On December 14, 2022, the SEC implemented amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 to enhance disclosure requirements and protect investors against insider trading. These amendments bring updates to Rule 10b5-1(c)(1), which provides an affirmative defense to insider trading liability under Section 10(b) and Rule 10b-5.

The revised Rule 10b5-1 introduces several new conditions to the affirmative defense. One key change is the introduction of cooling-off periods before trading can commence under a Rule 10b5-1 plan. Additionally, the Rule mandates that all individuals entering a Rule 10b5-1 plan must act in good faith concerning the plan. Directors and officers are now required to include representations in their plans certifying that: (i) they are not aware of any material nonpublic information about the issuer or its securities, and (ii) they are adopting the plan in good faith and not to evade Rule 10b-5 prohibitions.

Furthermore, the Rule restricts the use of multiple overlapping trading plans and limits the ability to rely on the affirmative defense for a single-trade plan to one single-trade plan per twelve-month period for all persons other than issuers. The Rule also enhances disclosures regarding a company’s insider trading policies and procedures, including quarterly disclosures about the use of Rule 10b5-1 plans by directors and officers.

Enhanced disclosures now include policies and practices regarding the timing of options grants and the release of material nonpublic information. Companies must report any option awards beginning four business days before the filing of a periodic report or a current report on Form 8-K that discloses material nonpublic information and ends one business day after such a triggering event. Insiders filing Forms 4 or 5 must indicate by checkbox whether a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and disclose the date of adoption of the trading plan.

SELL-TO-COVER EXCEPTION

The Rule generally restricts the use of multiple overlapping trading plans and limits the reliance on the affirmative defense for a single-trade plan to one per twelve-month period, except for issuers. A “sell-to-cover transaction” involves selling securities to cover the withholding taxes associated with equity vesting and elections under 401(k) plans or employee stock purchase plans. These transactions often utilize a separate Rule 10b5-1 plan from the traditional ones.

To accommodate this process, the restriction against multiple overlapping trading plans includes an exception for sell-to-cover plans, provided these plans only authorize qualified sell-to-cover transactions. Such a plan qualifies if it authorizes an agent to sell only the necessary securities to satisfy tax withholding obligations from the vesting of a compensatory award, and the insider does not control the timing of these sales. The value of the award and the associated taxes determine the amount of securities to be sold, as vesting schedules are usually set in advance by the issuer. Importantly, this exception does not extend to the exercise of options, which are controlled by the option holder.

The Rules also include an exception to the limitation on single trade plans to one every 12 months for sell-to-cover transactions.

Since the adoption of the amended 10b5-1 rules, many interpretive questions have arisen regarding the sell-to-cover exception.

SEC GUIDANCE

Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) specifies that “[A] contract, instruction, or plan provides for an eligible sell-to-cover transaction where the contract, instruction, or plan authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award, such as restricted stock or stock appreciation rights, and the insider does not otherwise exercise control over the timing of such sales.”

Practitioners were concerned that this language might limit the amount of securities to only what is required to satisfy statutory minimum tax withholding rates. Some companies allow employees to designate a higher expected effective tax rate for withholding taxes upon vesting. To address this, the ABA’s Joint Committee on Employee Benefits requested interpretive guidance from the SEC last summer.

The Committee proposed the following interpretation: A plan could qualify as providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations” if it allows for the sale of shares at the rate identified by the employee as their expected effective tax rate, provided this rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates permitted under tax and accounting rules.

Although the SEC did not publish this specific guidance, discussions with ABA Committee members confirmed that the SEC agreed with this interpretation. The SEC emphasized that it did not intend to disrupt normal tax planning practices. However, it clarified that the sell-to-cover transaction must not be used to satisfy taxes related to income from sources other than the vesting of a compensatory award.