By Kate Nahapetian
Shareholder Advocate Winter 2023
After a long gestation period, the SEC issued its final rules to address insider trading on December 14, 2022.1 Investors have been clamoring for reforms of Rule 10b5- 1, which provides an affirmative defense against insider trading claims to corporate executives who use prearranged plans to buy and sell their company’s stock. The SEC agreed with critics who said existing plans were too easily manipulated and adopted the changes unanimously—an accomplishment of note in these politically charged times. While less ambitious than proposed rules announced last year (see discussion in the Winter 2022 Shareholder Advocate), the changes are significant, nonetheless.
The major changes include:
- A “cooling off” period before a Rule 10b5-1 plan can be executed
- Restrictions on multiple Rule 10b5 plans
- Restrictions on single-trade plans
- New disclosure requirements
- Enhanced “good faith” certification requirements
Rule 10b5-1, which was adopted over 20 years ago, provides corporate insiders protection from insider trading claims if their trades were exercised according to a written pre-arranged plan that was devised before the executive was aware of any material non-public information (“MNPI”). In its December 14, 2022 final rule, the SEC explained, “We are concerned that some corporate insiders use Rule 10b5-1 plans in ways that are not consistent with the objectives of the rule, and that harm investors and undermine the integrity of the securities markets.”
In fact, courts have also raised concerns over these plans. For instance, before issuing an important ruling for investors limiting the use of Rule 10b5-1 plans, the Tenth U.S. Circuit Court of Appeals recently recognized such abuses in Indiana Public Retirement System, et. al. v. Pluralsight, Inc., where Cohen Milstein serves as lead counsel. Finding that the “text and history of Rule 10b5-1 shows that such plans can be manipulated easily for personal financial gain,” the court reversed the district court and stripped defendants of their purported “get out of jail free card,” finding that the Rule 10b5-1 trading plan did not rebut an inference of scienter per se (see discussion in the Fall 2022 Shareholder Advocate).
One of the most important changes the SEC has issued in its final rule is the creation of a “cooling off” period. Under the old rules, insiders could make and use a trading plan the very same day, which practically eviscerated its purpose to prevent insider trading. Under the SEC’s new rules, anyone other than an issuer, i.e., the company itself, must wait a certain period of time before executing a trade under a Rule 10b5-1 plan. Directors or officers must wait between 90 and 120 days, depending on the circumstances.2 All other persons other than issuers must wait 30 days.
Another change places restrictions on overlapping plans. Previously, traders could create multiple plans and decide later to cancel one that became disadvantageous. Now, the SEC prohibits the use of a Rule 10b5-1 affirmative defense if persons (other than issuers) have multiple overlapping plans.
The SEC amendments also impose new restrictions on “single-trade plans,” which are designed to execute a single trade on one occasion rather than multiple trades over time. Before the change, traders could create multiple single-trade plans; under the new rules, the SEC limits their use to just one plan per 12-month period.
As for the new disclosure requirements, the SEC now requires that the creation, modification, or termination of any directors’ or officers’ Rule 10b5-1 plans be disclosed in quarterly reports (Form 10-Q or Form 10-K as applicable) starting with the financial reports covering the first quarter of 2023. Under the old rules, Rule 10b5-1 plans did not need to be disclosed, which kept investors from knowing whether suspicious trades by officers or directors were made pursuant to a plan or not.
In addition, the SEC now requires companies to disclose whether they have an insider trading policy and to provide it annually as an exhibit. The SEC explained that seeing the details of such policies and whether they are merely perfunctory declarations or ones with effective controls will give investors important information.3
Finally, the SEC heightened the “good faith” certification requirements. While the SEC currently requires that plans be entered in good faith, the new rule requires a certification that the plans have been exercised and operated in good faith. The SEC now requires traders to certify that they both entered in and “acted in good faith with respect to” the plan.
Although the changes are not as robust as originally contemplated in the proposed rules issued last year, they are still welcome restrictions that will tighten investor protections. The Council for Institutional Investors, which has been advocating for many of these reforms for more than a decade, has praised the SEC for instituting them. We now look forward to utilizing them in practice to protect our clients’ interests and strengthen investor protections.
1 The rules were announced on December 14, 2022 but will not become effective until February 27, 2023.
2 The SEC now requires directors or officers to wait “until the later of (1) 90 days after the adoption of the Rule 10b5-1 plan or (2) two business days following the disclosure of the issuer’s financial results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted or, for foreign private issuers, in a Form 20-F or Form 6-K that discloses the issuer’s financial results (but in any event, the required cooling-off period is subject to a maximum of 120 days after adoption of the plan).”
3 "The thoroughness and precision of such policies and procedures may help investors to understand whether they will be successfully implemented…An investor might reasonably conclude that an issuer adopting a policy generally prohibiting insider trading, but without disclosing how it prevents the unlawful communication of and trading on material nonpublic information, provides fewer such assurances to investors than an issuer that has developed and disclosed more particular and thorough policies and procedures.”