Rule 10b5-1 trading plans are prearranged plans for selling and/or buying company stock under SEC rules. This provides an affirmative defense against charges of insider trading if the employee trades stock while they possess Material Nonpublic Information (MNPI). Many companies now either require or strongly encourage their executives and key employees to set up 10b5-1 plans. The SEC has recently finalized important additional rules for 10b5-1 plans that affect the employees that use them.
Background: Misuse of Rule 10b5-1 Trading Plans
The law prohibits individuals from trading stock on the basis of MNPI. This is information that can affect the company’s stock price when it is made public (i.e., earnings, new product availability, mergers, etc.). One can commit insider trading accidentally as well as intentionally, even if the MNPI possessed does not influence their decision to trade.
Avoiding insider trading is a major concern for executives and employees holding company stock or options that want to sell shares to diversify or generate cash. This is because these people often possess MNPI. It does not matter whether the shares were purchased on the open market or from a stock option exercise, restricted stock vesting, or employee stock purchase plan (ESPP).
The SEC has been considering new rules for 10b5-1 plans over the past several years because evidence suggests that these plans have been abused to commit insider trading rather than prevent it. Consequently, the SEC has been scrutinizing 10b5-1 plans for a while and has brought enforcement actions for abuses.
In September 2022, the SEC announced it had settled an enforcement proceeding involving alleged insider trading by Cheetah Mobile’s CEO and its former president. This case involved the misuse of a 10b5-1 plan. The SEC’s statement on the matter quotes Joseph G. Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit, who explained that “while trading pursuant to 10b5-1 plans can shield employees from insider-trading liability under certain circumstances, these executives’ plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it.”
SEC Adopts Additional 10b5-1 Plan Rules
In response to these situations, the SEC has taken action to tighten up the rules for 10b5-1 plans. Effective December 14, 2022, the agency adopted amendments for 10b5-1 plans. For corporate officers and key employees seeking to use 10b5-1 plans as an affirmative defense against insider-trading liability, these rule changes include:
1. A “cooling off” (i.e., waiting) period before trades can start after the plan’s adoption or modification:
- For officers and directors, the later of (1) 90 days or (2) two business days after the disclosure in SEC Form 10-Q or 10-K of the company’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days). The proposed rules had a 120-day cooling-off period before any trading could start after the plan’s adoption or modification.
- For people other than officer and directors, 30 days. This is an important difference from the proposed rules, which did not clearly specify a cooling-off period for regular employees and managers.
2. A requirement to certify in the plan itself when adopting or modifying it that you are not aware of material nonpublic information about the company. This certification requirement is only for directors and officers.
3. No overlapping 10b5-1 plans for open-market trades. One exception would be another plan set up just to allow sales of stock (i.e. sell-to-cover) for tax withholding when restricted stock/RSUs vest.
4. A limit on single-trade plans to one per 12-month period.
These final rules are effective 60 days after publication of the adopting release in the Federal Register. Existing plans appear to be grandfathered unless modified.
Companies must also now annually disclose their insider-trading policies and procedures. For more details on the additional requirements, including the need to check a box on SEC Form 4 and Form 5 when a reported stock transaction is made under a 10b5-1 plan, see the SEC Fact Sheet on the rule changes.