December 17, 2021

SEC’s Proposed 10b5-1 Rules: Actions Companies Should Take Now

I blogged yesterday about the SEC’s proposed amendments to the Rule 10b5-1 safe harbor. Orrick’s JT Ho, Carolyn Frantz and Soo Hwang kindly provided this guest post to outline what steps companies should consider taking right now, in light of this proposal:

Earlier this week, the SEC proposed amendments – subject to a 45-day comment period – to add new conditions to the availability of an affirmative defense under Rule 10b5-1 and add new disclosure requirements regarding insider trading policies and procedures of issuers as well as the timing of stock option grants. Many of the proposed amendments, such as a statutory cooling-off period for 10b5-1 plans, were expected and aligned with the recommendations issued by the Investor Advisory Committee in September 2021.

However, the proposed amendments requiring that companies publicly disclose their “insider trading policies and procedures,” as well as the timing of stock option grants to directors and officers, were not as widely expected. We expect that companies will likely wait for the SEC’s final rules before formally modifying their 10b5-1 guidelines, though they would be well advised to brief their treasury departments and individuals using those plans about the potential changes now. Outside of 10b5-1-specific issues, however, we believe there are several steps companies should take now in advance of potential required disclosure, including:

• Reviewing and updating their insider trading policies;

• Creating or reviewing formal written insider trading procedures; and

• Reviewing stock option grant timing practices, or creating stock option grant timing policies.

Potential Updates to Insider Trading Policies

The SEC’s proposed amendments do not precisely specify what types of information about company insider trading policies would need to be disclosed, though indications are that significant detail will be expected. The proposed rule contemplates that companies would provide detailed information to allow investors to assess the sufficiency of insider trading policies and procedures. Elaborating, the SEC explained:

“For example investors may find useful, to the extent it is included in the issuer’s relevant policies and procedures, information on the issuer’s process for analyzing whether directors, officers, employees, or the issuer itself when conducting an open-market share repurchase have material nonpublic information; the issuer’s process for documenting such analyses and approving requests to purchase or sell its securities; or how the issuer enforces compliance with any such policies and procedures it may have. Furthermore, the disclosure under proposed Item 408 could address not only policies and procedures that apply to the purchase and sale of the registrant’s securities, but also other dispositions of the issuer’s securities where material nonpublic information could be misused such as, for example, through gifts of such securities.”

Given the complexity and importance of insider trading policies, we believe companies should begin reviewing their policies before they must be described in SEC filings. Aside from 10b5-1 plan related issues, we note several issues that, in our experience, may need to be updated in company insider trading policies:

• Preclearance procedures – upcoming public and investor scrutiny may result in companies wishing to adopt preclearance procedures, or expand the scope of individuals covered by them, and may also occasion a reevaluation of issues like the length of time after pre-clearance during which a trade may be made.

• Scope of insider trading definitions – Especially in light of the SEC’s recent insider trading complaint against an employee of a biopharmaceutical company for trading in the stock of a competing company about which the employee did not have direct information, many companies are updating their definitions of insider trading.

• Gifts – some insider trading policies do not have clear guidance for whether, and when, gifts are subject to the policy’s restrictions. The SEC’s proposed rule specially calls out gifts as an area for disclosure.

• Definition of material non-public information (“MNPI”) – insider trading policies often include lists of examples of MNPI. Companies have recently been updating these lists to include issues of growing significance, such as cybersecurity and certain sustainability matters.

Formalization of Insider Trading Procedures

In addition to disclosure about insider trading policies themselves, the SEC’s proposed rule contemplates required disclosure about insider trading procedures. Many companies do not today have formal written procedures for insider trading. We anticipate that many companies will wish to adopt such procedures well in advance of any disclosure requirement, to provide an opportunity for multi-stakeholder review and to ensure that the procedures work well in practice before they are revealed publicly. Such procedures could include: a discussion of the availability of the insider trading policy, the type and frequency of training about that policy, the process for determining whether a potential trader possesses MNPI, the process for creating documentation about preclearance and other decisions, the process for creating and enforcing special blackout periods, the process for reporting and investigating potential violations, and principles guiding the consequences for violations.

Stock Option Grant Timing

Under the proposed rules, companies would be required to disclose in a new table any option awards to named executive officers or directors that are made within a certain timeframe within the release of material nonpublic information such as an earnings announcement. Such disclosure will likely lead to even more scrutiny regarding the timing of option grants. Companies should begin considering their practices now, and determine whether to adopt a formal policy regarding the timing of stock option grants, if they do not already have one. Such policies can help address the potential shareholder claims that can arise when stock options are granted during closed windows or just prior to the release of MNPI.