Executive and director trading under new SEC Rule 10b5-1 

Corporate executives, directors and other insiders will have less flexibility to trade in company securities using pre-established trading plans under new SEC Rule 10b5-1 adopted by the SEC Dec. 14. The final rule imposes new conditions on the timing of trades after the adoption or modification of a plan and limits the number of plans an insider can have in place at a time. Executives and directors typically adopt these plans to trade in company securities since the rule gives insiders an affirmative defense against liability if they trade while in possession of material nonpublic information (MNPI). The rule is aimed at curbing potential trading abuses and will increase the scrutiny of insider trading policies and equity grant timing.

The new conditions prohibit trades under a plan until the later of (i) 90-days after plan adoption or modification, and (ii) two business days after disclosure of financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days). In addition, the rule limits most overlapping (i.e., concurrent) plans and single-trade plans. The final rule also requires insider certifications that the plan was adopted in good faith and new Section 16, periodic report and/or proxy disclosures with respect to insider trading policies, the use of trading plans and trading plan transactions, grants of stock options close in time to the release of MNPI, and bona fide gifts by insiders. To prepare for the final rule, companies should ensure their policies and procedures for the use of 10b5-1 plans comply with the new requirements, and review their equity grant timing and insider trading policies for compliance with best practices. 

The new trading plan conditions are effective 60 days after publication in the Federal Register. The Section 16 disclosures are required in SEC filings on or after April 1, 2023 and the new periodic report disclosures on Forms 10-Q, 10-K, and 20-F and in proxy or information statements are required in the first filing that covers the first full fiscal period beginning on or after April 1, 2023. Disclosure compliance for smaller reporting companies is deferred six months. 

Rule 10b-5 of the Securities Exchange Act of 1934 prohibits trading in company stock on the basis of MNPI (“insider trading”). A trader need not have “relied on” or “used” the information in making the trade; mere “awareness” is sufficient to create liability. To facilitate trading by insiders (large shareholders, officers and directors) and other individuals who are often in possession of MNPI, Rule 10b5-1 provides an affirmative defense to a charge of insider trading for trades made under a written trading plan established before the individual became aware of MNPI. For the defense to apply, the plan must do one of the following:

• Specify the amount, price, and date of the purchase or sale
• Provide a written formula or algorithm, or a computer program, for determining the amount, price, and date
• Deny the individual subsequent influence over how, when, or whether to purchase or sell (such as by giving full discretion to make trades to a broker who is not in possession of MNPI)

New conditions for affirmative defense

The rule includes new requirements aimed at limiting insider flexibility that may lead to trading plan abuse, including the following:

• Cooling-off period before trading for directors and officers of the later of: (i) 90 days after plan adoption or modification (down from 120 days as proposed) before the first trade under the plan; or (ii) two business days after the disclosure in periodic reports of the company’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification)
• Cooling-off period after plan adoption or modification for persons other than directors and officers of 30 days before trading can commence under the trading arrangement or modification
• Representation by directors and officers when adopting or modifying a plan, that: (i) they are not aware of MNPI; and (ii) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5
• Limit on multiple overlapping plans, with an exception for “sell-to-cover” transactions, which are used by insiders to meet tax withholding obligations related to the vesting of equity awards
• Limit on single-trade plans to one such plan during any consecutive 12-month period
• Condition that the person entering into a plan is acting in good faith with respect to the plan

Note: While companies may also use trading plans for stock buyback programs, most of the new conditions don’t apply to those trades. 

The cooling-off period is designed to address concerns that some insiders may be adopting Rule 10b5-1 plans while aware of MNPI (such as upcoming quarterly earnings results), and then shortly after executing a trade under the plan before the information becomes public. Similarly, insiders could cancel a plan shortly before a scheduled sale of shares based on MNPI of pending favorable company disclosures.

The limit on overlapping plans is designed to prohibit hedging by insiders where they adopt multiple overlapping trading arrangements and exploit MNPI by setting up trades timed to occur around dates on which they expect the company to release MNPI (such as earnings releases) and then selectively cancel trades or terminate plans before the information is publicly disclosed. Similarly, an executive could circumvent the cooling-off period by setting up multiple overlapping plans and deciding later which trades to execute and which to cancel after they become aware of MNPI.

The limit on single-trade plans is based on research indicating single-trade plans are consistently loss-avoiding and their adoption often precedes stock price declines. Allowing one single-trade plan during any consecutive 12-month period is intended to balance the need for liquidity against the potential for abuse of such plans.

New disclosures

The rule requires several new disclosures:

• Quarterly disclosure on Form 10-Q of the use of Rule 10b5-1 plans and certain other written trading arrangements by a company’s directors and officers
• Annual disclosure on Form 10-K (or 20-F for foreign private issuers) and proxy or information statements of a company’s insider trading policies and procedures
• Tabular and narrative disclosures regarding option grants close in time to the release of MNPI and related policies and procedures
• Section 16 filings on Forms 4 and 5 to identify transactions under a trading plan and disclosing bona fide gifts of securities
• Tagging of the required disclosures 

The SEC’s increased scrutiny of opportunistic trading and equity grant timing isn’t limited to director and officer trading plans. 

• On Dec. 7, 2022, the SEC reopened the comment period on a proposed rule to improve disclosures around stock buyback programs (which are sometimes implemented using a 10b5-1 plan) over concerns companies may be repurchasing shares opportunistically to enhance insider stock value and executive pay. 
• The new stock option disclosures in the final rule complement Staff Accounting Bulletin No. 120 (published in Nov. 2021), which provides guidance about proper recognition and disclosure of compensation cost for “spring-loaded” awards made to executives. Spring-loaded awards are where a company “grants stock options or other awards shortly before it announces market-moving information such as an earnings release with better than expected results or a significant  transaction.” According to the Bulletin, companies “must consider the impact that the MNPI will have upon release” and reflect in compensation cost any estimated additional value conveyed to recipients from anticipated announcements of material information. Spring-loaded grants that aren’t routine (e.g., prescheduled annual grants) merit particular scrutiny.

Companies should take the following steps to prepare to comply:

• Enhance internal controls to track use of trading plans and ensure compliance with Rule 10b5-1 policies, procedures, and disclosures.
• Review current insider trading policies and procedures and prepare draft disclosures.
• Review equity grant timing policies and practices.
• Educate directors about the rule and update committee charters to reflect any new responsibilities.
• Educate insiders so they are aware of the changes and implications for their trading plans.