A Small Entity Compliance Guide[1]

Introduction

On December 14, 2022, the Securities and Exchange Commission (the “Commission”) adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), which provides affirmative defenses to trading on the basis of material nonpublic information in insider trading cases. The Commission also adopted new disclosure requirements under Regulation S-K and revisions to Rule 16a-3 and Forms 4 and 5. The amendments:

• Add new conditions to the availability of the affirmative defense under Rule 10b5-1(c)(1), including cooling-off periods for directors, officers, and for all other persons other than issuers;
• Create new disclosure requirements regarding an issuer’s insider trading policies and procedures, and the adoption and termination (including modification) of Rule 10b5-1 plans and certain other trading arrangements by directors and officers;
• Create new disclosure requirements about an issuer’s policies and practices on the timing of option awards, as well as about named executive officer equity compensation awards made close in time to the issuer’s disclosure of material nonpublic information;
• Revise Forms 4 and 5 to require filers to identify transactions made pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c); and
• Require filers to disclose dispositions of equity securities by bona fide gifts on Form 4 rather than Form 5, which expedites the reporting of such gifts.

Who is affected by the amendments?

The amendments affect both domestic companies and foreign private issuers that file periodic reports and proxy statements under the Exchange Act, persons who seek to rely on the Rule 10b5-1 affirmative defense, as well as directors, officers, and other persons who are subject to the reporting requirements under Section 16 of the Exchange Act.

What are the changes under the amendments?

Changes to Exchange Act Rule 10b5-1

Rule 10b5-1(c)(1) provides an affirmative defense to Exchange Act Section 10(b) and Rule 10b-5 liability for insider trading in circumstances where the individual purchasing or selling a security (the “trader”) can demonstrate that material nonpublic information did not factor into the trading decision because, before becoming aware of material nonpublic information, the trader entered into a binding contract to purchase or sell the security, provided instructions to another person to execute the trade for the trader’s account, or adopted a written plan for trading the securities.^[2]

The amendments to Rule 10b5-1 add new conditions to the affirmative defense under Rule 10b5-1(c)(1). These new conditions are designed to address concerns about abuse of the rule to opportunistically trade securities on the basis of material nonpublic information in ways that harm investors and undermine the integrity of the securities markets. First, the amendments establish a mandatory cooling-off period before any trading can commence under a Rule 10b5-1 plan by persons other than the issuer of the securities after the adoption of a new or modified plan. Second, the amendments require directors and officers, as a condition to the Rule 10b5-1(c)(1) affirmative defense, to include a representation in a written Rule 10b5-1 plan certifying that at the time of the adoption of a new or modified plan: (1) they are not aware of material nonpublic information about the issuer or its securities; and (2) 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. Third, the amendments restrict the availability of the affirmative defense for multiple overlapping trading arrangements of all persons, other than issuers, involving open market transactions in any class of securities of the issuer. They also limit the availability of the affirmative defense for any “single-trade” Rule 10b5-1 plan of persons, other than issuers, to one single-trade Rule 10b5-1 plan per twelve-month period. Finally, the amendments expand the current “good faith” condition under Rule 10b5-1(c)(1) to require that traders act in good faith with respect to the Rule 10b5-1 plan.

New Regulation S-K Disclosure Requirements

Item 402(x) of Regulation S-K generally requires:

• Narrative disclosure of an issuer’s policies and practices on the timing of awards of options in relation to the disclosure of material nonpublic information by the issuer, including the following:

• how the issuer’s board of directors determines when to grant such awards (for example, whether these awards are granted on a predetermined schedule);
• whether, and if so, how, the board (or the compensation committee) takes material nonpublic information into account when determining the timing and terms of an award; and
• whether the issuer has timed the disclosure of material nonpublic information for the purpose of affecting the value of executive compensation;

• Tabular disclosure regarding any awards of options granted to a named executive officer within a period starting four business days before and ending one business day after the filing of the issuer’s Form 10-Q or Form 10-K, or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information (other than a Form 8-K used to disclose the grant of a new material option award under Item 5.02(e) of Form 8-K); and
• Issuers to tag these disclosures in Inline eXtensive Business Reporting language (“XBRL”).

New Item 408 of Regulation S-K generally requires:

• Quarterly disclosure regarding the adoption and termination (including modification) of Rule 10b5‑1 plans and non-Rule 10b5-1 trading arrangements by officers and directors of the issuer, and a description of the material terms of such plans (other than pricing terms);
• Annual disclosure of whether an issuer has adopted insider trading policies and procedures governing the purchase, sale, and/or other dispositions of the issuer’s securities by directors, officers and employees, or the issuer itself, that are reasonably designed to promote compliance with insider trading laws, rules and regulations, and any listing standards applicable to the issuer and, if the issuer has not adopted such policies and procedures, an explanation why not. If the issuer has adopted insider trading policies and procedures, it must file them as an exhibit to its annual report on Form 10-K;^[3] and
• Issuers to tag these disclosures in XBRL (except for the issuer’s insider trading policies and procedures that are filed as an exhibit).

Changes to Exchange Act Rule 16a-3 and Forms 4 and 5

The amendments to Rule 16a-3 and Forms 4 and 5:

• • Require directors, officers, and other persons who are subject to the reporting requirements under Exchange Act Section 16 to report dispositions of equity securities by bona fide gifts on Form 4 rather than Form 5, which will mean that these gift transactions are reported earlier than previously required; and

• • Add a new checkbox to Forms 4 and 5 that requires a filer of either form to indicate whether a transaction reported on that form was made pursuant to a contract, instruction or written plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c). Filers will also be required to provide the date of adoption of such contract, instruction, or written plan.

Please refer to the adopting release for a complete description of all of the amendments.

What are the compliance dates of the amendments?

The amendments are effective February 27, 2023. Compliance with the amendments to Rules 10b5-1 and 16a-3 will be mandatory on the effective date, but compliance with the other disclosure requirements will be phased-in as follows:

Other Resources

The adopting release for the amendments can be found on the SEC’s website at https://www.sec.gov/rules/final/2022/33-11138.pdf.

The SEC’s disclosure forms are available on the SEC’s website at https://www.sec.gov/forms.

Contacting the Commission

The SEC’s Division of Corporation Finance is happy to assist small companies and others with questions regarding the amendments. You may contact the Division for this purpose at (202) 551-3500 or at https://www.sec.gov/forms/corp_fin_interpretive.

Questions on other SEC regulatory matters concerning small companies may be directed to the Division’s Office of Small Business Policy at (202) 551-3460 or smallbusiness@sec.gov.