SEC Adopts Amendments to Rule 10b5-1

The SEC has adopted amendments for Rule 10b5-1 plans. In this blog entry, I take a look at the new requirements.

Why Rule 10b5-1 and Why Now?

Academics have long been suspicious of Rule 10b5-1 plans, pointing to research that shows that executives who use 10b5-1 plans experience better results than other investors. Here’s the recent timeline of events that brought us these amendments:

November 2020: Moderna and Pfizer CEOs sell stock around the same time that their respective companies make important announcements related to their COVID vaccines. The sales are pursuant to Rule 10b5-1 plans that were modified earlier in the year.

January 2021: A study identifies three red flags for Rule 10b5-1 plans: short cooling-off periods, single-trade plans, and plans implemented and executed before earnings announcements.

February 2021: Senators Elizabeth Warren (D-NY), Sherrod Brown (D-OH), and Chris Van Hollen (D-MD) submit a letter to the SEC urging the Commission to review and reform its policies for Rule 10b5-1 plans.

June 2021: SEC Chairman Gensler directs the SEC staff to provide recommendations on how to freshen up Rule 10b5-1.

August 2021: The Investor Advisory Committee issues recommendations to the SEC on how to tighten up Rule 10b5-1, including requiring a four-month cooling-off period, prohibiting overlapping plans, requiring electronic filing of Form 144, and disclosure of 10b5-1 plans.

December 2021: The SEC proposes amendments to Rule 10b5-1 to address the aforementioned concerns.

December 2022: The SEC issues final amendments to Rule 10b5-1.

Now that we’ve finished our history lesson, let’s take a look at how the final rule differs from the current and proposed rule. [This blog entry does not discuss how Rule 10b5-1 applies to issuer transactions. Some of the requirements discussed do not apply or apply differently to issuer transactions.]

Cooling-Off Period

Prior Rule: None

Proposed Rule: 120-days for officers and directors

Final Rule: It’s complicated

• Officers and directors: Later of A) 90 days or B) two business days after disclosure of financial results in 10-Q or 10-K
• Other persons: 30 days

The cooling-off period is the length of time that must elapse between when a Rule 10b5-1 plan is adopted and trades begin under the plan. The longer this period, the more clear it is that the insider didn’t have material nonpublic information with respect to the stock at the time the plan was entered into.

The SEC had proposed a 120-day cooling-off period for officers and directors (and no required cooling off period for anyone else), which aligned with the IAC’s recommendation. The length of this proposed period has generated a fair amount of controversy; a number of commenters, even some of those who supported a mandated cooling-off period, felt it was unnecessarily long. Some commenters suggested the cooling-off period should apply to any person who adopts a Rule 10b5-1 plan, not just officers and directors.

The SEC decided to take a bifurcated approach in the final rules. Trades under Rule 10b5-1 plans adopted by Section 16 officers and directors cannot begin until the later of:

• 90 days after the plan is adopted, or
• Two business days after disclosure of financial results in Form 10-Q or 10-K for the quarter in which the plan is adopted

Trades under Rule 10b5-1 plans adopted by other individuals must be subject to a 30-day cooling off period.

No Overlapping Plans

Prior Rule: No restrictions

Proposed Rule: Overlapping plans prohibited

Final Rule: Proposal adopted with modifications

Another IAC recommendation that the SEC proposed adopting is the prohibition of overlapping plans. Under the current rule, which permits overlapping plans, insiders could theoretically set up multiple plans with varying trade dates, then strategically cancel or modify the plans once more information is available, thereby maximizing their profits while claiming the protection of Rule 10b5-1.

The final rules adopt the prohibition on overlapping plans, with some modifications and exceptions. Under the final rules, overlapping plans are prohibited in all securities of the issuer, rather than just plans that involve the same class of securities, as was proposed.

The final rules will permit 10b5-1 plans to overlap, provided trades cannot occur under both plans during the same period—specifically, trades under the later-commencing plan cannot begin until all trades under the first plan have executed or expired. In addition, once the original plan terminates, a period of time equal to the cooling-off period applicable to the adopter of the two 10b5-1 plans must elapse before trades can begin under the new plan.

For example, say that an officer with a 10b5-1 plan that is terminating on May 15 would like to enter into a new 10b5-1 plan during the fiscal period ending on June 30. Let’s further say that the 10-Q for this period is filed on August 2. Trades under the new plan cannot commence until August 13 (90 days after May 15, which is later than two business days after the 10-Q is filed).

Helpfully, the rules exempt Rule 10b5-1 plans implemented solely to cover tax withholding for restricted stock and units from the prohibition on overlapping plans, provided the plans do not provide the adopter with any control over the timing of the trades. (10b5-1 plans to cover tax withholding or costs to exercise stock options are not exempted.)

The SEC agrees with commenters that these limited sell-to-cover plans offer little danger of opportunistic trading. Award holders generally do not have control over vesting dates and the amount of securities to be sold are determined by the value of the award and the taxes due. Moreover, the SEC acknowledges that some adopters of Rule 10b5-1 plans, such as rank-and-file employees, “may have liquidity and diversification needs that are greater than those of more highly compensated officers.”

Limited Use of Single-Trade Plans

Prior Rule: No restrictions

Proposed Rule: Only one single-trade plan permitted during a 12-month period

Final Rule: Proposal adopted with modifications

The SEC’s proposing release cites research indicating that single-trade plans are consistently loss avoiding, often precede price declines, and may be executed on the basis of material nonpublic information. At the same time, however, the SEC acknowledges that there are legitimate uses of single-trade plans. To strike a compromise between these concerns, the release proposed allowing the use of single-trade plans, but only once during a 12-month period.

The final rules adopt the proposed amendment. Similarly to the prohibition on overlapping plans, the final amendments carve out an exception for single-trade plans used to execute sales to cover the tax withholding due on restricted stock and units (but not stock options).

Good Faith

Prior Rule: Requires plans to be adopted in good faith but does not require good faith operation

Proposed Rule: Would require plans to be adopted and operated in good faith

Final Rule: Requires plans to be adopted in good faith and for the person adopting the plan to act in good faith with respect to the plan

Currently Rule 10b5-1 requires that trading plans be entered into in good faith. The SEC proposed also requiring plans to be operated in good faith. This proposal is intended to address two primary concerns:

• Insiders who, after establishing a 10b5-1 plan, influence the timing of the company’s public disclosures to ensure maximum profitability for their trades under the plan.
• Insiders who cancel or modify plans in an effort to evade the prohibitions on insider trading under Rule 10b-5.

Commenters express concern that the word “operated” might be unclear. Thus, the final rules do not use this word and instead require a person who has entered into 10b5-1 plan to act in good faith with respect to the plan.

Certification

Prior Rule: No certification requirement

Proposed Rule: Would require Section 16 officers and directors to make certain certifications when entering into a 10b5-1 plan

Final Rule: Proposal adopted with modifications

The SEC’s proposed rules for 10b5-1 plans include a requirement that Section 16 officers and directors certify the following in writing at the time they adopt the plan:

• They are not in possession of material nonpublic information.
• They are adopting the trading plan in good faith and not as part of a scheme to evade the prohibitions on insider trading.

The final rules adopt this requirement. In the adopting release, the SEC indicates that the certification is intended to emphasize plan adopters’ obligation to act in good faith, to determine whether they are in possession of material nonpublic information before entering into a Rule 10b5-1 plan, and to enter into such plans only when not in posession of material nonpublic information.  

The final rules require the certification to be incorporated into the 10b5-1 plan itself (the SEC originally proposed that the certification be a separate document). The proposed rules would have required officers or directors adopting Rule 10b5-1 plans to retain a copy of the certification for ten years. The final rules do not include this retention requirement.

Effective Date

The amendments discussed in this blog go into effect on February 27, 2023. All Rule 10b5-1 plans adopted on or after this date must comply with the aforementioned requirements. Rule 10b5-1 plans adopted prior to February 27 do not need to comply with the new rule unless they are modified on or after this date.

Stay Tuned—More to Come

The adopting release also finalizes a number of new disclosures relating to Rule 10b5-1 plans and grants made shortly before or after the release of material nonpublic information. I will cover these disclosures in a future blog.

NASPP Webinar on 10b5-1 Plans

Check out our webinar on the amendments, “Understanding the New Rules for 10b5-1 Plans.” In addition to examining what is required under the new rules, our expert panelists discuss how your company’s policies for 10b5-1 plans need to be adjusted and highlight specific implications for equity plan transactions.