As expected from the Spring 2021 Regulatory Agenda, on December 15, 2021, the SEC proposed amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (“Exchange Act”) to enhance disclosure requirements and investor protections against insider trading. Although there is a statutory framework, the laws surrounding insider trading are largely based on judicial precedence and are difficult to navigate. I last wrote about insider trading in 2014 (see HERE) but there have been many curves in the road since that time.
Since the adoption of Rule 10b5-1, courts, commentators, and members of Congress have expressed concern that the affirmative defense under Rule 10b5-1(c)(1)(i) has allowed traders to take advantage of the liability protections provided by the rule to opportunistically trade securities on the basis of material nonpublic information. Furthermore, some academic studies of Rule 10b5-1 trading arrangements have shown that corporate insiders trading pursuant to Rule 10b5-1 consistently outperform trading of executives and directors not conducted under a Rule 10b5-1 trading arrangement. The purpose of the new proposed rules is to prevent these perceived abuses of the existing structure.
Insider trading is prohibited by the general anti-fraud provisions and in particular Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Section 10(b) of the Exchange Act makes it unlawful for any person, directly or indirectly, to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the SEC may prescribe as necessary or appropriate in the public interest or for the protection of investors.
Rule 10b-5 provides that it shall be unlawful for any person, directly or indirectly to: (i) employ any device, scheme, or artifice to defraud; (ii) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (iii) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
As mentioned, the law of insider trading is otherwise defined by judicial opinions. There are three main theories on which insider trading is based: (i) the classical theory; (ii) misappropriation theory; and (iii) tipper/tippee theory. Rule 10b5-1(b) defines “on the basis of” for trading on insider information as “[S]ubject to the affirmative defenses in paragraph (c) of this section, a purchase or sale of a security of an issuer is ‘on the basis of’ material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale.”
Rule 10b5-1(c) provides an affirmative defense to insider trading including for parties that frequently have access to material nonpublic information, including corporate officers, directors and issuers. Currently, Rule 10b5-1(c) provides that a person’s purchase or sale is not on the basis of material non-public information if:
- Before becoming aware of the information, the person had: (a) entered into a binding contract to purchase or sell the security; (b) instructed another person to purchase or sell the security for the instructing person’s account, or (c) adopted a written plan for trading securities;
- The contract, instruction or plan described in (i) above: (a) must have specified the amount of securities to be purchased or sold and the price at which and the date on which the securities were to be purchased or sold; (b) must have included a written formula or algorithm, or computer program, for determining the amount of and price at which the securities will be purchased or sold; or (c) did not permit the person to exercise any subsequent influence over how, when, or whether to effect purchases or sales; provided, in addition, that any other person who, pursuant to the contract, instruction, or plan, did exercise such influence must not have been aware of the material nonpublic information when doing so; and
- The purchase or sale that occurred was pursuant to the contract, instruction, or plan. A purchase or sale is not “pursuant to a contract, instruction, or plan” if, among other things, the person who entered into the contract, instruction, or plan altered or deviated from the contract, instruction, or plan to purchase or sell securities (whether by changing the amount, price, or timing of the purchase or sale), or entered into or altered a corresponding or hedging transaction or position with respect to those securities.
As is common with many federal securities laws and rules, Rule 10b5-1 also includes a provision that the affirmative defenses in (c) are only available when the contract, instruction, or plan to purchase or sell securities was given or entered in good faith and not as part of a plan or scheme to evade the prohibitions of the law.
Proposed Rule Changes
The proposed amendments to Rule 10b5-1 would update the requirements for the affirmative defense, including imposing a cooling off period before trading could commence under a plan, prohibiting overlapping trading plans, and limiting single-trade plans to one trading plan per twelve-month period. In addition, the proposed rules would require directors and officers to furnish written certifications that they are not aware of any material nonpublic information when they enter into the plans and expand the existing good faith requirement for trading under Rule 10b5-1 plans.
In addition, the proposed amendments require more comprehensive disclosure about a company’s policies and procedures related to insider trading and its practices around the timing of options grants and the release of material nonpublic information. A new table would be required to report any options granted within 14 days of the release of material nonpublic information and the market price of the underlying securities the trading day before and the trading day after the disclosure of the material non-public information. Moreover, Forms 4 and 5 would be amended to add a new checkbox to disclose whether a transaction was made pursuant to a Rule 10b5-1(c) or other trading plan. Also, gifts of securities would have to be reported on Form 4 instead of being exempt and allowed to be reported on a yearly Form 5.
Insider Trading Affirmative Defenses
The proposed amendments to Rule 10b5-1 would add new conditions to the affirmative defense to insider trading liability found in Rule 10b5-1(c)(1), including:
- 10b5-1 trading plans entered into by corporate officers and directors must include a 120-day cooling off period before any trading can commence under the trading plan after its adoption, including adoption of a modified trading plan;
- 10b5-1 trading plans entered into by companies must include a 30-day cooling off period before any trading can commence under the trading plan after its adoption, including adoption of a modified trading plan;
- Officers and directors must certify that they are not aware of material nonpublic information about the company or the security when adopting a new or modified trading plan;
- The affirmative defense under Rule 10b5-1(c)(1) does not apply to multiple overlapping Rule 10b5-1 trading plans for open market trades in the same class of securities;
- 10b5-1 trading plans to execute a single trade are limited to one plan per 12-month period; and
- 10b5-1 trading arrangements must be entered into and operated in good faith.
New Disclosure Obligations
The proposed amendments require more comprehensive disclosure regarding Rule 10b5-1 trading plans, option grants, and issuer insider trading policies and procedures, including:
- A requirement for a company to disclose in its annual reports whether or not (and if not, why not) the company has adopted insider trading policies and procedures. Additionally, companies would be required to disclose their insider trading policies and procedures, if they have adopted such policies and procedures;
- A requirement for a company to disclose in its annual reports its option grant policies and practices, and to provide tabular disclosure showing grants made within 14 days of the release of material nonpublic information and the market price of the underlying securities on the trading day before and after the release of such information;
- A requirement for a company to disclose in its quarterly reports the adoption and termination of Rule 10b5‑1 trading plans and other trading arrangements by directors, officers, and issuers, and the terms of such trading arrangements;
- A requirement that Section 16 officers and directors disclose by checking a box on Forms 4 and 5 whether a reported transaction was made pursuant to a 10b5-1(c) trading arrangement; and
- A requirement that Section 16 officers and directors disclose bona gifts of securities on Form 4.
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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