December 16, 2022
On December 14, 2022, the Securities and Exchange Commission (“SEC” or “Commission”), in a rare unanimous vote, adopted final rules on the affirmative defense to insider trading liability and new disclosures related to insider trading. The final rules: (i) add new conditions to the affirmative defense to insider trading pursuant to a contract, instruction, or plan intended to satisfy the conditions of Exchange Act Rule 10b5-1(c) (a “Rule 10b5-1 plan”), (ii) introduce new periodic disclosure requirements related to insider trading, including with respect to company insider trading policies and procedures and the adoption and termination of Rule 10b5-1 plans by directors and officers, and director and officer equity compensation awards made close in time to the company’s disclosure of material nonpublic information (“MNPI”), and (iii) require identification of transactions made pursuant to a Rule 10b5-1 plan on Forms 4 and 5, and require that bona fide gifts be reported on Form 4 within two business days rather than after year-end on Form 5. The final rules are thematically aligned with the rule proposal issued by the Commission in December of last year[i] – also in a unanimous vote – but with meaningful changes and the addition of several carve outs, particularly for companies.
The adopting release is available here and a Fact Sheet is available here. The final rules will become effective 60 days after publication in the Federal Register (the “Effective Date”), at which point any Rule 10b5-1 plan thereafter adopted or modified should comply with the new requirements. Companies will be required to comply with the new periodic disclosure requirements in the first filing that covers the first full fiscal period that begins on or after April 1, 2023 (i.e., the second-quarter Form 10-Q for a company with a December 31 fiscal year-end). Smaller reporting companies have until the first filing covering a period that begins on or after October 1, 2023 to comply (i.e., the fiscal 2023 Form 10-K for a company with a December 31 fiscal year-end). Section 16 insiders will be required to comply with the amendments to Form 4 beginning with reports filed on or after April 1, 2023. Set forth below is a summary of the final rules and some considerations for companies and insiders.
Summary of Final Rules
New Conditions for Rule 10b5-1 Plans. The rules introduce new conditions on the availability of the affirmative defense to Rule 10b-5 liability pursuant to a Rule 10b5-1 plan. Any plans adopted after the Effective Date must comply with the new conditions or the person adopting the plan will not be able to rely on the affirmative defense. Note that these changes do not affect the affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the Effective Date, unless it is modified in a manner that is treated as an adoption of a new plan (described below) after the Effective Date.[ii] The new conditions for Rule 10b5-1 plans consist of the following:
New Periodic Reporting Requirements. The final rules introduce the following new periodic reporting requirements:
Unlike the proposed rules, the final rules do not require disclosure of whether the company adopted a Rule 10b5-1 plan or non-Rule 10b5-1 trading arrangement.[xiii] The proposed rules also did not specifically carve out price from the material terms of Rule 10b5-1 plans or non-Rule 10b5-1 trading arrangements that are required to be disclosed.[xiv]
Number of securities underlying the award
Exercise price of the award ($/Sh)
Grant date fair value of the award
Percentage change in the closing market price of the securities underlying the award between the trading day ending immediately prior to the disclosure of material nonpublic information and the trading day beginning immediately following the disclosure of material nonpublic information
The window in which awards will trigger disclosure is significantly reduced from the proposed rules, which would have covered 14 days both before and after the relevant filing.[xv] The final rules also clarify that a Form 8-K reporting a material new option award grant under Item 5.02(e) would not trigger the disclosure requirement, and removes company share repurchases as events that would trigger disclosure.
This new disclosure requirement will not affect foreign private issuers.
New Beneficial Ownership Reporting Requirements. The amendments add a checkbox to Forms 4 and 5 for insiders to indicate whether the reported transaction is pursuant to a plan that is “intended to satisfy the affirmative defense conditions” of Rule 10b5-1(c). In addition, insiders will be required to report dispositions of bona fide gifts of equity securities on Form 4 (rather than Form 5), thereby shortening the deadline to report gifts from 45 days after fiscal year-end to two business days following the date of execution. The final rules do not adopt the proposed second checkbox for indicating a transaction was made pursuant to a plan that did not qualify for Rule 10b5-1(c).[xvi]
Importantly, the adopting release builds on the note from the proposing release that opined that gifts are subject to Section 10(b) liability, and the SEC reiterated that the affirmative defense of Rule 10b5-1(c)(1) is available for any bona fide gift of securities.[xvii]
Observations and Considerations for Companies and Insiders
Insider trading policies should be updated as of the Effective Date, but existing Rule 10b5-1 plans do not need to be amended unless any Essential Terms are modified after the Effective Date. Companies should update their current insider trading policies and procedures (including any separate Rule 10b5-1 plan guidelines), to amend any provisions that conflict with the final rules. For example, many companies already require their employees’ Rule 10b5-1 plans to have cooling-off periods. If the cooling-off periods permissible under a company’s policy are shorter than those under the final rules, the policy should be updated to reflect the required cooling-off periods, subject to the grandfathering accommodations for Rule 10b5-1 plans existing prior to the Effective Date. Companies may consider removing policy provisions requiring insiders to trade only through Rule 10b5-1 plans in light of the final rules, which will require disclosure of the number of shares insiders intend to sell under such plans. This disclosure could cause an unfavorable market price reaction and become a topic of discussion in shareholder engagement or a point of contention for shareholder activists, causing a chilling effect on the use of Rule 10b5-1 plans by insiders. Some companies may determine to instead encourage insiders to trade during ordinary open window periods after pre-clearance from the company’s general counsel, at least with respect to transactions other than sell-to-cover trades. In addition, with the new requirement to file insider trading policies and procedures as an exhibit to the Form 10-K, companies may want to revisit their policies to make sure they are sufficiently robust.
Companies should consider waiting at least two business days following the release of MNPI to make equity compensation awards. The new disclosure requirement regarding equity awards made close in time to the release of MNPI is meant to combat the practice of “spring-loading,” in which equity grants are made immediately before positive MNPI is released so that executives benefit from the increased share price when the MNPI is made public. Companies should be aware of the optics of making awards close to the public release of MNPI, and can mitigate potential concerns by waiting at least two business days following the release of MNPI before making equity awards. This will entail coordinating board and board committee meeting and/or schedules with the reporting calendar for periodic reports and any planned Form 8-K filings.
Corporate insiders should be cautious when gifting while aware of MNPI. The SEC has historically been silent with respect to the liability of gifts under Section 10(b). With the Commission’s reaffirmations in the adopting release, corporate insiders who are aware of MNPI should proceed with caution when gifting company securities, as they could be liable if they gift securities when they are aware of MNPI and while knowing (or being reckless in not knowing) that the donee would sell the securities prior to the disclosure of the MNPI. Many, if not most, non-profit organizations have a policy of immediately selling any securities received as a gift, as they are not in the business of holding securities. Companies also may want to revisit how their insider trading policies apply to gifts.
There are no new share repurchase requirements for companies, but this is likely to change. The single new condition on Rule 10b5-1 plans applicable to companies is the requirement to act in good faith, as companies are carved out from the other new conditions, allowing them to implement overlapping and multiple single-trade plans, all without cooling-off periods. Although the proposed rules contemplated periodic disclosure requirements with respect to a company’s adoption and termination of Rule 10b5-1 plans, these provisions were removed in the final rules. However, the Commission noted in the adopting release that it is continuing to consider whether regulatory action is needed to mitigate the risk of misuse of Rule 10b5-1 plans by companies, such as in the share repurchase context.[xviii] The SEC is still working on final rules for share repurchase disclosure, which were originally proposed alongside the insider trading rules last year. The SEC recently reopened the comment period for the share repurchase rule proposal so that commenters could consider a SEC Staff memorandum analyzing the impact of the new excise tax on share repurchases on the potential economic effects of the SEC’s rule proposal.[xix]
[i] For our discussion of the proposed rules, see Gibson Dunn Client Alert, SEC Proposes Rules on Insider Trading, Rule 10b5-1 and Share Repurchases (Dec. 23, 2021).
[ii] Insider Trading Arrangements and Related Disclosures, Exchange Act Release No. 96492 (Dec. 14, 2022) (the “Adopting Release”) at III, available at https://www.sec.gov/rules/final/2022/33-11138.pdf.
[iii] The term “officer” refers to how that term is defined in Exchange Act Rule 16a-1(f).
[iv] Adopting Release at II.A.1.c.
[v] See Rule 10b5-1 and Insider Trading, Exchange Act Release No. 93782 (Dec. 15, 2021) (the “Proposing Release”), at II.A.1, available at https://www.sec.gov/rules/proposed/2022/33-11013.pdf
[vi] Adopting Release at II.A.3.c.
[vii] Proposing Release at II.A.3.
[viii] See Adopting Release at II.A.3.c.
[xi] Proposing Release at II.A.4.
[xii] See Adopting Release at II.B.1.c.
[xiii] See Id.
[xiv] See Proposing Release at II.B.1.
[xv] Proposing Release at II.C.
[xvi] See Proposing Release at II.B.4.
[xvii] See Proposing Release at II.B.2.; Adopting Release at II.E.3.
[xviii] Adopting Release at II.A.1.c.
[xix] Reopening of Comment Period for Share Repurchase Disclosure Modernization, Exchange Act Release No. 96458 (Dec. 7, 2022), available at https://www.sec.gov/rules/proposed/2022/34-96458.pdf.
The following Gibson Dunn attorneys assisted in preparing this client update: Aaron K. Briggs, Joel M. Cohen, Thomas J. Kim, Brian J. Lane, Ronald O. Mueller, Lori Zyskowski and Matthew L. Dolloff.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Securities Enforcement or Securities Regulation and Corporate Governance practice groups:
Securities Enforcement Group:
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])
Securities Regulation and Corporate Governance Group:
Aaron Briggs – San Francisco (+1 415-393-8297, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Brian J. Lane – Washington, D.C. (+1 202-887-3646, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
James J. Moloney – Orange County (+1 949-451-4343, [email protected])
Ron Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, [email protected])
Michael Titera – Orange County (+1 949-451-4365, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
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