On December 14, 2022, the SEC adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (“Exchange Act”) to enhance disclosure requirements and investor protections against insider trading. The amendments include updates to Rule 10b5-1(c)(1), which provides an affirmative defense to insider trading liability under Section 10(b) and Rule 10b-5. For a review of the Rules see HERE and HERE.
Updated Rule 10b5-1 adds conditions to the affirmative defense to insider trading. The Rule now has cooling-off periods before trading can commence under a Rule 10b5-1 plan and adds a condition that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to the plan. The Rule also requires directors and officers to include representations in their plans certifying at the time of the adoption of a new or modified Rule 10b5-1 plan 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 as part of a plan or scheme to evade the prohibitions of Rule 10b-5.
Moreover, subject to certain exceptions, 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. Further, the Rule enhances disclosures about a company’s policies and procedures related to insider trading, including quarterly disclosure by a company regarding the use of Rule 10b5-1 plans and certain other trading arrangements by its directors and officers.
Enhanced disclosures include policies and practices around the timing of options grants and the release of material nonpublic information. The Rules require that companies report in tabular format, any option awards beginning four business days before the filing of a periodic report or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information, including earnings information, other than a Form 8-K that discloses a material new option award grant, and ending one business day after a triggering event. Insiders that report on Forms 4 or 5 are required to indicate by checkbox that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose the date of adoption of the trading plan.
Sell-To-Cover Exception
As mentioned, subject to certain exceptions, 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. A “sell-to-cover transaction” is to sell securities to generate funds to cover the withholding taxes associated with equity vesting and elections under 401(k) plans or employee stock purchase plans. Often times, a Rule 10b5-1 plan is utilized in the sell-to-cover process which plan is separate from a traditional Rule 10b5-1 plan.
In order to continue to allow this process, the restriction against multiple overlapping trading plans contains an exception for sell-to-cover plans so long as the additional plan or plans only authorize qualified sell-to-cover transactions. A plan authorizing sell-to-cover transactions is qualified for this provision where the plan authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations incident to 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. Because vesting schedules are generally set in advance by the issuer, the amount of securities to be sold would be determined by the value of the award and the taxes due on that value. An eligible plan cannot provide the insider with control over the timing of any sales. The exception does not extend to the exercise of options which exercise is in the control of the option holder.
Likewise, the Rules contain an exception to the limitation on single trade plans to one such plan every 12 months, for sell-to-cover transactions.
Since the adoption of the amended 10b5-1 rules, many interpretive questions have arisen related to the sell-to-cover exception.
SEC Guidance
Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) provides 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.”
There has been concern among practitioners that the language of the definition would limit the amount of securities to only the amount required to satisfy statutory minimum tax withholding rates, when some companies allow employees to designate a higher expected effective tax rate as the rate at which their employer will withhold taxes upon the vesting of a compensatory award. Accordingly, last summer, the ABA’s Joint Committee on Employee Benefits submitted a request to the SEC for interpretive guidance.
The Committee proposed the following interpretive question and answer:
Question: Can a contract, instruction, or plan qualify as one providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award,” and thus be an “eligible sell-to-cover transaction” under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3), if it provides for the sale of shares at the rate identified by the employee as the employee’s expected effective tax rate, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules?
Suggested Answer: An “eligible sell-to-cover” transaction under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) means the sale of shares up to the tax rate designated by the employee for withholding, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules.
Although the SEC did not publish the requested C&DI, the staff did have discussions with members of the ABA Committee and agreed with their interpretation of the rule. The SEC was clear that it did not intend to change normal tax planning practices. However, to be clear, the sell-to-cover transaction cannot be used to satisfy taxes relating to income from sources other than the vesting of a compensatory award.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony, Linder & Cacomanolis
A Corporate and Securities Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, 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, Linder & Cacomanolis, 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 ALC 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.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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