such plans to comply with the amended Rule 10b5-1.
 Under the final rule, a “non-Rule 10b5-1 trading arrangement” is a written arrangement for trading in securities, adopted at a time when the individual adopting the arrangement asserts that he or she was not aware of MNPI about the security or issuer, that: (i) specified the amount of securities to be purchased or sold and the price at which and the date on which the securities were to be subsequently purchased or sold; (ii) included a written formula or algorithm, or computer program, for determining the amount of securities to be purchased or sold and the price at which the securities were to be purchased or sold; or (iii) did not permit the covered person to exercise any subsequent influence over how, when, or whether to effect purchases or sales.
 October 1, 2023 for smaller reporting companies.
 “Adoption” of a plan includes the modification of a plan in a way that alters the price, amount or timing of a transaction, such that any such change would be considered the adoption of a new plan under the final rules. References in this update to “adopting” a plan include such modifications.
 Although not covered in depth in this update, equity plan sponsors should note that the final rule also introduces new Regulation S-K Item 402(x), which will require disclosure on Form 10-K or in the annual meeting proxy statement of an issuer’s policies and practices on the timing of option (or similar) grants in relation to the disclosure of MNPI, including tabular disclosure of any such grants made to a named executive officer in the period beginning four business days before or one business day after the filing of Form 10-Q or 10-K or the filing or furnishing of a Form 8-K that discloses MNPI (other than a material option grant). These disclosures will be required in the Form 10-K or proxy statement covering the first fiscal year that begins on or after April 1, 2023, so in 2025 covering 2024 for calendar year companies.