SEC Proposes Amendments to Rule 10b5-1 - Banner

SEC Proposes Amendments to Rule 10b5-1

December 21, 2021

It wouldn’t feel like the holiday season without a flurry of rulemaking to close out the year. In keeping with this tradition, the SEC has proposed amendments to Rule 10b5-1. For your holiday reading pleasure, the proposing release is 163 pages (for those of you who want the cliff notes version, the SEC provides a two-page fact sheet).

Here’s a quick run-down of the proposals. (This blog addresses only the proposals that apply to Rule 10b5-1 plans entered into by individuals. There are also proposals relating to issuer 10b5-1 trading plans that I do not cover.)

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. But here’s the recent timeline of events that got us to this year’s holiday rulemaking:

  • 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 new 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 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.

Four-Month Cooling-Off Period

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. As recommended by the IAC, the SEC has proposed amending Rule 10b5-1 to require a four-month cooling-off period.

The length of this proposed period has generated some controversy. In TheCorporateCounsel.net blog, John Jenkins notes that it seems unreasonably long and Liz Dunshee reports that some practitioners take issue with the term “cooling-off”  itself.

No Overlapping Plans

The SEC also proposes adoption of the IAC’s recommendation that overlapping plans be prohibited. Under the current rule, which permits overlapping plans, insiders can 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.

Limited Use of Single-Trade Plans

The proposed rule would allow single-trade Rule 10b5-1 plans to be used by an insider only once during a 12-month period. This is a compromise position. The SEC 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.

Good Faith

Currently Rule 10b5-1 requires that trading plans be entered into in good faith. The SEC proposes 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.

Certification

The proposal would require Section 16 officers and directors to 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.

TheCorporateCounsel.net’s John Jenkins calls this requirement “something that only a bureaucrat could love.”  The requirement does not seem to have a lot of teeth to it. The proposing release states that:

The proposed certification would not be an independent basis of liability for directors or officers under Exchange Act Section 10(b) and Rule 10b-5. Rather the proposed certification would underscore the certifiers’ awareness of their legal obligations under the federal securities law related to the trading in the issuer’s securities.

In other words, the SEC just wants officers and directors to take their obligations under Rule 1-b5-1 more seriously.

Quarterly Disclosure of Trading Plans

The SEC does not adopt the IAC’s recommendations for disclosure of 10b5-1 trading plans on Form 8-K and in the company’s proxy statement. Instead, the SEC recommends requiring the following disclosures on a quarterly basis in Forms 10-Q and 10-K:

  • The names and titles of the officers and directors who have adopted or terminated trading plans during the quarter.
  • The duration of the plans.
  • The aggregate number of securities to be purchased or sold pursuant to the plans.

One thing I didn’t mention in my blog about Elon Musk’s recent tweet asking his followers to vote on whether he should sell his stock is that many of his sales were pursuant to a Rule 10b5-1 plan entered into in September, well in advance of his November Twitter poll, making either the poll or the trading plan arguably disingenuous. With quarterly disclosure, the trading plan would have been public information by the time of his tweet.

Disclosure of Insider Trading Policies

Companies would be required to describe their insider trading policies and procedures on an annual basis in Form 10-K and their proxy statement.

Section 16 Reporting

The SEC proposes two changes to Section 16 reporting requirements:

  • Adding a mandatory checkbox to Forms 4 and 5 to indicate when trades are executed pursuant to Rule 10b5-1 plans. The SEC previously proposed this as an optional checkbox.
  • Requiring gifts to be reported within two business days on Form 4.

Why target gifts? The SEC makes the following observation on this proposal:

We have become aware that the length of the filing period for Form 5 may allow insiders to engage in problematic practices involving gifts of securities, such as insiders making stock gifts while in possession of material nonpublic information,89 or backdating a stock gift in order to maximize a donor’s tax benefit.

New Grant Disclosure

Finally, the SEC proposes requiring tabular disclosure of options granted to named executive officers or directors within 14 calendar days before or after filing of a periodic report, filing or furnishing of a Form 8-K that contains material nonpublic information, or an issuer repurchase. The table would include the following information:

  • Number of options granted, grant date, and exercise price.
  • FMV on the trading days before and after disclosure of the material nonpublic information.

The objective of this disclosure is to help investors identify spring-loading and bullet-dodging in a company’s grant practices. The SEC already requires the CD&A to include information about the timing of option grants, but this disclosure is not in tabular format and the SEC is concerned that it may be insufficient.

Comment Period

The comment period will be open for 45 days from when the release is published in the Federal Register (which will happen any day now).  

Happy Holidays!

This will be our last blog entry of the year. Jenn and I hope that all of you have a happy and safe holiday season and we'll see you in the new year!

  • Barbara Baksa
    By Barbara Baksa

    Executive Director

    NASPP