Rule 10b5-1 and Insider Trading

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229, 232, 240, and 249

[Release No. 33-11013; 34-93782; File No. S7-20-21]

RIN 3235-AM86

Rule 10b5-1 and Insider Trading

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is proposing amendments to its rules under the Securities Exchange Act of 1934. The proposed amendments would add new conditions to the availability of an affirmative defense under an Exchange Act rule that 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. The Commission is also proposing new disclosure requirements regarding the insider trading policies of issuers, and the adoption and termination (including modification) of certain trading arrangements by directors, officers, and issuers. In addition, the Commission is proposing amendments to the disclosure requirements for executive and director compensation regarding the timing of equity compensation awards made in close proximity in time to the issuer's disclosure of material nonpublic information. Finally, the Commission is proposing amendments to Forms 4 and 5 to identify transactions made pursuant to certain trading arrangements, and to disclose all gifts of securities on Form 4.

DATES:

Comments should be received on or before April 1, 2022.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use our internet comment form (

https://www.sec.gov/regulatory-actions/how-to-submit-comments

); or

• Send an email to

rule-comments@sec.gov.

Please include File Number S7-20-21 on the subject line.

Paper Comments

• Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-20-21. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method of submission. We will post all comments on our website (

https://www.sec.gov/rules/proposed.shtml

). Comments also are available for website viewing and printing in our Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Operating conditions may limit access to the Commission's public reference room. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available.

We or the staff may add studies, memoranda, or other substantive items to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on our website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Sean Harrison, Special Counsel, or Felicia Kung, Office Chief, Office of Rulemaking, at (202) 551-3430, Division of Corporation Finance, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is proposing amendments to:

Commission reference

CFR citation

(17 CFR)

Regulation S-K [17 CFR 229.10 through 229.1305]:

Item 402

§ 229.402.

Item 408

§ 229.408.

Regulation S-T [17 CFR 232.11 through 232.903]:

Item 405

§ 232.405.

Securities Exchange Act of 1934 (Exchange Act) [15 U.S.C. 78a

et seq.

]:

Rule 10b5-1

§ 240.10b5-1.

Schedule 14A

§ 240.14a-101.

Schedule 14C

§ 240.14c-101.

Rule 16a-3

§ 240.16a-3.

Form 4

§ 249.104.

Form 5

§ 249.105.

Form 20-F

§ 249.220f.

Form 10-Q

§ 249.308a.

Form 10-K

§ 249.310.

Table of Contents

I. Introduction

II. Discussion of the Proposed Amendments

A. Amendments to Rule 10b5-1

1. Cooling-Off Period

2. Director and Officer Certifications

3. Restricting Multiple Overlapping Rule 10b5-1 Trading Arrangements and Single-Trade Arrangements

4. Requiring That Trading Arrangements Be Operated in Good Faith

B. Additional Disclosures Regarding Rule 10b5-1 Trading Arrangements

1. Quarterly Reporting of Rule 10b5-1(c) and Non-Rule 10b5-1(c) Trading Arrangements

2. Disclosure of Insider Trading Policies and Procedures

3. Structured Data Requirements

4. Identification of Rule 10b5-1(c) and Non-Rule 10b5-1(c)(1) Transactions on Forms 4 and 5

C. Disclosure Regarding the Timing of Option Grants and Similar Equity Instruments Shortly Before or After the Release of Material Nonpublic Information

D. Reporting of Gifts on Form 4

III. General Request for Comment

IV. Economic Analysis

A. Broad Economic Considerations

B. Amendments to Rule 10b5-1(c)(1)

1. Baseline and Affected Parties

2. Benefits

3. Costs

4. Effects on Efficiency, Competition, and Capital Formation

5. Reasonable Alternatives

6. Request for Comment

C. Disclosure of Trading Arrangements in New Item 408 of Regulation S-K and Mandatory Rule 10b5-1 Checkbox in Amended Forms 4 and 5

1. Baseline and Affected Parties

2. Benefits

3. Costs

4. Effects on Efficiency, Competition, and Capital Formation

5. Reasonable Alternatives

6. Request for Comment

D. Additional Disclosure of the Timing of Option Grants and Related Company Policies and Practices (Amendments to Item 402 of Regulation S-K)

1. Baseline and Affected Parties

2. Benefits

3. Costs

4. Effects on Efficiency, Competition, and Capital Formation

5. Reasonable Alternatives

6. Request for Comment

E. Additional Disclosure of Insider Gifts of Stock

1. Baseline and Affected Parties

2. Benefits

3. Costs

4. Effects on Efficiency, Competition, and Capital Formation

5. Reasonable Alternatives

6. Request for Comment

V. Paperwork Reduction Act

A. Summary of the Collections of Information

B. Estimates of the Proposed Amendments' Effects on the Collections of Information

C. Incremental and Aggregate Burden and Cost Estimates

VI. Initial Regulatory Flexibility Act Analysis

A. Reasons for, and Objectives of, the Proposed Action

B. Legal Basis

C. Small Entities Subject to the Proposed Rules

D. Reporting, Recordkeeping, and Other Compliance Requirements

E. Duplicative, Overlapping, or Conflicting Federal Rules

F. Significant Alternatives

G. Request for Comments

VII. Small Business Regulatory Enforcement Fairness Act

VIII. Statutory Authority

I. Introduction

Congress enacted the Federal securities laws to promote fair and transparent securities markets, “avoid [ ] frauds,” and “substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.”

1

The securities laws' antifraud provisions that proscribe insider trading play an essential role in maintaining the fairness and integrity of our markets. We have long recognized that insider trading and the fraudulent use of material nonpublic information by corporate insiders

2

not only harm individual investors but also undermine the foundations of our markets by eroding investor confidence.

3

Congress has recognized the harmful impact of insider trading on multiple occasions and has authorized enhanced civil penalties specifically for insider trading.

4

1

Affiliated Ute Citizens of Utah

v.

United States,

406 U.S. 128, 151 (1972); accord

Lorenzo

v.

SEC,

139 S. Ct. 1094, 1103 (2019).

2

The term “corporate insider” as used in this release, refers to officers and directors of an issuer.

3

See In re Cady, Roberts & Co.,

40 SEC. 907, 1961 WL 60638, at *4 n.15 (1961) (“A significant purpose of the Exchange Act was to eliminate the idea that use of inside information for personal advantage was a normal emolument of corporate office.”);

see also United States

v.

O'Hagan,

521 U.S. 642, 658 (1997) (The insider trading prohibition is consistent with the “animating purpose” of the Federal securities laws: “to insure honest securities markets and thereby promote investor confidence.”).

4

See

Insider Trading Sanctions Act of 1984, Public Law 98-376, 98 Stat. 1264; Insider Trading and Securities Fraud Enforcement Act of 1988, Public Law 100-704, 102 Stat. 4677, codified at Section 21A of the Exchange Act, 15 U.S.C. 78u-1. Congress has enacted other laws that build on the insider trading prohibition.

See, e.g.,

Section 20(d) of the Exchange Act [15 U.S.C. 78t(d)]; Section 20A of the Exchange Act [15 U.S.C. 78t-1]; STOCK Act, Public Law 112-105, 126 Stat. 291.

Section 10(b) of the Exchange Act is one of the securities laws' primary antifraud provisions.

5

Section 10(b) makes it unlawful to use or employ, in connection with the purchase or sale of any security, “any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.”

6

The “manipulative or deceptive device[s] or contrivance[s]” prohibited by Section 10(b) and 17 CFR 240.10b-5 (Rule 10b-5) (adopted thereunder) include the purchase or sale of a security of any issuer on the basis of material nonpublic information about that security or its issuer, in breach of a duty owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any person who is the source of the material nonpublic information.

7

5

15 U.S.C. 78j(b).

6

Rule 10b-5, adopted pursuant to Section 10(b), prohibits the use of “any device, scheme, or artifice to defraud”; the making of “any untrue statement of a material fact” or the “omi[ssion]” of “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 “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.”

7

See Salman

v.

United States,

137 S.Ct. 420, 425 n.2 (2016) (an insider who trades in the securities of his corporation on the basis of material nonpublic information “breaches a duty to, and takes advantage of, the shareholders of his corporation”);

O'Hagan,

521 U.S. at 651-53;

Chiarella

v.

United States,

445 U.S. 222, 228-29 (1980);

see also

15 U.S.C. 78u-1(a)(1); 17 CFR 240.10b5-2 (non-exclusive definition of circumstances in which a person has the requisite duty for purposes of the “misappropriation” theory of insider trading). Liability for insider trading under Section 10(b) requires “scienter,”

i.e.,

“an intent on the part of the defendant to deceive, manipulate or defraud.”

Aaron

v.

SEC,

446 U.S. 680, 686 & n.5, 689-95 (1980);

see also Selective Disclosure and Insider Trading,

Release No. 33-7881 (Aug. 15, 2000) [65 FR 51716 at 51727 (Aug. 24, 2000)] (“2000 Adopting Release”).

The Commission adopted Rule 10b5-1 in August 2000 to provide more clarity on the meaning of “manipulative or deceptive device[s] or contrivance[s]” prohibited by Exchange Act Section 10(b) and Rule 10b-5 with respect to trading on the basis of material nonpublic information.

8

At the time, Federal appellate courts diverged on the issue of what, if any, connection must be shown between a trader's possession of material nonpublic information and his or her trading to establish liability under Rule 10b-5. Rule 10b5-1 addressed this issue by providing that a purchase or sale of an issuer's security is on the basis of material nonpublic information about that security or issuer for purposes of Section 10(b) if the person making the purchase or sale

was aware of

material nonpublic information when the person made the purchase or sale.

9

In addition, Rule 10b5-1(c) established an affirmative defense to Rule 10b-5 liability for insider trading in circumstances where it is apparent that the trading was not made on the basis of material nonpublic information because the trade was pursuant to a binding contract, an instruction to another person to execute the trade for the instructing person's account, or a written plan (collectively or individually a “trading arrangement”) adopted when the trader was not aware of material nonpublic information.

10

Rule 10b5-1 also provides a separate affirmative defense

designed solely for non-natural persons that trade.

11

8

See

2000 Adopting Release

supra

note 7.

9

A person is aware of material nonpublic information if they know, consciously avoid knowing, or are reckless in not knowing that the information is material and nonpublic.

See SEC

v.

Obus,

693 F.3d 276, 286-88, 293 (2d Cir. 2012);

United States

v.

Gansma

n, 657 F.3d 85, 91 n.7, 94 (2d Cir. 2011). Rule 10b5-1 and its awareness standard is “entitled to deference.”

United States

v.

Royer,

549 F.3d 886, 899 (2d Cir. 2008) (applying

Chevron U.S.A., Inc.

v.

Natural Res. Def. Council, Inc.,

467 U.S. 837, 843-44 (1984)),

cert. denied,

558 U.S. 934, and 558 U.S. 935 (2009);

see also United States

v.

Rajaratnam,

719 F.3d 139, 157-61 (2d Cir. 2013),

cert. denied,

134 S. Ct. 2820 (2014). The decision in

Fried

v.

Stiefel Labs., Inc.,

814 F.3d 1288, 1295 (11th Cir. 2016), erroneously suggests that a person must “use” the inside information to purchase or sell securities, but the court did not address Rule 10b5-1 in that private action. The proposed rule would not alter the “awareness” standard.

10

Rule 10b5-1 does not modify or address any other aspect of insider trading law. Nor does Rule 10b5-1 provide an affirmative defense for other securities fraud claims, such as a claim under Rule 10b-5 for an “untrue statement of a material fact.” 17 CFR 240.10b-5(b).

11

See

Rule 10b5-1(c)(2) [17 CFR 240.10b5-1(c)(2)]. This affirmative defense is available to entities that demonstrate that the individual making the investment decision on behalf of the entity was not aware of material nonpublic information; and the entity had implemented reasonable policies and procedures to prevent insider trading.

Since the adoption of Rule 10b5-1, courts,

12

commentators

13

and members of Congress

14

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.

15

Practices that have raised concern include corporate insiders using multiple overlapping plans to selectively cancel individual trades on the basis of material nonpublic information, or commencing trades soon after the adoption of a new plan or the modification of an existing plan.

16

In addition, concerns have been raised about issuers abusing Rule 10b5-1(c)(1) plans to conduct share repurchases to boost the price of the issuer's stock before sales by corporate insiders.

17

Recently, the Commission's Investor Advisory Committee (“IAC”)

18

recommended that we consider revising Rule 10b5-1 to address apparent loopholes in the rule that allow corporate insiders to unfairly exploit informational asymmetries.

19

12

District courts in private securities law actions have “acknowledge[d] the possibility that a clever insider might `maximize' their gain from knowledge of an impending [stock] price drop over an extended amount of time, and seek to disguise their conduct with a 10b5-1 plan.”

In re Immucor Inc. Sec. Litig.,

2006 WL 3000133, at *18 n.8 (N.D. Ga. Oct. 4, 2006);

accord Nguyen

v.

New Link Genetics Corp.,

297 F. Supp. 3d 472, 494-96 (S.D.N.Y. 2018);

Freudenberg

v.

E*Trade Fin. Corp.,

712 F. Supp. 2d 171, 200 (S.D.N.Y. 2010);

Malin

v.

XL Cap. Ltd.,

499 F. Supp. 2d 117, 156 (D. Conn. 2007),

aff'd,

312 F. App'x 400 (2d Cir. 2009).

13

In December 2020, the Commission proposed to amend Forms 4 and 5 to add a checkbox to permit filers to indicate that the reported transaction satisfied Rule 10b5-1.

See Rule 144 Holding Period and Form 144 Filings,

Release No. 33-10991 (Dec. 22, 2020) [85 FR 79936]. The Commission received several comment letters in response expressing concern about potential abuse of Rule 10b5-1.

See, e.g.,

letter from David Larcker et al. (dated Mar. 10, 2021) at

https://www.sec.gov/comments/s7-24-20/s72420-8488827-229970.pdf;

letter from Council of Institutional Investors (“CII”) (dated Apr. 22, 2021) at

https://www.sec.gov/comments/s7-14-20/s71420-8709408-236962.pdf;

letter from CII (dated Mar. 18, 2021) at

https://www.sec.gov/comments/s7-24-20/s72420-8519687-230183.pdf.

In response to the publication of its semiannual regulatory agenda, the Commission also received a letter requesting that a rulemaking project be initiated to address potential abuses of Rule 10b5-1. See letter from CII (dated Dec. 13, 2018) at

https://www.sec.gov/comments/s7-20-18/s72018-4766666-176839.pdf.

14

See

letter from Senator Elizabeth Warren et al. (Feb. 10, 2021) at

https://www.warren.senate.gov/imo/media/doc/02.10.2021%20Letter%20from%20Senators%20Warren,%20Brown,%20and%20Van%20Hollen%20to%20Acting%20Chair%20Lee.pdf.

15

See, e.g.,

Alan D. Jagolinzer,

SEC Rule 10b5-1 and Insiders' Strategic Trade,

55 Mgmt. Sci. 224 (2009); M. Todd Henderson et al.,

Hiding in Plain Sight: Can Disclosure Enhance Insiders' Trade Returns,

103 Geo. L.J. 1275 (2015); Taylan Mavruk et al.,

Do SEC's 10b5-1 Safe Harbor Rules Need to be Rewritten?,

2016 Colum. Bus. L. Rev., 133 (2016); Artur Hugon and Yen-Jung Lee,

SEC Rule 10b5-1 Plans and Strategic Trade around Earnings Announcements

(2016) at

https://ssrn.com/abstract=2880878

or

http://dx.doi.org/10.2139/ssrn.2880878.

16

See,

e.g.,

John P. Anderson, Anticipating a Sea Change for Insider Trading Law: From Trading Plan Crisis to Rational Reform, 2015 Utah L. Rev. 339 (2015).; David F. Larcker et al., Gaming the System: Three “Red Flags” of Potential 10b5-1 Abuse, Stanford Closer Look Series (Jan. 19, 2021) (“Gaming the System”) (noting from their analysis of a sample of sales transactions made pursuant to Rule 10b5-1 plans between January 2016 and May 2020 that trades occurring within 30 days of adoption of a Rule 10b5-1 plan are approximately 50 percent larger than trades made six or more months later); see also infra note 112 and accompanying text.

17

See

Jesse M. Fried, Testimony before the Investor Protection, Entrepreneurship, and Capital Markets Subcommittee, U.S. House Committee on Financial Services, (Oct. 17, 2019) at

https://ssrn.com/abstract=3474175

(“Fried Testimony”).

18

The IAC was established in April 2012 pursuant to Section 911 of the Dodd-Frank Wall Street Reform and Consumer Protection Act [Pub. L. 111-203, sec. 911, 124 Stat. 1376, 1822 (2010)] to advise and make recommendations to the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace.

19

See

Recommendations of the Investor Advisory Committee Regarding Rule 10b5-1 Plans (Sept. 9, 2021) (“IAC Recommendations”), at

https://www.sec.gov/spotlight/investor-advisory-committee-2012/20210916-10b5-1-recommendation.pdf.

The IAC also held a panel discussion regarding Rule 10b5-1 plans at its June 10, 2021 meeting, at

https://www.sec.gov/video/webcast-archive-player.shtml?document_id=iac061021-2.

We share the concern about the prevalence of trading practices by corporate insiders and issuers that suggest the misuse of material nonpublic information. We also understand that some issuers have engaged in a practice of granting stock options and other equity awards with option-like features to executive officers and directors in coordination with the release of material nonpublic information.

20

In addition, there is research indicating that some corporate insiders may be opportunistically timing gifts of securities while aware of material nonpublic information relating to such securities.

21

These practices can undermine the public's confidence and expectations of honest and fair capital markets by creating the appearance that some insiders, by virtue of their positions, do not play by the same rules as everyone else.

20

See,

e.g.,

William Hughes, Stock Option Spring-loading: An Examination of Loaded Justifications and New SEC Disclosure Rules, 33 J. Corp. L. 777 (2008);

Howland

v.

Kumar

, 2019 Del. Ch. LEXIS 221.

21

See, e.g.,

S. Burcu Avci et al., Manipulative Games of Gifts by Corporate Executives, 18 U. Pa. J. Bus. L. 1131 (2016); David Yermack,

Deductio ad absurdum: CEOs donating their own stock to their family foundations,

94 J. Fin. Econ. 107 (2009); S. Burcu Avci et al.,

Insider Giving,

71 Duke L.J. (Forthcoming 2021) electronic copy available at:

https://ssrn.com/abstract=3795537.

We note that similar concerns about misuse of material nonpublic information have been raised in connection with an issuer's stock repurchases. In a separate release, we are proposing amendments to update the disclosure requirements for purchases of equity securities by an issuer and affiliated purchasers under 17 CFR 229.703 (Item 703 of Regulation S-K).

22

22

See Share Repurchase Disclosure Modernization,

Release No. 34-93783 (Dec. 15, 2021). Item 703 of Regulation S-K requires disclosure about a registrant's or affiliated purchaser's purchases of any class of the registrant's equity securities that are registered under Exchange Act Section 12. Many registrants use Rule 10b5-1 trading arrangements in their repurchase programs.

In this release, we are proposing several rule and form amendments to address potentially abusive practices associated with Rule 10b5-1 trading arrangements, grants of options and other equity instruments with similar features and the gifting of securities. Specifically, our proposals would:

• Require a Rule 10b5-1 trading arrangement entered into by officers or directors to include a 120-day mandatory cooling-off period before any trading can commence under the trading arrangement after its adoption (including adoption of a modified trading arrangement);

23

23

A modification of a Rule 10b5-1(c) trading arrangement, including cancelling a trade, is equivalent to terminating the prior trading arrangement and adopting a new Rule 10b5-1 trading arrangement.

• Require a Rule 10b5-1 trading arrangement entered into by issuers to include a 30-day mandatory cooling-off period before any trading can commence under the trading arrangement after its adoption (including adoption of a modified trading arrangement);

• Require officers and directors to personally certify that they are not aware of material nonpublic information about the issuer or the security when

they adopt a Rule 10b5-1 trading arrangement;

• Enhance existing corporate disclosures and require new quarterly disclosure regarding the adoption and termination of Rule 10b5-1 trading arrangements and other trading arrangements of directors, officers, and issuers, and the terms of such trading arrangements, and require that the disclosure be reported using a structured data language (specifically, Inline eXtensible Business Reporting Language (“Inline XBRL”));

• Provide that the affirmative defense under Rule 10b5-1(c)(1) does not apply to multiple overlapping Rule 10b5-1 trading arrangements for open market trades in the same class of securities;

• Limit the availability of the affirmative defense under Rule 10b5-1(c)(1) for a single-trade plan to one single-trade plan during any consecutive 12-month period;

• Require an issuer to disclose in its Form 10-K or Form 20-F whether or not (and if not, why not) the issuer has adopted insider trading policies and procedures that govern the purchase, sale, or other disposition of the registrant's securities by directors, officers, and employees that are reasonably designed to promote compliance with insider trading laws, rules, and regulations. If the issuer has adopted such policies and procedures, the issuer would be required to disclose such policies. Such disclosures would be subject to the principal executive and principal financial officer certifications required by Section 302 of the Sarbanes-Oxley Act,

24

and required to be tagged using Inline XBRL;

24

15 U.S.C. 7241.

See infra

notes 52 and 53 and accompanying text.

• Require new disclosure regarding grants of equity compensation awards such as stock options and stock appreciation rights (“SARs”) close in time to the issuer's disclosure of material nonpublic information (including earnings releases and other major announcements) and require that the disclosure be reported using Inline XBRL; and

• Require prompt disclosure of dispositions by gifts of securities by insiders on Form 4 within two business days after such a gift is made.

We welcome feedback and encourage interested parties to submit comments on any or all aspects of the proposed amendments. When commenting, it would be most helpful if you include the reasoning behind your position or recommendation.

II. Discussion of the Proposed Amendments

A. Amendments to Rule 10b5-1

25

25

In addition to the proposed revisions to Rule 10b5-1 discussed in this release, due to current

Federal Register

formatting requirements, we are also proposing a technical change that, as indicated, incorporates the Preliminary Note to Rule 10b5-1 into the body of the rule.

As noted above, Rule 10b5-1(c)(1) established an affirmative defense to Rule 10b-5 liability if the trade was made pursuant to a binding contract, an instruction to another person to execute the trade for the instructing person's account, or a written plan. A person asserting a Rule 10b5-1(c)(1) defense must satisfy several conditions. First, the person must demonstrate that, before becoming aware of material nonpublic information, they had entered into a binding contract to purchase or sell the security, provided instructions to another person to execute the trade for the instructing person's account, or adopted a written plan for trading the securities.

26

Second, the person must demonstrate that the applicable contract, instructions, or plan:

26

See, e.g., SEC

v.

Mozilo,

2010 WL 3656068, at *20 (C.D. Cal. Sept. 16, 2010) (“Although [officer's/director's] stock sales were made pursuant to Rule 10b5-1 trading plans, the SEC has raised genuine issues of material fact that [he] was aware of material, nonpublic information at the time he adopted or amended these trading plans.”).

• Specified the amount of securities to be purchased or sold, price, and date;

• Provided a written formula or algorithm, or computer program, for determining amounts, prices, and dates; or

• 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 exercised such influence was not aware of the material nonpublic information when doing so.

Third, the person must demonstrate that the purchase or sale was pursuant to the prior contract, instruction, or plan. Rule 10b5-1(c)(1) states that a purchase or sale is not pursuant to a contract, instruction, or plan if, among other things, the person who entered into the arrangement altered or deviated from the contract, instruction, or plan, or entered into or altered a corresponding or hedging transaction or position with respect to the securities.

27

Finally, the rule provides that the affirmative defense of a trading arrangement is only available if the trading arrangement was entered into “in good faith and not as part of a plan or scheme to evade the prohibitions” of the rule.

28

27

Rule 10b5-1(c)(1)(i)(C).

28

Rule 10b5-1(c)(1)(ii).

Since the adoption of Rule 10b5-1, the use of trading arrangements under Rule 10b5-1(c)(1) has become widespread.

29

Over the years concerns have arisen that the design of Rule 10b5-1(c)(1) has enabled corporate insiders to trade on material nonpublic information. Examples of potentially abusive practices include the use of multiple overlapping plans with selective cancellation of certain plans or trades on the basis of material nonpublic information, as well as initiation or resumption of trading close in time to plan adoption or modification. Furthermore, multiple studies examining Rule 10b5-1(c)(1) trading arrangements have identified potentially abusive activity where trades occur soon after the adoption of the arrangement (

e.g.,

commencing trades within the same fiscal quarter as the adoption of the arrangement), and trading arrangements that are terminated shortly after adoption.

30

The amendments that we are proposing to Rule 10b5-1(c)(1) are intended to reduce these potentially abusive practices associated with Rule 10b5-1(c)(1) trading arrangements.

29

According to one survey, directors and executives at more than half of S&P 500 companies used Rule 10b5-1 trading arrangements in 2015.

See

Morgan Stanley, “Defining the Fine Line: Mitigating Risk with 10b5-1 Plans” (2018) at

https://advisor.morganstanley.com/austin.cornish/documents/field/a/au/austin-cornish/Mitigating%20Risk%20with%2010b5-1%20Plans.pdf. See also

Bonaimé et al.,

Payout Policy Trade-Offs, infra

note 159 and accompanying text;

Skadden Insights: Share Repurchases

4-6 (Mar. 16, 2020) (discussing the use of Rule 10b5-1 plans for issuer share repurchases) at

https://www.skadden.com/insights/publications/2020/03/share-repurchases.

30

See, e.g.,

Alan D. Jagolinzer,

SEC Rule 10b5-1 and Insiders' Strategic Trade,

Mgmt. Sci. 224 (2009); Gaming the System

supra

note 16 (noting that Rule 10b5-1 plans with a short cooling-off period, or adopted in a given quarter that begin trading before that quarter's earnings announcement systematically avoid losses and foreshadow considerable stock declines over the subsequent six months); and Taylan Mavruk et al.,

Do SEC's 10b5-1 Safe Harbor Rules Need to be Rewritten?, Colum. Bus. L. Rev.,

133, 165 (2016) (observing from their study that the first trade pursuant to a Rule 10b5-1 plan showed abnormal profitability and suggesting that insiders set up Rule 10b5-1 plans when in possession of material nonpublic information).

See also

discussion at

infra

Section IV.A.

1. Cooling-Off Period

Currently, Rule 10b5-1(c)(1) does not impose any waiting period between the date the trading arrangement is adopted and the date of the first transaction to be executed under the trading arrangement. Under the current rule, a trader can adopt a Rule 10b5-1(c)(1)

trading arrangement and execute a trade under the arrangement on the same day. Investors and other commentators have suggested that requiring a minimum waiting period of several months between the adoption of a trading arrangement and the date on which trading can commence would reduce the risk that an insider could benefit from any material nonpublic information of which they may have been aware at the time of adopting the trading arrangement.

31

We propose to amend Rule 10b5-1(c)(1) to add as a condition to the availability of the affirmative defense (1) a minimum 120-day cooling-off period after the date of adoption of any Rule 10b5-1(c)(1) trading arrangement (including adoption of a modified trading arrangement) by a director or officer (as defined in 17 CFR 240.16a-1(f) (Rule 16a-1(f))) before any purchases or sales under the new or modified trading arrangement; and (2) a minimum 30-day cooling-off period after the date of adoption of any Rule 10b5-1(c)(1) trading arrangement by an issuer before any purchases or sales under the new or modified trading arrangement. Under the proposed amendments, for directors and officers subject to Exchange Act Section 16 reporting, and for issuers, the Rule 10b5-1(c)(1) affirmative defense would only be available for a trading arrangement that includes a cooling-off period that delays transactions under the trading arrangement for at least 120 or 30 days (whichever is applicable) after the date of adoption of any new/modified trading arrangement. The proposed amendments also include a note that clarifies that a “modification” of an existing Rule 10b5-1(c)(1) trading arrangement, including cancelling one or more trades, would be deemed equivalent to terminating the plan in its entirety, and the cooling-off period would therefore apply after a “modification” before any new trades could commence.

32

31

See

Rulemaking petition regarding Rule 10b5-1 Trading Plans, File No. 4-658 (Jan. 2, 2013) (“CII Rulemaking Petition”) at

https://www.sec.gov/rules/petitions/2013/petn4-658.pdf;

Alan D. Jagolinzer, David F. Larcker, and Daniel J. Taylor, “How the SEC can and should fix insider trading rules” the Hill (Dec. 17, 2020) at

https://thehill.com/opinion/finance/530668-how-the-sec-can-and-should-fix-insider-trading-rules;

IAC Recommendations,

supra

note 19.

32

See

proposed note to Rule 10b5-1(c); and 2000 Adopting Release,

supra

note 8, at 51718, n 111.

We are proposing these cooling off periods to address concerns that traders are able to misuse the rule to set up trading arrangements that use material nonpublic information about an issuer prior to the disclosure of such information. In particular, evidence suggests that Rule 10b5-1(c)(1) trading arrangements that commence trades prior to an earnings announcement are more likely to result in abnormal returns.

33

In the case of officers and directors, a 120-day cooling off period would span an entire quarter, meaning that no trading could occur under a Rule 10b5-1(c)(1) plan adopted during a particular quarter until after that quarter's financial results are announced. The length of the proposed cooling-off period would deter insiders from seeking to capitalize on unreleased material nonpublic information for the upcoming quarter. In addition, a 120-day cooling off period and the 30-day cooling off period for issuers between adoption or modification of a Rule 10b5-1(c)(1) trading arrangement and transactions made under the arrangement align with recommendations from a wide range of commentators about the appropriate length of time for such a cooling off period.

34

We anticipate that, if adopted, the proposed cooling-off periods would deter officers, directors, and issuers from adopting or modifying their Rule 10b5-1 plans on the basis of material nonpublic information.

33

See

the discussion at

infra

Section IV.B.1.

34

See

IAC Recommendations,

supra

note 19 (recommending a cooling off period of four months); Gaming the System,

supra

note 16, at 3 (recommending a cooling off period of four to six months); SEC Targets 10b5-1 Plans,

supra

note 16 (recommendation from a law firm for a cooling off period of one fiscal quarter); letter from Senator Elizabeth Warren et al.,

supra

note 14 (recommending a cooling off period of four to six months); Robert H. Friedman et al,

Navigating Public Company Equity Buybacks,

Insights: Corporate and Securities Law Advisor, (December 2011) (recommending a 30 day waiting period for issuers after a Rule 10b5-1(c)(1) plan's adoption or modification).

The proposed cooling-off periods would apply to directors and officers (as defined in Rule 16a-1(f)) of the issuer,

35

as well as to an issuer that structures a share repurchase plan as a Rule 10b5-1(c)(1)(i) trading arrangement. This requirement would prevent directors, officers, and issuers who might be aware of material nonpublic information from adopting or modifying a Rule 10b5-1 trading arrangement and trading immediately pursuant to the arrangement. The proposed cooling off period should also discourage registrants, directors, and officers from selectively terminating or cancelling a planned trade under a Rule 10b5-1 trading arrangement because they would be subject to a cooling-off period with respect to the adoption of any new/modified plan.

35

Exchange Act Rule 16a-1(f) [17 CFR 240.16a-1(f)] provides that the “officer” is an issuer's president, principal financial officer, or principal accounting officer (or, if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer. Officers of the issuer's parent(s) or subsidiaries shall be deemed officers of the issuer if they perform such policy-making functions for the issuer.

Applying a cooling-off period to directors and “officers” as that term is defined in Exchange Act Rule 16a-1(f)

36

is appropriate because such individuals are more likely than others to be aware of material nonpublic information in the general course of events, and also more likely to be involved in making or overseeing key corporate decisions that have the potential to affect the issuer's stock price, including decisions about the timing of the disclosure of such information.

37

In addition, applying a cooling-off period to issuers addresses the concern that issuers may conduct stock buybacks while aware of material nonpublic information. For example, executives of an issuer who are aware of materially positive but undisclosed developments can cause the issuer to buy its stock from current shareholders who are unaware of those developments. Once the development is publicly disclosed, the issuer's share price may increase. Further, once the issuer repurchase program is announced, executives who initiated the buyback can economically benefit because it may allow them to sell shares at prices strategically inflated by the company buyback, in addition to the disclosed developments.

38

A cooling off period for issuers would reduce the likelihood of such scenarios and promote investor confidence.

36

This would include anyone who performs a policy-making function for the issuer.

Id.

37

See O'Hagan,

521, U.S. at 651-52;

Chiarella,

445 U.S. at 227;

Steginsky

v.

Xcelera Inc.,

741 F.3d 365, 370 n.5 (2d Cir. 2014).

See also, Colby

v.

Klune,

178 F.2d 872 (2d Cir. 1949).

38

See

Fried Testimony

supra

note 17.

Request for Comment

1. Is the proposed cooling-off period an appropriate condition to the Rule 10b5-1(c)(1) affirmative defense for contracts, instructions and written plans? Would a cooling-off period effectively reduce the potential to abuse the rule, such as from selective termination of trades?

2. Should the application of a cooling-off period be limited to directors, officers (as defined in Rule 16a-1(f)) and issuers, as proposed? Should the proposed cooling-off period instead apply to all traders who rely on the Rule 10b5-1(c)(1) affirmative defense?

3. Is the Rule 16a-1(f) definition the appropriate definition of “officer” for purposes of the proposed amendment? Are there other corporate insiders or employees who also should be subject to the cooling-off period?

4. Is the proposed 120-day cooling-off period appropriate for directors and officers? Should we require a shorter or longer cooling-off period? For example, should we require a cooling-off period of sixty days after the adoption of a new/modified trading arrangement or a cooling-off period of 180 days?

5. Is the proposed 30-day cooling off period appropriate for issuers? Would a different period be more appropriate? For example, would a 60-day, 90-day, or 180-day cooling off period be more appropriate for issuers relying on the 10b5-1(c)(1) affirmative defense? If issuers were subject to the proposed requirements, how would their use of Rule 10b5-1(c)(1) trading arrangements to conduct share repurchases be affected? Would the proposed cooling-off period affect existing practices regarding when a repurchase window is “open” or “closed”?

6. Should we define “modify” or “a modification” for purposes of Rule 10b5-1(c)? If so, how should we define these terms?

7. Should there be an exception from the cooling-off period for

de minimis

changes to a Rule 10b5-1(c) trading arrangement? If so, what should be the parameters of such an exception?

2. Director and Officer Certifications

We also are proposing to amend Rule 10b5-1(c)(1)(ii) to impose a certification requirement as a condition to the affirmative defense. Under the proposed amendment, if a director or officer (as defined in Rule 16a-1(f)) of the issuer of the securities adopts a Rule 10b5-1 trading arrangement, as a condition to the availability of the affirmative defense, such director or officer would be required to promptly furnish to the issuer a written certification, described below, at the time of the adoption of a new/modified trading arrangement.

39

39

The proposed amendment would not require these personal certifications where a director or officer terminates an existing Rule 10b5-1 trading arrangement and does not adopt a new/modified trading arrangement for which the affirmative defense is sought. However, proposed Item 408 of Regulation S-K would require registrants to disclose whether any director or officer has terminated a Rule 10b5-1 trading arrangement (or any similar trading arrangement).

See infra

Section II.B.1. An issuer's insider trading policies and procedures may otherwise govern such plan terminations.

See infra

at Section II.B.2. Finally, whether an inference can be drawn that an individual unlawfully traded on the basis of inside information may be informed by the manner in which they trade (

see, e.g., SEC

v.

Warde,

151 F.3d, 42, 47 (2d Cir. 1998), including where termination of a Rule 10b5-1 trading arrangement is soon followed by non-Rule 10b5-1 trades in the same security or issuer.

The certification would require a director or officer to certify at the time of the adoption of the trading arrangement:

• That they are not aware of material nonpublic information about the issuer or its securities; and

• That they are adopting the contract, instruction, or plan in good faith and not as part of a plan or scheme to evade the prohibitions of Exchange Act Section 10(b) and Exchange Act Rule 10b-5.

For purposes of the proposed amendment, the term “officer” would have the same meaning as the definition for “officer” contained in Exchange Act Rule 16a-1(f). The definition in Exchange Act Rule 16a-1(f) is appropriate for the reasons discussed above with respect to the cooling-off period,

i.e.,

these individuals are more likely to be aware of material nonpublic information regarding the issuer and its securities, as well as more likely to be involved in making or overseeing corporate decisions about whether and when to disclose information.

The proposed certification requirement is intended to reinforce directors' and officers' cognizance of their obligation not to trade or adopt a trading plan while aware of material nonpublic information, that it is their responsibility to determine whether they are aware of material non-public information when adopting Rule 10b5-1 plans, and that the affirmative defense under Rule 10b5-1 requires them to act in good faith and not to adopt such plans as part of a plan or scheme to evade the insider trading laws.

We recognize that this certification involves important considerations, especially because directors and officers are often aware of material nonpublic information. Subject to their confidentiality obligations, directors and officers can consult with experts to determine whether they can make this representation truthfully. Legal counsel can assist directors and officers in understanding the meaning of the terms “material” and “nonpublic information.”

40

However, the issue of whether a director or officer has material nonpublic information is an inherently fact-specific analysis. Thus, a director or officer's completion of this certification would reflect their personal determination that they do not have material nonpublic information.

40

As we have said previously, we rely on existing definitions of the terms “material” and “nonpublic” established in the case law. Information is material if “there is a substantial likelihood” that its disclosure “would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available.”

see Basic

v.

Levinson,

485 U.S. 224, 231 (1988) (materiality with respect to contingent or speculative events will depend on a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of company activity);

see also TSC Industries, Inc.

v.

Northway, Inc.,

426 U.S. 438, 449 (1976); Securities Act Rule 405 [17 CFR 230.405]; 17 CFR 240.12b-2 [Exchange Act Rule 12b-2] Information is nonpublic until the information is broadly disseminated in a manner sufficient to ensure its availability to the investing public generally, without favoring any special person or group.

See Dirks

v.

SEC,

463 U.S. 646, 653-54 & n.12 (1983);

Texas Gulf Sulphur,

401 F.2d 833, 854 (2d Cir. 1968),

cert. denied,

394 U.S. 976 (1969); 17 CFR 243.101(e) [Regulation FD]. For purposes of insider trading law, insiders must wait a “reasonable” time after disclosure before trading. What constitutes a reasonable time depends on the circumstances of the dissemination.

In re Faberge, Inc.,

45 SEC. 249, 255 (1973),

citing Texas Gulf Sulphur,

401 F.2d at 854. Under the misappropriation doctrine, a recipient of inside information must make a “full disclosure” to the sources of the information that they plan to trade on or tip the information within a reasonable time before doing so.

O'Hagan,

521 U.S. at 655, 659 n.9;

see also SEC

v.

Rocklage,

470 F.3d 1, 11-12 (1st Cir. 2006).

The proposed amendment also includes an instruction that a director or officer seeking to rely on the affirmative defense should retain a copy of the certification for a period of ten years.

41

The proposed amendments would not require a director, officer, or the issuer to file the certification with the Commission. The proposed certification would not be an independent basis of liability for directors or officers under Exchange Act Section 10(b) and Rule 10b-5. Rather the proposed certification would underscore the certifiers' awareness of their legal obligations under the Federal securities law related to the trading in the issuer's securities.

42

41

See

Proposed instruction to Rule 10b5-1(c)(1)(ii)(C). We have included a ten-year retention period in consideration of the statutes of limitations that govern the Commission's ability to seek certain remedies for insider trading claims.

See

Exchange Act Section 21(d)(8) [15 U.S.C. 78u(d)(8)] (ten years for injunctions and disgorgement of fraud proceeds).

42

See, e.g., O'Hagan,

521, U.S. at 651-52;

Chiarella,

445 U.S. at 227;

Steginsky

v.

Xcelera Inc.,

741 F.3d 365, 370 n.5 (2d Cir. 2014).

Request for Comment

8. Is the proposed certification requirement an appropriate condition to the availability of the Rule 10b5-1(c)(1)(ii) affirmative defense for directors and officers? Are there other ways that an officer or director could demonstrate that they do not possess material nonpublic information when adopting a trading arrangement?

9. Is the proposed language of the certification appropriate? If not, what alternative formulation, would be more

appropriate? Should the certification contain different or additional conditions?

10. Should the proposed certification requirement also apply to individuals who are not “officers” under Exchange Rule 16a-1(f)?

11. The proposed instruction provides guidance that a director or officer should retain the certification for ten years consistent with the ten-year statutes of limitations that govern the Commission's insider trading actions. Should we instead require the issuer to retain the certification, either instead of or in addition to the director or officer? If so, how long should the issuer be required to retain the certification? Should we allow the individuals and issuers to develop their own retention policies for the certification?

12. Should we specifically provide in the proposed amendments to Rule 10b5-1(c)(1)(ii) that the certification does not establish an independent basis of liability for directors or officers under Exchange Act Section 10(b) and Rule 10b-5?

3. Restricting Multiple Overlapping Rule 10b5-1 Trading Arrangements and Single-Trade Arrangements

Currently, Rule 10b5-1(c)(1)(i)(C) provides that a person will not be entitled to the affirmative defense for a trade if they enter into or alter a “corresponding or hedging transaction or position” with respect to the planned transactions. In the Rule 10b5-1 proposing release, the Commission explained that this requirement was designed to prevent persons from devising schemes to exploit inside information by setting up pre-existing hedged trading programs, and then canceling execution of the unfavorable side of the hedge, while permitting execution of the favorable transaction.

43

The use of multiple trading arrangements can be used to simulate this kind of impermissible hedging.

43

See Selective Disclosure and Insider Trading,

Release No. 33-7787 (Dec. 20, 1999) [64 FR 72590 (Dec. 28, 1999)].

As discussed above, currently, a person can adopt and employ multiple overlapping Rule 10b5-1(c)(1) trading arrangements and exploit inside information by setting up trades timed to occur around dates on which they expect the issuer will likely release material nonpublic information. We are also concerned that a person could circumvent the proposed cooling-off period by setting up multiple overlapping Rule 10b5-1(c)(1) trading arrangements, and deciding later which trades to execute and which to cancel after they become aware of material nonpublic information but before it is publicly released. We are proposing to amend Rule 10b5-1(c)(1) to eliminate the affirmative defense for any trades by a trader who has established multiple overlapping trading arrangements for open market purchases or sales of the same class of securities. Under the proposed amendment, the affirmative defense would not be available for trades under a trading arrangement when the trader maintains another trading arrangement, or subsequently enters into an additional overlapping trading arrangement, for open market purchases or sales of the same class of securities. The proposed restriction with respect to multiple overlapping Rule 10b5-1(c)(1) trading arrangements is designed to eliminate the ability of traders to use multiple plans to strategically execute trades based on material nonpublic information and still claim the protection of an affirmative defense for such trades.

The proposed amendment would not apply to transactions where a person acquires (or sells) securities directly from the issuer, such as acquiring shares through participation in employee stock ownership plans (“ESOPs”) or dividend reinvestment plans (“DRIPs”), which are not executed by the director or officer on the open market. Participation in these programs is sometimes effected through Rule 10b5-1(c)(1) trading arrangements, and because the transactions are directly with the issuer, they are less likely to give rise to insider trading.

44

This provision is intended to preserve the benefits of flexibility for plan participants with respect to such plans.

44

However, “fiduciaries” of employee stock ownership plans should consider the extent to which “refraining on the basis of inside information from making a planned trade . . . could conflict with the complex insider trading . . . requirement imposed by the federal securities laws or with the objectives of those laws.”

See Fifth Third Bancorp

v.

Dudenhoeffer,

573 U.S. 409, 429 (2014). Officers and directors also need to follow Regulation Blackout Trading Restrictions, 17 CFR 245.100-245.104.

In addition to restricting the use of multiple overlapping trading arrangements, we are also proposing to amend Rule 10b5-1(c)(1)(ii) to limit the availability of the affirmative defense for a trading arrangement designed to cover a single trade, so that the affirmative defense would only be available for one single-trade plan during any 12-month period. Under the proposed amendment, the affirmative defense would not be available for a single-trade plan if the trader had, within a 12-month period, purchased or sold securities pursuant to another single-trade plan. Recent research indicates that single-trade plans are consistently loss avoiding and often precede stock price declines.

45

This research suggests that insiders using single-trade plans may be executing trades based on material nonpublic information. At the same time, we recognize the legitimate use of single-trade plans to address one-time liquidity needs. The proposed limitation on single-trade plans is intended to balance this legitimate use against potential for abuse.

45

See

Gaming the System,

supra

note 16.

See also infra

Section IV.B.

Request for Comment

13. Are there legitimate uses of multiple, overlapping Rule 10b5-1 trade arrangements? If so, what are they? Is it appropriate to exclude from the affirmative defense multiple concurrent trading arrangements for open market purchases or sales of the same class of securities as proposed? Would the proposal create incentives for corporate insiders to own different classes of stock? Are there alternative approaches to addressing the concerns with multiple trading arrangements discussed above?

14. Is the proposed amendment sufficiently clear as to what types of overlapping trading arrangements a trader can maintain, while still preserving the availability of the Rule 10b5-1(c)(1) affirmative defense? If not, how could additional clarity be provided? In particular, how would the proposed exclusion affect current practices with respect to tax qualified retirement savings plans, and tax withholding transactions with respect to equity compensation arrangements, such as stock options and restricted stock units?

15. Is it appropriate to limit the availability of the Rule 10b5-1(c)(1) affirmative defense for single-trade plans as proposed? If not, are there alternative approaches to addressing concerns about the potential abuse of single-trade plans? Would the proposed cooling-off periods sufficiently mitigate the potential to misuse single-trade plans to execute trades based on material nonpublic information? Alternatively, would the limited availability of the Rule 10b5-1(c)(1) affirmative defense for single-trade plans as proposed still allow for potential abuse? Should we consider prohibiting the use of single-trade plans entirely?

4. Requiring That Trading Arrangements Be Operated in Good Faith

As discussed above, the Rule 10b5-1 affirmative defense is only available if a trading arrangement was entered into in good faith and not as part of a plan or scheme to evade the prohibitions of the rule. The ability to trade on the basis of material nonpublic information through a Rule 10b5-1(c)(1) trading arrangement may incentivize corporate insiders to improperly influence the timing of corporate disclosures to benefit their trades under the trading arrangement, for example, by delaying or accelerating the release of material nonpublic information.

46

We are concerned that a trading arrangement may be canceled or modified in an attempt to evade the prohibitions of the rule without affecting the availability of the affirmative defense.

46

See infra

note 106 and accompanying text.

We are also concerned that a corporate insider, after entering into a Rule 10b5-1(c)(1) trading arrangement, may improperly influence the timing of the announcement of material nonpublic information in a way that benefits a planned trade under their trading arrangement. To address these concerns, we are proposing to amend Rule 10b5-1(c)(1)(ii) to add the condition that a contract, instruction, or plan be “operated” in good faith. Amending the condition that a Rule 10b5-1 trading arrangement be entered into in good faith to further require that the trading arrangement also be operated in good faith would help deter fraudulent and manipulative conduct and enhance investor protection throughout the duration of the trading arrangement. The proposed amendment is intended to make clear that the affirmative defense would not be available to a trader that cancels or modifies their plan in an effort to evade the prohibitions of the rule or uses their influence to affect the timing of a corporate disclosure to occur before or after a planned trade under a trading arrangement to make such trade more profitable or to avoid or reduce a loss.

Request for Comment

16. Would the addition of “and operated” to the good faith requirement in Rule 10b5-1(c)(1)(ii), as proposed, have a meaningful impact? If not, what are alternative approaches that would address the concern over the manipulation of the timing of corporate disclosures to benefit a trade under a Rule 10b5-1(c)(1) trading arrangement?

17. Is there evidence to suggest that corporate insiders influence the timing of corporate disclosures to benefit their trades under a Rule 10b5-1 trading arrangement? Is there evidence to suggest that any efforts to time corporate disclosures would not be sufficiently mitigated by the 120-day cooling-off period?

18. Is the term “operated” or the concept of “operated in good faith” sufficiently clear as to the conduct it is meant to describe? If not, should we provide additional guidance as to its meaning in this context? Should we define the phrase “entered into and operated in good faith”? If so, how should it be defined?

19. Is there another formulation that would better address the underlying policy concern of an insider improperly influencing the timing of the release of material nonpublic information to benefit a trade under a Rule 10b5-1 trading arrangement?

20. Does requiring the trading arrangements to be operated in good faith create incentives for corporate insiders to take into account their existing Rule 10b5-1 trading arrangements when making decisions with respect to the timing of corporate disclosures?

B. Additional Disclosures Regarding Rule 10b5-1 Trading Arrangements

Currently, there are no mandatory disclosure requirements concerning the use of Rule 10b5-1 trading arrangements or other trading arrangements by companies or insiders.

47

The lack of comprehensive public information about the use of these arrangements by officers, directors, and issuers—whether pursuant to Rule 10b5-1(c)(1) trading arrangement or otherwise—deprives investors of the ability to assess whether those parties may be misusing their access to material nonpublic information. This lack of transparency may be allowing improper trading to go undetected and undermining the deterrent impact of our insider trading laws. In addition, the lack of public information about the use of these arrangements by companies and corporate insiders limits investors' ability to assess potential incentive conflicts and information asymmetries when making investment and voting decisions. Requiring more robust disclosure of particular trading arrangements should reduce potential abuse of the rule, and inform investors and the Commission regarding potential violations of Rule 10b-5.

47

Form 144 (17 CFR 239.144) under the Securities Act contains a representation that is used by a filer of the form to indicate whether such person has adopted a written trading plan or given trading instructions to satisfy Rule 10b5-1. Form 144 is a notice form that must be filed with the Commission by an affiliate of an issuer who intends to resell restricted or “control” securities of that issuer in reliance upon 17 CFR 230.144 (Securities Act Rule 144). In 2002, the Commission proposed amendments to Form 8-K that, among other things, would have required registrants to report on the form any adoption, modification or termination of a Rule 10b5-1 trading arrangement by any director and certain officers of the registrant.

See Form 8-K Disclosure of Certain Management Transactions,

Release No. 33-8090 (Apr. 12, 2002) [67 FR 19914 (Apr. 23, 2002)].

Currently, issuers are not required to disclose their insider trading policies or procedures. We believe that information about insider trading policies and procedures is important and would help investors to understand and assess how the registrant protects material nonpublic information from misuse. While codes of ethics may address insider trading issues, they often lack the detail necessary for investors to assess actual practices surrounding potential insider trading. Accordingly, we are proposing new Item 408 under Regulation S-K and corresponding amendments to Forms 10-Q and 10-K to require: (1) Quarterly disclosure of the use of Rule 10b5-1 and other trading arrangements by a registrant, and its directors and officers for the trading of the issuer's securities; and (2) annual disclosure of a registrant's insider trading policies and procedures. We are also proposing new Item 16J to Form 20-F to require annual disclosure of a foreign private issuer's insider trading policies and procedures. In addition, we are proposing amendments to Forms 4 and 5 to require insiders to identify whether a reported transaction was executed pursuant to a Rule 10b5-1(c) trading arrangement.

The proposed disclosures that would be required in Forms 10-Q, 10-K, and Form 20-F would be subject to the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002.

48

Section 302 requires an issuers' principal executive officer and principal financial officer to certify, among other things, that based on their knowledge, the Form 10-K, Form 10-Q, or Form 20-F that they have signed does not contain untrue statements of material facts or omit to state material facts necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by the reports.

49

48

Public Law 107-204, 116 Stat. 745 (2002).

49

In effectuating this statutory responsibility, the principal executive and financial officers of an issuer may be aided by a written representation (such as a sub-certification) from the issuer's principal legal or compliance officer (or person

performing similar functions) that, based on a reasonable review, they have determined the issuer's insider trading practices and procedures comport with what the issuer is disclosing about them in its periodic reports. However, it would not be reasonable for a principal executive or financial officer to rely on such a representation if they are aware of information that is inconsistent with, or raises doubts about the reliability of, the representation.

1. Quarterly Reporting of Rule 10b5-1(c) and Non-Rule 10b5-1(c) Trading Arrangements

Currently, issuers are not required to disclose trading arrangements by directors, officers, or the issuer itself when conducting a share buyback. Nor are issuers required to disclose terminations of, including modifications to, trading arrangements previously adopted by directors, officers, or the issuer itself. The disclosure of such information would allow investors to assess the extent to which directors, officers, and the issuer are adopting or terminating such trading arrangements during periods when they may be aware of material nonpublic information. Proposed Item 408(a) of Regulation S-K would require registrants to disclose:

• Whether, during the registrant's last fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report), the registrant has adopted or terminated any contract, instruction or written plan to purchase or sell securities of the registrant, whether or not intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and provide a description of the material terms of the contract, instruction or written plan, including:

○ The date of adoption or termination;

50

50

As discussed above, we have proposed clarifying that any modification or amendment of an existing Rule 10b5-1 trading arrangement is the equivalent of terminating the existing arrangement and adopting a new arrangement.

See supra

note 23. Accordingly, the proposal would require a description of the modification.

○ The duration of the contract, instruction or written plan; and

○ The aggregate amount of securities to be sold or purchased pursuant to the contract, instruction or written plan.

• Whether, during the registrant's last fiscal quarter, any director or officer has adopted or terminated any contract, instruction or written plan for the purchase or sale of equity securities of the registrant, whether or not intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and provide a description of the material terms of the contract, instruction or written plan, including:

○ The name and title of the director or officer;

○ The date on which the director or officer adopted or terminated the contract instruction or written plan;

○ The duration of the contract instruction or written plan; and

○ The aggregate number of securities to be sold or purchased pursuant to the contract, instruction or written plan.

We are proposing to require these disclosures in Form 10-Q and Form 10-K. Under the proposal, a registrant would be required to provide this disclosure if during the quarterly period covered by the report, the registrant, or any director or officer who is required to file reports under Section 16 of the Exchange Act, adopted or terminated a Rule 10b5-1(c) trading arrangement. Such disclosures would allow investors to assess whether, and if so, how, issuers monitor trading by their directors and officers for compliance with insider trading laws and whether their compliance programs are effective at preventing the misuse of material nonpublic information.

We recognize that as a result of the proposed amendments some issuers, directors or officers may seek to execute sales or purchases through trading arrangements that do not satisfy the conditions of Rule 10b5-1(c)(1). For this reason, we are also proposing to require similar disclosures with respect to the adoption or termination of other pre-planned trading contracts, instructions, or plans (“non-Rule 10b5-1 trading arrangements”) through which the issuer, officer or directors seek to transact in issuer securities.

Requiring quarterly disclosure of the adoption or termination of a trading arrangement by a director, officer or the issuer provides important information that would better allow investors, the Commission, and other market participants to observe how these trading arrangements are being used. For example, disclosure of the termination (including a modification) of a trading arrangement by an officer, even in the absence of subsequent trading by the officer, could provide investors or the Commission with important information about the potential misuse of inside information if the termination coincides with the release of material nonpublic information by the issuer. Making information about these arrangements public may also serve as a deterrent against potential abuses of Rule 10b5-1(c)(1) trading arrangements or other trading arrangements by making those who use these arrangements more likely to focus on following the requirements applicable to such arrangements and compliance with Rule 10b-5. In addition, requiring disclosure of these events on a quarterly basis would present this disclosure to investors in a consolidated manner in a single document.

Request for Comment

21. Would the disclosures in proposed Item 408(a) provide useful information to investors and the markets? Does the proposed disclosure requirement specify all of the information that should be disclosed as to registrants' trading arrangements? Does the proposed disclosure requirement specify all of the information that should be disclosed as to trading arrangements of officers and directors? Are there other disclosures that we should require that would provide more transparency into the use of Rule 10b5-1 and non-Rule 10b5-1 trading arrangements? Is there any information that we have proposed to require be disclosed that we should not require? We are proposing disclosure about trading arrangements both for registrants and for officers and directors. Should we instead require disclosure about only one of those categories of traders? Should we consider requiring disclosure of trading arrangements of insiders who are not officers or directors? If so, at what level of specificity?

22. Would a description of the material terms of a trading arrangement encourage front-running of trades under the trading arrangement? Should the required disclosures be limited to particular terms of a trading arrangement?

23. Do registrants currently have access to information about a director's or officer's adoption or termination of a non-Rule 10b5-1 trading arrangement that would allow them collect and prepare this information for disclosure in a Form 10-Q in a timely fashion? If not, what would they need to do to collect and prepare this information for disclosure?

24. Is it appropriate to require disclosures regarding both Rule 10b5-1 trading arrangements and non-Rule 10b5-1 trading arrangements? Is the scope of the term “non-Rule 10b5-1” sufficiently clear? Should we define the term?

25. Is the proposal to require disclosure in Forms 10-Q and 10-K appropriate? Should we instead require disclosure in a different form? Should we consider a different frequency of disclosure?

26. The proposed Item 408(a) disclosure requirement would not apply to foreign private issuers that file annual reports using Form 20-F because such issuers are not required to file quarterly

reports on Form 10-Q. Should the proposed amendments apply to foreign private issuers or would the information be less useful if reported annually on Form 20-F?

2. Disclosure of Insider Trading Policies and Procedures

Well-designed policies and procedures that address the potential misuse of material nonpublic information can play an important role in deterring and preventing trading on the basis of material nonpublic information. Specific disclosures concerning registrants' insider trading policies and procedures would benefit investors by enabling them to assess registrants' corporate governance practices and to evaluate the extent to which those policies and procedures protect shareholders from the misuse of material nonpublic information. We are thus proposing to add new Item 408(b) to Regulation S-K, which would require registrants to:

• Disclose whether the registrant has adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of the registrant's securities by directors, officers, and employees or the registrant itself that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the registrant. If the registrant has not adopted such insider trading policies and procedures, explain why it has not done so; and

• If the registrant has adopted insider trading policies and procedures, disclose such policies and procedures.

These disclosures would be required in a registrant's annual reports on Form 10-K and proxy and information statements on Schedules 14A and 14C.

51

Foreign private issuers would also be required to provide analogous disclosure in their annual reports pursuant to a new Item 16J in that form.

51

Item 1 of Schedule 14C requires that a registrant furnish the information called for by all of the items of Schedule 14A (other than Items 1(c), 2, 4 and 5) which would be applicable to any matter to be acted upon at the meeting if proxies were to be solicited in connection with the meeting.

Currently, 17 CFR 232.406 (Item 406 of Regulation S-K) requires a registrant to disclose whether it has adopted a code of ethics that applies to its principal executive officer, chief financial officer, and other appropriate executives and, if it has not adopted such a code, to state why it has not done so.

52

Many registrants are required to maintain codes of ethics or conduct under exchange listing standards.

53

These codes may contain specific policies and restrictions that address insider trading.

54

Apart from these codes of ethics or conduct, some registrants have other policies and procedures specifically addressing insider trading. The proposed amendments are designed to provide investors with meaningful information regarding a registrant's insider trading policies and procedures to enable them to better assess the manner in which the registrant promotes compliance with insider trading laws and protects material nonpublic information from misuse.

52

See also

Section 406 of the Sarbanes-Oxley Act of 2002 (“SOX”), 15 U.S.C. 7264.

53

See e.g.,

NYSE Listed Company Manual Section 303A.10, which states in relevant part that every NYSE “listed company should proactively promote compliance with laws, rules and regulations, including insider trading laws. Insider trading is both unethical and illegal, and should be dealt with decisively.”

See also

NASDAQ Listing Rule 5610 that requires every Nasdaq listed company to adopt a code of conduct that must comply with the definition of a “code of ethics” set out in SOX Section 406 (c) and that must apply to all directors, officers, and employees.

54

Insider trading policies and procedures may be part of the standards that are reasonably necessary to promote: Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; full, fair, accurate, timely, and understandable disclosure in the periodic reports required to be filed by the issuer; and compliance with applicable governmental rules and regulations.

See

15 U.S.C. 7264(c);

see also supra

Section I.

We recognize that insider trading policies and procedures may vary from company to company and that decisions as to specific provisions of the policies and procedures are best left to the company. Therefore, the proposed amendments do not specify all details that a registrant should address in its insider trading policies, nor do they prescribe any specific language that such policies must include (although this release does include some guidance as to the appropriate subject matter below). We also recognize that registrant's existing code of ethics may contain insider trading policies. In this case, the registrant, could cross-reference to the particular components of its code of ethics that constitute insider trading policies and procedures in response to proposed Item 408(b)(2).

When making disclosure about their insider trading policies and procedures under proposed Item 408(b)(2), registrants should endeavor to provide detailed and meaningful information from which investors can assess the sufficiency of their insider trading policies and procedures. 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.

55

55

The Exchange Act does not require that a “sale” of securities be for value, and instead provides that the “terms `sale' or `sell' each include any contract to sell or otherwise dispose of.” Exchange Act Section 3(a)(14) [15 U.S.C. 78c(a)(14)]

compare with

Securities Act Section 2(a)(3) [15 U.S.C. 77b(a)(3)] (“the terms `sale' or `sell' shall include every contract of sale or disposition of a security or interest in a security, for value.”). For example, a donor of securities violates Exchange Act Section 10(b) if the donor gifts a security of an issuer in fraudulent breach of a duty of trust and confidence when the donor was aware of material nonpublic information about the security or issuer, and knew or was reckless in not knowing that the donee would sell the securities prior to the disclosure of such information. The affirmative defense under Rule 10b5-1(c)(1) is available for planned securities gifts.

Request for Comment

27. Would the proposed disclosure requirements regarding a registrant's insider trading policies and procedures or lack thereof provide useful information to investors? Is there other information that would be useful to include in Item 408(b)?

28. Is the proposed scope of the term “insider trading policies and procedures” sufficiently clear? Should we more specifically define the term? Are there other elements or objectives of an insider trading policy or procedure that should be included in the proposed Item?

29. Should the Item 408(b) disclosure be required in Schedules 14A and 14C, as proposed?

30. Should foreign private issuers be required to provide disclosure of their insider trading policies and procedures? Are any modifications to the proposed disclosure requirement appropriate to recognize the different legal regimes in which foreign private issuers may operate?

3. Structured Data Requirements

We are proposing to require registrants to tag the information specified by Item 408 in Inline XBRL in accordance with Rule 405 of Regulation S-T (17 CFR 232.405) and the EDGAR

Filer Manual.

56

The proposed requirements would include block text tagging of narrative disclosures, as well as detail tagging of quantitative amounts disclosed within the narrative disclosures. Inline XBRL is both machine-readable and human-readable, which improves the quality and usability of XBRL data for investors.

57

56

This tagging requirement would be implemented by including a cross-references to Rule 405 of Regulation S-T in proposed Item 408(a)(3) and Item 408(b)(3), and by revising Rule 405(b) of Regulation S-T [17 CFR 232.405(b)] to include the Item 408 disclosure. In conjunction with the EDGAR Filer Manual, Regulation S-T governs the electronic submission of documents filed with the Commission. Rule 405 of Regulation S-T specifically governs the scope and manner of disclosure tagging requirements for operating companies and investment companies, including the requirement in Rule 405(a)(3) to use Inline XBRL as the specific structured data language to use for tagging the disclosures.

57

See Inline XBRL Filing of Tagged Data,

Securities Act Release No. 10514 (June 28, 2018) [83 FR 40846 (Aug. 16, 2018)]. Inline XBRL allows filers to embed XBRL data directly into an HTML document, eliminating the need to tag a copy of the information in a separate XBRL exhibit. Inline XBRL is both human-readable and machine-readable for purposes of validation, aggregation, and analysis.

Id.

at 40851.

Requiring Inline XBRL tagging of the disclosures provided pursuant to Item 408 would benefit investors by making the disclosures more readily available and easily accessible to investors, market participants, and others for aggregation, comparison, filtering, and other analysis, as compared to requiring a non-machine readable data language such as ASCII or HTML. This would enable automated extraction and analysis of the granular data required by the proposed rules, allowing investors and other market participants to more efficiently perform large-scale analysis and comparison of this information across issuers and time periods. For narrative disclosures, an Inline XBRL requirement would allow investors to extract and search for disclosures about a registrant's insider trading policies and procedures (rather than having to manually run searches for these disclosures through entire documents), automatically compare/redline these disclosures against prior periods, and perform targeted AI/ML assessments of specific narrative disclosures rather than the entire unstructured document. At the same time, we do not expect the incremental compliance burden associated with tagging the additional information to be unduly burdensome, because issuers subject to the proposed tagging requirements are for the most part subject to similar Inline XBRL requirements in other Commission filings.

Request for Comment

31. Should we require issuers to tag the disclosures required by Item 408 of Regulation S-K in Inline XBRL, as proposed? Are there any changes we should make to ensure accurate and consistent tagging? If so, what changes should we make?

32. Should we modify the scope of the disclosures required to be tagged? Should the narrative disclosure about a registrant's insider policies and procedures be tagged using Inline XBRL, as proposed?

33. Should we require issuers to use a different structured data language to tag these disclosures? If so, what structured data language should we require?

34. Are there any issuers, such as smaller reporting companies, emerging growth companies or foreign private issuers that we should exempt from the tagging requirement? If so, how would investors in such issuers receive the information that they need to make informed decisions regarding these issuers?

4. Identification of Rule 10b5-1(c) and Non-Rule 10b5-1(c)(1) Transactions on Forms 4 and 5

Section 16(a) of the Exchange Act provides that every person who beneficially owns, directly or indirectly, more than 10 percent of any class of equity security (other than an exempted security) registered pursuant to Exchange Act Section 12, or who is an officer or director of the issuer of such security, shall file with the Commission an initial report disclosing the amount of all equity securities of such issuer of which the insider is the beneficial owner, and a subsequent transaction report to disclose any changes in beneficial ownership. Section 16 of the Exchange Act was designed to provide the public with information on securities transactions and holdings of corporate officers, directors, and principal shareholders, and to deter those individuals from seeking to profit from short-term trading in the securities of their corporations while in possession of material, nonpublic information.

58

58

See Ownership Reports and Trading By Officers, Directors and Principal Security Holders, Release No. 34-28869 (Feb. 8, 1991) [56 FR 7242 (Feb. 21, 1991)].

Persons subject to Section 16 reporting must disclose changes in their beneficial ownership on Form 4 or 5. Exchange Act Rule 16a-3(g)

59

provides that a reporting person must report specified changes in beneficial ownership on Form 4 before the end of the second business day following the date of execution of the transaction. In December 2020, the Commission proposed, among other things, amendments to Form 4 and Form 5

60

to add a checkbox to these forms that would permit filers, at their option, to indicate whether a transaction reported on the form was made pursuant to a contract, instruction, or written trading plan for the purchase or sale of equity securities of the issuer that satisfies the conditions of Rule 10b5-1(c).

61

In the December 2020 Proposing Release, the Commission noted that many Form 4 and Form 5 filers voluntarily provide additional disclosure in these forms stating that a reported transaction satisfied the affirmative defenses conditions of Rule 10b5-1(c). The Commission indicated that the checkbox option would provide filers with a more efficient method to disclose this information.

59

17 CFR 240.16a-3(g).

60

Form 5 is a year-end report to be used by any person who was an officer, director or a 10% beneficial owner during any portion of the issuer's fiscal year to disclose transactions and holdings that are exempt from Section 16(b) or that were required to be reported during the fiscal year, but were not.

61

See Rule 144 Holding Period and Form 144 Filings,

Release No. 33-10911 (Dec. 22, 2020) [86 FR 5063 (Jan. 19, 2021)] (“December 2020 Proposing Release”).

In response to the December 2020 Proposing Release, the Commission received feedback from several commenters who asserted, based on analyses of sales of securities executed under Rule 10b5-1 trading arrangements, that many of these transactions were likely made on the basis of material nonpublic information.

62

These commenters recommended that the proposed Rule 10b5-1 checkbox disclosure be mandatory on Forms 4 and 5 because such disclosure would help investors and the public better discern whether Rule 10b5-1 trading arrangements are being used to engage in opportunistic trading on the basis of inside information.

63

62

See

letters from Council of Institutional Investors (dated Mar. 18, 2021), Alan Jagolinzer (dated Mar. 10, 2021), and David Larcker

et al.

(dated Mar. 10, 2021), available at

https://www.sec.gov/comments/s7-24-20/s72420.htm.

63

Id.

In consideration of this feedback, we are proposing to add a Rule 10b5-1(c) checkbox as a mandatory disclosure requirement on Forms 4 and 5. The checkbox would require a Form 4 or 5 filer to indicate whether a sale or purchase reported on that form was made pursuant to a Rule 10b5-1(c) trading arrangement. Filers would also be required to provide the date of

adoption of the Rule 10b5-1 trading arrangement, and would have the option to provide additional relevant information about the reported transaction. Requiring this disclosure on Forms 4 and 5 would provide greater transparency around the use of Rule 10b5-1 plans and would be consistent with the primary purpose of Exchange Act Section 16.

64

It also would provide information that could be used by registrants to comply with their Item 408 disclosure obligations.

64

See

S. Rep. No. 1455, 73d Cong., 2d Sess. 55 (1934).

In addition, we are proposing to add a second, optional checkbox to both of Forms 4 and 5. This optional checkbox would allow a filer to indicate whether a transaction reported on the form was made pursuant to a pre-planned contract, instruction, or written plan that is not intended to satisfy the conditions of Rule 10b5-1(c).

Request for Comment

35. Should we add a mandatory checkbox on Forms 4 and 5 to indicate whether a sale or purchase was made pursuant to a Rule 10b5-1(c) plan? Should we require disclosure of the date of adoption of the Rule 10b5-1 plan? Would the Rule 10b5-1(c) checkbox and disclosure of the date of adoption of the plan help provide useful information about whether a Rule 10b5-1 plan was being used to engage in opportunistic trading based on material nonpublic information? Are there alternative methods of providing this information that we should consider?

36. Should we add an optional checkbox on Forms 4 and 5 to indicate that a sale or purchase reported on these forms was made pursuant to a contract, instruction or written plan that did not satisfy the conditions of Rule 10b5-1(c), as proposed? Would such an affirmative indication provide useful information to investors and market participants? Are filers already sufficiently able to provide this information elsewhere if they choose to do so? If so, should we make the use of the checkbox mandatory?

C. Disclosure Regarding the Timing of Option Grants and Similar Equity Instruments Shortly Before or After the Release of Material Nonpublic Information

Since the enactment of the Securities Act and the Exchange Act, the Commission has sought to enhance its rules regarding the disclosure of executive and director compensation and to improve the presentation of this information to investors.

65

One area of focus for the Commission has been disclosure related to equity-based compensation. Many companies use stock options as a form of compensation for their employees and executives.

66

In a simple stock option award, a company may grant an employee the right to purchase a specified number of shares of the company's stock at a specified price, called the exercise price, which is typically set as the fair market value of the company's stock on the grant date. Stock options with exercise prices at or above the fair market value of the underlying stock are designed to motivate the recipient to work towards increasing company value, because the option holder would only benefit if the company's stock price exceeds the exercise price at the time of exercise.

67

65

See, e.g., Executive Compensation and Related Person Disclosure,

Release No. 33-8732A (Aug. 29, 2006) [71 FR 53158 at 53160, n. 45 (Sept. 8, 2006)] (hereinafter “2006 Executive Compensation Release”);

Proxy Disclosure Enhancements,

Release No. 33-9089 (Dec, 16, 2009) [74 FR 68334 (Dec. 24, 2009)].

66

The term “option” includes stock options, SARs and similar instruments with option-like features.

See

17 CFR 229.402(a)(6).

67

When the exercise price for an option is less than the fair market value of the underlying security, the option is “in the money.” If the exercise price and fair market value are the same, the option is “at the money.” If the exercise price is greater than the fair market value, the option is “out of the money.”

In 2006, the Commission revised its executive compensation disclosure rules to, among other things, provide investors a more complete picture of compensation to principal executive officers, principal financial officers, and the other highest paid executive officers and directors.

68

In the 2006 Executive Compensation Release, the Commission stated that under the principles-based compensation disclosure requirements of Item 402 of Regulation S-K, registrants may be required to disclose in their Compensation Discussion and Analysis (“CD&A”) information about the timing of option grants in close proximity to the release of nonpublic information by the company.

69

Such disclosure should include, for example, whether a company is aware of material nonpublic information that is likely to result in an increase of its stock price, such as a product development announcement or positive earnings, and grants stock options immediately before the release of this information. Timing option grants to occur immediately before the release of positive material nonpublic information (“spring-loading”) can benefit executives with an option award that will likely be in-the-money as soon as the material nonpublic information is made public.

70

Alternatively, if a company is aware of material nonpublic information that is likely to decrease its stock price, it may decide to delay a planned option award until after the release of such information (“bullet-dodging”).

71

68

2006 Executive Compensation Release,

supra

note 65, at 53164.

69

See

17 CFR 229.402(b)(2)(iv) and 2006 Executive Compensation Release,

supra

note 65, at 53163-4.

70

See

Lucian A. Bebchuk and Jesse M. Fried,

Paying for Long-Term Performance,

158 U. Pa. L. Rev. 1915, 1937-39 & n. 63 (2010) (noting that the practice of spring-loading may also disguise an in-the-money option award as having been granted at-the-money).

71

See

Allan Horwich,

The Legality of Opportunistically Timing Public Company Disclosures in the Context of SEC Rule 10b5-1,

71 Bus. Law. 1113, 1143 (2016) (noting that “bullet-dodging” occurs when a board delays the grant of an option until adverse material nonpublic information known to the board is disclosed, which reduces the market price and the option exercise price that is set at the time of the grant).

In the release, the Commission noted that the existence of a program, plan or practice to select option grant dates for executive officers in coordination with the release of material nonpublic information would be material to investors and should be fully disclosed.

72

72

2006 Executive Compensation Release,

supra

note 65, at 53163.

We are concerned, however, that our existing disclosure requirements do not provide investors with adequate information regarding an issuer's policies and practices on stock option awards timed to precede or follow the release of material nonpublic information. Under our current executive compensation disclosure rules, compensation-related equity interests (including options, restricted stock, and similar grants) are required to be presented in a tabular format and accompanied by appropriate narrative disclosure necessary for an understanding of the information presented in a table. Option grants that are spring-loaded or bullet-dodging are not required to be separately identified in these tables. Consequently, investors may not have a clear picture of the effect of an option award that is made close in time to the release of material nonpublic information on the executives' or directors' compensation and on the company's financial statements. Understanding that issuers may have reasons for granting these types of options, but that increased transparency may be warranted, we are proposing amendments that would require registrants to disclose in a new table any option awards to named executive officers

73

or directors that are made

within a certain time proximity of the release of material nonpublic information such as an earnings announcement.

73

Named executive officers include all individuals serving as the registrant's Principal Executive Officer (“PEO”) or Principal Financial

Officer (“PFO”) during the last completed fiscal year, the registrant's three most highly compensated officers other than the PEO and PFO who were serving as executive officers at the end of the last completed fiscal year, and up to two additional individuals for whom disclosure would have been provided but for the fact that the individual was not serving as an executive officer at fiscal year-end.

See

Item 402(a)(3) of Regulation S-K.

Under the proposal, to identify if any such timed options are granted, a new paragraph (x) would be added to Item 402 of Regulation S-K

74

that would require tabular disclosure of each option award (including the number of securities underlying the award, the date of grant, the grant date fair value, and the option's exercise price) granted within 14 calendar days before or after the filing of a periodic report, an issuer share repurchase, or the filing or furnishing of a current report on Form 8-K that contains material nonpublic information; the market price of the underlying securities the trading day before disclosure of the material nonpublic information; and the market price of the underlying securities the trading day after disclosure of the material nonpublic information.

75

74

In Release No. 33-9861, the Commission proposed to add paragraph (w) to Item 402. The proposed Item 402(x) designation is consistent with the new designations proposed in that release, but could change depending on Commission action to adopt those proposals.

See Listing Standards for Recovery of Erroneously Awarded Compensation,

Release No. 33-9861 (July 1, 2015) [80 FR 41144 (July 14, 2015)].

See also Reopening of Comment Period for Listing Standards for Recovery of Erroneously Awarded Compensation,

Release No. 33-10998 (Oct. 14, 2021) [86 FR 58232 (October 21, 2021)].

75

Under the proposed rule, disclosure would also be required of the grant date fair value of each equity award computed in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718.

Many companies required to file Exchange Act periodic reports also voluntarily communicate material nonpublic information regarding their results of operations or financial condition for a completed fiscal quarter or annual period through an earnings release.

76

After completion of a fiscal quarter, a company's board of directors will usually meet a week or two before announcing the earnings release.

77

During this period, the board would likely be aware of material nonpublic information that could affect the stock price of the company. The proposed fourteen day window is designed to cover the period that a company would be aware of material nonpublic information at the time that its board of directors' grants an option award. In addition, new Item 402(x) would require narrative disclosure about an issuer's option grant policies and practices regarding the timing of option grants and the release of material nonpublic information, including how the board determines when to grant options and whether, and if so, how, the board or compensation committee takes material nonpublic information into account when determining the timing and terms of an award. For companies that are subject to CD&A, the proposed narrative disclosure could be included in CD&A.

76

Commission staff estimates that approximately 63% of the Form 10-Qs filed with the Commission in calendar year 2017 were accompanied by a prior or concurrent earnings release by the issuer.

77

While some companies provide earnings releases in advance of the corresponding Form 10-Q filings, many companies also issue earnings releases concurrently with their Form 10-Q filings.

The proposed amendments are intended to provide shareholders a full and complete picture of any spring-loaded or bullet-dodging option grants during the fiscal year. It is important for shareholders to understand company practices with respect to these types of options grants as they consider their say-on-pay votes, and when approving executive compensation and electing directors. Accordingly, we are proposing to require this disclosure in annual reports on Form 10-K,

78

as well as in proxy statements and information statements related to the election of directors, shareholder approval of new compensation plans, and solicitations of advisory votes to approve executive compensation.

79

78

The executive compensation disclosure requirements in Part III of Form 10-K may be incorporated by reference from a proxy or information statement involving the election of directors, if filed within 120 days of the end of the fiscal year.

See

Note 3 to General Instruction G(3) to Form 10-K.

79

17 CFR 240.14a-21 [Exchange Act Rule 14a-21] requires, among other things, companies soliciting proxies for an annual or other meeting of shareholders at which directors will be elected to include a separate resolution subject to a shareholder advisory vote to approve the compensation of named executive officers.

We are also proposing to require registrants to tag the information required by Item 402(x) in Inline XBRL in accordance with Rule 405 of Regulation S-T (17 CFR 232.405) and the EDGAR Filer Manual.

80

We expect that the disclosure of this data in a structured data language would improve the usability of the data for investors, other market participants and the Commission, and facilitate the analysis of this information.

80

This tagging requirement would be implemented by including a cross-references to Rule 405 of Regulation S-T in proposed Item 402(x), and by revising Rule 405(b) of RegulationS-T [17 CFR 232.405(b)] to include the Item 402(x) disclosure. In conjunction with the EDGAR Filer Manual, Regulation S-T governs the electronic submission of documents filed with the Commission. Rule 405 of Regulation S-T specifically governs the scope and manner of disclosure tagging requirements for operating companies and investment companies, including the requirement in Rule 405(a)(3) to use Inline XBRL as the specific structured data language to use for tagging the disclosures.

We do not propose to exempt smaller reporting companies

81

or emerging growth companies (“EGCs”)

82

from the proposed Item 402(x) disclosures. Information about grants of options awards while a board of directors is aware of material nonpublic information is material to all investors, and no less relevant to shareholders of a smaller reporting company or an EGC. Accordingly, smaller reporting companies and EGCs would be subject to the new disclosure requirement. However, consistent with the scaled approach to their executive compensation disclosure,

83

smaller reporting companies and EGCs would be permitted to limit their disclosures about specific option awards to the PEO, the two most highly compensated executive officers other than the PEO at fiscal year-end, and up to two additional individuals who would have been the most highly compensated but for not serving as executive officers at fiscal year-end.

84

81

“Smaller reporting company” is defined in Securities Act Rule 405 and 17 CFR 240.12b-2 [Exchange Act Rule 12b-2] as an issuer that is not an investment company, an asset-backed issuer (as defined in 17 CFR 229.1101), or a majority-owned subsidiary of a parent that is not a smaller reporting company and that: (1) Had a public float of less than $250 million; or (2) had annual revenues of less than $100 million and either: (a) No public float; or (b) a public float of less than $700 million.

82

An EGC is defined as a company that has total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year and, as of December 8, 2011, had not sold common equity securities under a registration statement. A company continues to be an EGC for the first five fiscal years after it completes an IPO, unless one of the following occurs: Its total annual gross revenues are $1.07 billion or more; it has issued more than $1 billion in non-convertible debt in the past three years; or it becomes a “large accelerated filer,” as defined in Exchange Act Rule 12b-2.

See

Securities Act Rule 405 and Exchange Act Rule 12b-2.

83

See

Item 402(l) of Regulation S-K.

84

See

Item 402(m)(2) of Regulation S-K.

Request for Comment

37. To what extent does the board of directors or compensation committee currently consider the impact of granting option awards made close in time to disclosure of material nonpublic information? What type of effect would the proposed disclosures have on the timing and granting of option awards if this requirement for Item 402(x) were adopted?

38. Would the proposed table in Item 402(x) provide meaningful information

to shareholders regarding option awards made close in time to the disclosure of material nonpublic information? What, if any, other information should be required? Should the proposed table include a column to specify the date on which the material nonpublic information was released? Should any of the proposed disclosure elements be eliminated?

39. The proposed disclosure requirements under new Item 402(x) would apply to option awards made within a 14-day period before or after the filing of a Form 10-Q or the filing (or furnishing) of a Form 8-K containing material nonpublic information with the Commission. Is the proposed 14-day time period appropriate? Should the period be longer or shorter than 14 days, and if so, what time period would be appropriate? What percent of option grants would be included in this disclosure based on these reporting windows?

40. Is a one-day period after the disclosure of material nonpublic information a sufficient period for the material nonpublic information to be reflected in the market price of the issuer's securities? Is a one-day period prior to the disclosure too late to reflect the change in the share price to the extent that the material nonpublic information may have been previously disclosed to the market (

e.g.,

leaked)? Should the window for measuring the change in market price based on the release of material nonpublic information be longer or shorter?

41. Should smaller reporting companies and emerging growth companies be required to provide all of the proposed disclosure?

42. Are there material tax implications that could result from the timing of stock option grants with the release of material nonpublic information that should be disclosed?

D. Reporting of Gifts on Form 4

Currently, Section 16 reporting persons are required to report any “bona fide”

85

gift of equity securities registered under Exchange Act Section 12 on Form 5. Exchange Act Rule 16a-3(f) provides that every person who at any time during an issuer's fiscal year was subject to Section 16 of the Exchange Act must file a Form 5 within 45 days after the issuer's fiscal year end to disclose certain beneficial ownership transactions and holdings not reported previously on Forms 3, 4, or 5.

86

As transactions that are exempted from Section 16(b) by 17 CFR 240.16b-5,

87

including both the acquisition and disposition of bona fide gifts are eligible for delayed reporting on Form 5 pursuant to Rule 16a-3(f)(1). This filing schedule, under the current rules, can permit insiders to report “bona fide” gifts more than one year after the date of the gift.

88

85

A bona fide gift is a gift that is not required or inspired by any legal duty or that is in any sense a payment to settle a debt or other obligation, and not made with the thought of reward for past services or hope for future consideration.

See Ownership Reports and Trading by Officers, Directors and Principal Stockholders,

Release No. 34-26333 (Dec. 2, 1988) [53 FR 49997 (Dec. 13, 1988)].

86

17 CFR 240.16a-3(f).

87

Rule 16b-5.

88

Reports on Form 5 are due within 45 days after the issuer's fiscal year end, which potentially allows a delay of up to 410 days between a reportable transaction and the filing of the Form 5.

We have become aware that the length of the filing period for Form 5 may allow insiders to engage in problematic practices involving gifts of securities, such as insiders making stock gifts while in possession of material nonpublic information,

89

or backdating a stock gift in order to maximize a donor's tax benefit.

90

To address these concerns, we are proposing to amend Exchange Act Rule 16a-3 to require the reporting of dispositions of bona fide gifts of equity securities on Form 4. Under the proposed amendment, an officer, director, or a beneficial owner of more than 10 percent of the issuer's registered equity securities making a gift of equity securities would be required to report the gift on Form 4 before the end of the second business day following the date of execution of the transaction. This would be significantly earlier than what is required under current reporting rules. This earlier reporting deadline would help investors, other market participants, and the Commission better evaluate the actions of these insiders and the context in which equity securities gifts are being made.

89

See

Daisy Maxey, “Improper `Insider Charitable Giving' Is Widespread, Study Says”, WALL ST. J., July 5, 2021, at

https://www.wsj.com/articles/insider-charitable-giving-11625418315?mod=searchresults_pos1&page=1. See also supra

note 55 above.

90

See

S. Burcu Avci et al.,

Insider Giving, supra

note 21 above (finding that insiders' charitable gifts of securities are unusually well timed suggesting that such results are likely due to the possession of material nonpublic information and from the backdating of the stock gift).

Request for Comment

43. Should we require dispositions by gifts of equity securities to be disclosed Form 4 instead of Form 5, as proposed?

44. Should we require disclosure of other information about gifts on Form 4 that are not already required by Form 4? If so, what information should we require?

III. General Request for Comment

We request and encourage any interested person to submit comments on any aspect of the proposed amendments, other matters that might have an impact on the proposed amendments, and any suggestions for additional changes. With respect to any comments, we note that they are of greatest assistance to our rulemaking initiative if accompanied by supporting data and analysis of the issues addressed in those comments and by alternatives to our proposals where appropriate.

IV. Economic Analysis

We are mindful of the costs imposed by, and the benefits obtained from, our rules. Section 2(b) of the Securities Act,

91

Section 3(f) of the Exchange Act,

92

and Section 2(c) of the Investment Company Act

93

require us, when engaging in rulemaking, to consider or determine whether an action is necessary or appropriate in (or, with respect to the Investment Company Act, consistent with) the public interest, and to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. In addition, Section 23(a)(2) of the Exchange Act requires the Commission to consider the effects on competition of any rules the Commission adopts under the Exchange Act and prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.

94

91

15 U.S.C. 77b(b).

92

15 U.S.C. 78c(f).

93

15 U.S.C. 80a-2(c).

94

15 U.S.C. 78w(a)(2).

We have considered the economic effects of the proposed amendments, including their effects on competition, efficiency, and capital formation. Many of the effects discussed below cannot be quantified. Consequently, while we have, wherever possible, attempted to quantify the economic effects expected from this proposal, much of the discussion remains qualitative in nature. Where we are unable to quantify the economic effects of the proposed amendments, we provide a qualitative assessment of the potential effects and encourage commenters to provide data and information that would help quantify the benefits, costs, and the potential impacts of the proposed amendments on efficiency, competition, and capital formation.

We request comment from all interested parties. With regard to any comments, we note that such comments

are of greatest assistance to our rulemaking initiative if accompanied by supporting data and analysis of the issues addressed in those comments.

A. Broad Economic Considerations

The proposed amendments are expected to provide greater transparency to investors (

i.e.,

decrease information asymmetries between insiders and outside investors) about issuer and insider trading arrangements and restrictions, as well as insider compensation and incentives, enabling more informed decisions about investment in the company. The proposed amendments are also expected to limit the opportunity for insider trading based on material nonpublic information (“MNPI”) (referred to as “insider trading” throughout Section IV for brevity) under Rule 10b5-1 by amending the substantive conditions of the affirmative defense, resulting in benefits to investors and improvement in insiders' incentives.

Insider trading enables certain investors who have access to inside information or who control the timing or substance of corporate disclosures to profit at the expense of other investors. Due to their access to material nonpublic information, insiders can obtain profits through the strategic timing of trades in the issuer's securities. These profits are gained at the expense of ordinary investors, and essentially transfer wealth from other investors to the insider. In addition, insider trading can distort the incentives of corporate insiders, which results in a loss of shareholder value, and erode investor confidence in the markets. To the extent insider trading by a company's insiders imposes reputational costs for companies, by reducing insider trading, the proposed amendments also could offer reputational benefits to companies.

1. Insider trading harms investors, distorts insiders' incentives, and imposes economic costs on investors and capital markets.

The proposed amendments are expected to decrease the incidence of unlawful insider trading based on MNPI.

95

Insider trading represents a breach of fiduciary or other similar relation of trust and confidence.

96

Congress, the Courts, and the Commission have concluded that such insider trading is illegal.

97

Before analyzing each aspect of the proposed rule, in the interest of completeness, the Commission first reviews the economic literature on the insider trading prohibition.

98

95

The discussion of broad economic considerations generally focuses on insider trading in stock, except where specified otherwise. To the extent that insiders benefit from the timing of option awards and gifts of stock around MNPI, some of the economic effects associated with insider trading also may be manifested in those contexts. For a detailed discussion of the economic considerations applicable to option award timing and insider gift timing,

see infra

Sections IV.D and IV.E.

96

See infra

note 187.

97

See supra

Section I.

98

See generally

Alexandre Padilla and Brian Gardiner, Insider Trading: Is There an Economist in the Room? 24

J. Private Enterprise

113, 123 (2009) (noting “economists have progressively reached the same conclusion: that insider trading is harmful to investors, corporations, and stock exchanges, and, therefore, ought to be prohibited”).

Insiders have information advantages that place them in a unique position to obtain profits for themselves through strategic timing of trades. When an insider profits by trading on MNPI, those profits are obtained at other investors' expense.

99

Thus, reducing the incidence of insider trading would benefit investors.

100

99

See also

Michael Manove, The Harm from Insider Trading and Informed Speculation, 104(4)

Quarterly Journal of Economics,

823-845 (1989); William K.S. Wang, Trading on Material Non-Public Information on Impersonal Stock Markets: Who is Harmed and Who Can Sue Whom Under SEC Rule 10b-5?,

Southern California Law Review

(1981).

100

These arguments and those below apply to Rule 10b5-1 plans pertaining to trading in equity of other issuers as well as own company stock. Misappropriation of information may have many economic effects, including but not limited to, revealing information to the market in a manner suboptimal to the issuer, (and thus discouraging investment in information and increasing costs of keeping information private). Further, as with trading in own company stock, increased trading by insiders reduces incentives for liquidity provision through adverse selection, imposing economic costs on investors broadly. Finally, misappropriation has associated agency costs as it represents an undisclosed form of compensation, and may lead further divergence of interests between the manager and the shareholders.

See

Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information,

The Supreme Court Review,

315-16, 323, 331-34;

In re Melvin,

SEC Release No. 3682, 2015 WL 5172974, at *4 & n.31 (Sept. 4, 2015).

Insider trading also imposes a cost on the investors in the company by distorting managerial incentives, which results in a loss of shareholder value. Thus, whether insiders are strategically timing stock sales and purchases based on MNPI is informative about insider incentives and the value of the company. The ability of officers and directors (who are either involved in making corporate decisions or play a crucial role in the oversight of such decisions) to profit from MNPI exacerbates conflicts of interest between officers/directors and other shareholders, resulting in inefficient, value-decreasing corporate decisions. By protecting the insider from the full effects of poor corporate performance on the value of the insider's equity position, through the ability to sell ahead of negative news, insider trading weakens incentive alignment and exacerbates agency conflicts (and in turn increases the cost of monitoring insiders). The incentive distortions are discussed in greater detail below.

One incentive distortion is that an insider may prefer projects that require less effort or that yield higher private benefits, even if such projects have a negative net present value (NPV) and thus decrease shareholder value.

101

To mitigate agency conflicts and better align insider incentives with those of shareholders, insiders are often compensated with equity. The ability to sell shares in advance of negative news (to the extent the compensation has vested) protects the insider's equity position from the full effect of share price declines. This weakens incentive alignment and exacerbates the agency conflicts described above, increasing the likelihood that the insider would pursue negative-NPV projects. Downside protection also incentivizes the insider to choose riskier negative-NPV projects, due to the possibility of profiting on the upside.

102

Relatedly, if short-term investment projects yield more profitable MNPI (while MNPI about long-term projects arrives less frequently or is less definitive), an

insider may exhibit short-termism in investment decisions, at the expense of shareholder value.

103

101

See, e.g.,

Antonio E. Bernardo, Contractual Restrictions on Insider Trading: A Welfare Analysis, 18(1)

Economic Theory

7-35 (2001) (showing in a model that “[f]or many reasonable parameter values, however . . . that managers may be too willing to take risky projects. In fact, managers will often choose the risky investment project when it has a lower expected return than the riskless investment project.”). In some circumstances, insider trading may remedy a manager's excess conservatism due to under diversification.

See also

Lucian A. Bebchuk and Chaim Fershtman, Insider Trading and the Managerial Choice among Risky Projects, 29(1)

Journal of Financial and Quantitative Analysis,

1-14 (1994). However, Bebchuk and Fershtman (1994) similarly acknowledge that “[t]he desire to increase trading profits might lead the managers to prefer a very risky project even if it offers a lower expected return than a safer alternative.”

102

See, e.g.,

Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information,

The Supreme Court Review,

309-366, 332 (1981) (stating that “[t]he opportunity to gain from insider trading also may induce managers to increase the volatility of the firm's stock prices. . . They may select riskier projects than the shareholders would prefer, because if the risk pays off they can capture a portion of the gains in insider trading and, if the project flops, the shareholders bear the loss.”).

But see

Alexander P. Robbins,

The Rule 10b5-1 Loophole: An Empirical Study,

34 Review of Quantitative, Finance and Accounting, 199-224 (2010) (finding, in a sample of 10b5-1 plans of 81 NASDAQ-listed companies from 2004 to 2006 that “insiders do not appear to increase the volatility of their own firms' shares in order to profit by trading on the basis of material nonpublic information under the protection of the 10b5-1 affirmative defense”).

103

See

M. Todd Henderson,

Insider Trading and Executive Compensation: What We Can Learn from the Experience with Rule 10b5-1,

Research Handbook on Executive Pay, 299 (2012) (stating that short-termism is a cost of insider trading and that “[e]xecutives looking to maximize the value of their shares may engage in conduct that increases the stock price in the short run at the expense of the long term so that they can profit from trading in firm stock”). Such managerial short-termism/myopia reduces shareholder value.

See generally,

John R. Graham, Campbell R. Harvey, and Shiva Rajgopal,

The Economic Implications of Corporate Financial Reporting,

40(1-3) Journal of Accounting and Economics, 3-73 (2005); Alex Edmans, Blockholder Trading,

Market Efficiency, and Managerial Myopia,

64(6) Journal of Finance, 2481-2513 (2009).

Being able to profit from MNPI also can distort insider incentives with respect to other corporate decisions that can affect the share price (for example, repurchases in cases where such a payout is not efficient, motivated by the attempt to boost the share price in advance of an insider's sale of shares).

104

As another example, officers and directors engaged in insider trading may be disincentivized from sharing information efficiently within the firm if they can profit from withholding it and personally trading on it, which leads to inefficient corporate decisions and thus decreased shareholder value.

105

104

See, e.g.,

Konan Chan, David L. Ikenberry, Inmoo Lee, and Yanzhi Wang,

Share Repurchases as a Potential Tool to Mislead Investors,

16 Journal of Corporate Finance 137 (2010) (finding in 1980-2000 data that a limited number of managers may have used repurchases in a misleading way as “cheap talk”); Alice A. Bonaimé and Michael D. Ryngaert,

Insider Trading and Share Repurchases: Do Insiders and Firms Trade in the Same Direction?,

22 Journal of Corporate Finance, 35-53 (2013) (finding that repurchases that coincide with net insider selling may be related to price support and/or reasons related to option exercises); Peter Cziraki, Evgeny Lyandres, and Roni Michaely,

What do Insiders Know? Evidence from Insider Trading Around Share Repurchases and SEOs,

66 Journal of Corporate Finance 101544 (2021) (finding that, “[h]igher insider net buying is associated with better post-event operating performance, a reduction in undervaluation, and, for repurchases, lower post-event cost of capital. Insider trading also predicts announcement returns and long-term abnormal returns following events.” Their results suggests that “insider trades before corporate events [repurchases and SEOs] contain information about changes both in fundamentals and in investor sentiment”); Lenore Palladino, Do Corporate Insiders Use Stock Buybacks for Personal Gain?, 34(2)

International Review of Applied Economics,

152-174 (2020) (finding increased insider selling in quarters where buybacks are occurring); Waqar Ahmed,

Insider Trading Around Open Market Share Repurchase Announcements,

University of Warwick Working Paper (2017) (finding that “insiders take advantage of higher post-[repurchase] announcement price and sell more heavily”, and that such selling is predictive of lower long-term returns).

See also

Rulemaking Petition 4-746, Jun. 25, 2019,

available at https://www.sec.gov/rules/petitions/2019/petn4-746.pdf,

at 5 and note 17 (expressing concern and citing evidence of repurchases used to increase share prices at the time when insiders sell shares); Alex Edmans, Vivian Fang, and Allen Huang, The Long-Term Consequences of Short-Term Incentives,

Journal of Accounting Research,

forthcoming (2021) (finding that “[v]esting equity is positively associated with the probability of a firm repurchasing shares” but that “it is also associated with more negative long-term returns over the 2-3 years following repurchases” and that “CEOs sell their own stock shortly after using company money to buy the firm's stock, also inconsistent with repurchases being motivated by undervaluation”).

But see, e.g.,

Harrison Liu and Edward Swanson, Is Price Support a Motive for Increasing Share Repurchases?, 38

Journal of Corporate Finance,

77 (2016) (finding that “[c]orporate insiders do not sell from personal stock holdings during the price support quarter.”); Pascal Busch and Stefan Obernberger, Actual Share Repurchases, Price Efficiency, and The Information Content Of Stock Prices, 30

Review of Financial Studies,

324 (2017) (concluding, with respect to actual share repurchases, that price support provided by repurchases improves price efficiency, even when manipulation concerns might be highest, such as those that occur prior to insider sales).

105

See, e.g.,

Robert J. Haft, The Effect of Insider Trading Rules on the Internal Efficiency of the Large Corporation, 80(5)

Michigan Law Review,

1051-1071, 1055 (1982).

Another economic cost of insider trading is that it may incentivize insiders to adjust the timing or content of corporate disclosure (

e.g.,

delay the release of MNPI).

106

Manipulation of corporate disclosure causes price distortions and impairs the ability of investors to make informed investment decisions. Less informed investment decisions result in less efficient allocation of capital in investor portfolios, compared to a setting with no disclosure distortions. To the extent that investors anticipate such disclosure gaming, they may commensurately increase their information gathering effort, resulting in higher information gathering costs for investors. Investors, however, have a limited ability to identify specific corporate disclosures being manipulated or to obtain timely and accurate information elsewhere.

106

See, e.g.,

Ranga Narayanan, Insider Trading and the Voluntary Disclosure of Information by Firms, 24(3)

Journal of Banking and Finance,

395-425 (2000) (stating that “[s]tringent enforcement of insider trading regulations induces more disclosure by firms”); Qiang Cheng and Kin Lo, Insider Trading and Voluntary Disclosures, 44(5)

Journal of Accounting Research,

815-848 (2006) (finding that when “managers plan to purchase shares, they increase the number of bad news forecasts to reduce the purchase price . . . insiders do exploit voluntary disclosure opportunities for personal gain, but only selectively, when litigation risk is sufficiently low”); Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information,

Supreme Court Review 1981,

309-366, 333 (1981) (stating that “[t]he prospect of insiders' gains may lead the firm to delay the release of information”). Some studies also note that an opposite effect is possible—managers concerned about litigation may provide higher-quality disclosure before selling shares.

See

Jonathan L. Rogers, Disclosure Quality and Management Trading Incentives, 46(5)

Journal of Accounting Research,

1265-1296 (2008) (Finding that “[c]onsistent with a desire to reduce the probability of litigation . . . managers provide

higher quality

disclosures before selling shares than they provide in the absence of trading” but also finding that “[c]onsistent with a desire to maintain their information advantage, . . . some, albeit weaker, evidence that managers provide

lower quality

disclosures prior to purchasing shares than they provide in the absence of trading.”). In the context of Rule 10b5-1 plans,

see, e.g.,

Stanley Veliotis, Rule 10b5-1 Trading Plans and Insiders' Incentive to Misrepresent, 47(2)

American Business Law Journal,

313-360, at 330 & nn. 77-78 (2010) (stating that “Rule 10b5-1 plans give insiders an incentive to accelerate the release of good news ahead of planned stock sales and to delay the release of bad news until after the sales are completed . . . As a practical matter, manipulation of the announcement's timing would be extremely difficult to prove because insiders are not required to disclose their 10b5-1 plans and firms seldom disclose a schedule for corporate announcements in advance . . .”); Karl T. Muth, With Avarice Aforethought: Insider Trading and 10b5-1 Plans, 10(1)

U.C. Davis Business Law Journal,

65-82, at 71 & nn. 32-33 (2009) (stating that “executives can participate in the timing of news . . . about the company. Withholding or `timing' news allows the executive to (imperfectly) time market response to news . . .”); John Shon and Stanley Veliotis, Meeting or Beating Earnings Expectations, 59(9)

Management Science,

1988-2002 (2013) (finding that “firms with insider sales executed under Rule 10b5-1 plans exhibit a higher likelihood of meeting or beating analysts' earnings expectations (MBE) . . . [that] this relation between MBE and plan sales is more pronounced for the plan sales of chief executive officers (CEOs) and chief financial officers (CFOs) and is nonexistent for other key insiders,” and concluding that “[o]ne interpretation of [their] results is that CEOs and CFOs who sell under these plans may be more likely to engage in strategic behavior to meet or beat expectations in an effort to maximize their proceeds from plan sales”).

Investor recognition of the potential incentive distortions and the risk of lower-quality corporate disclosures resulting from insider trading, as well as the risk of buying shares from a better informed inside seller, is likely to decrease investor confidence in the issuer and make investors less willing to buy or hold the issuer's shares (trading against informed insiders generates what is known as “adverse selection”).

107

This in turn could have negative effects on capital formation and the ability to fund investments, due to challenges in raising the required amount of capital.

107

See, e.g.,

Lawrence M. Ausubel, Insider Trading in a Rational Expectations Economy, 80(5)

American Economic Review

1022-1041 (1990) (showing in a rational expectations model that “[i]f `outsiders' expect `insiders' to take advantage of them in trading, outsiders will reduce their investment. The insiders' loss from this diminished investor confidence may more than offset their trading gains. Consequently, a prohibition on insider trading may effect a Pareto improvement.”). Further, informed trading by insiders can reduce the incentive for outside investors to acquire information.

See

Michael J. Fishman and Kathleen M. Hagerty, Insider Trading and the Efficiency of Stock Prices, 23(1)

RAND Journal of Economics,

106-122 (1992).

Turning to the effects on the market as a whole, the risk of trading against informed insiders trading on MNPI negatively affects market integrity and erodes investor confidence in the

secondary trading market, deterring traders that do not have the advantage of MNPI. Insider trading is also likely to adversely affect price efficiency

108

and liquidity.

109

108

A number of studies demonstrate adverse effects of insider trading on market efficiency.

See, e.g.,

Michael J. Fishman and Kathleen M. Hagerty, Insider Trading and the Efficiency of Stock Prices, 23(1)

RAND Journal of Economics,

106-122 (1992) (showing that “under certain circumstances, insider trading leads to less efficient stock prices. This is because insider trading has two adverse effects on the competitiveness of the market: It deters other traders from acquiring information and trading, and it skews the distribution of information held by traders toward one trader.”); Zhihong Chen and Yuan Huang, Yuanto Kusnadi, and K.C. John Wei, The Real Effect of the Initial Enforcement of Insider Trading Laws, 45

Journal of Corporate Finance,

687-709 (2017) (finding evidence that the initial enforcement of insider trading laws “improves capital allocation efficiency by increasing price informativeness and reducing market frictions”); Robert M. Bushman, Joseph D. Piotroski, and Abbie J. Smith, Insider Trading Restrictions and Analysts' Incentives to Follow Firms, 60(1)

Journal of Finance,

35-66 (2005) (arguing that “insider trading crowds out private information acquisition by outsiders” and showing that “analyst following increases after initial enforcement of insider trading laws” in a cross-country sample); Nuno Fernandes and Miguel A. Ferreira, Insider Trading Laws and Stock Price Informativeness, 22(5)

Review of Financial Studies

1845-1887 (2009) (finding that price informativeness increases with the enforcement of insider trading laws, but only in countries with a strong “efficiency of the judicial system, investor protection, and financial reporting”).

See also

Alexander P. Robbins, The Rule 10b5-1 Loophole: An Empirical Study, 34

Review of Quantitative Finance and Accounting,

199-224 (2010) (finding, in a sample of 10b5-1 plans of 81 NASDAQ-listed companies from 2004 to 2006 that “10b5-1 plans have a significant negative effect on the liquidity of a firm's shares, and therefore the firm's cost of capital”). Some studies argue that insider trading improves price efficiency.

See, e.g.,

Hayne E. Leland, Insider Trading: Should It Be Prohibited?, 100(4)

Journal of Political Economy,

859-887 (1992) (showing in a model that “stock prices better reflect information” when insider trading is permitted.); Utpal Bhattacharya, Hazem Daouk, Brian Jorgenson, and Carl-Heinrich Kehr, When an Event is Not an Event: The Curious Case of An Emerging Market, 55(1)

Journal of Financial Economics,

69-101 (2000) (suggesting “that unrestricted insider trading causes prices to fully incorporate the information before its public release”);

see generally

Henry G. Manne, Insider Trading and the Stock Market (1966). A reduction in insider trading can have nuanced effects on market efficiency. For example, the conclusions about the effect on insider trading on market efficiency may depend on whether the framework is static or dynamic.

See

David Easley, Soeren Hvidkjaer, and Maureen O'Hara, Is Information Risk a Determinant of Asset Returns? 57(5)

Journal of Finance,

2185-2221 (2002).

109

Various studies show that insider trading negatively impacts liquidity. For example,

see

Raymond P.H. Fishe and Michel A. Robe, The Impact of Illegal Insider Trading in Dealer and Specialist Markets: Evidence From a Natural Experiment, 71(3)

Journal of Financial Economics,

461-488 (2004); Louis Cheng, Michael Firth, T.Y. Leung, and Oliver Rui, The Effects of Insider Trading on Liquidity, 14(5)

Pacific-Basin Finance Journal

467-483 (2006); Hayne E. Leland, Insider Trading: Should It Be Prohibited? 100(4)

Journal of Political Economy,

859-887 (1992) (showing in a model that “markets are less liquid” and “outside investors and liquidity traders will be hurt” when insider trading is permitted); Laura N. Beny, Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence, 7(1)

American Law and Economics Review,

144-183 (2005) (finding that “countries with more prohibitive insider trading laws have more diffuse equity ownership, more accurate stock prices, and more liquid stock markets”); Lawrence R. Glosten, Insider Trading, Liquidity, and the Role of the Monopolist Specialist, 62(2),

Journal of Business

211-235 (1989) (showing in a model that insider trading reduces liquidity). However, another study does not find a negative effect of insider trading on liquidity.

See e.g.,

Charles Cao, Laura C. Field, and Gordon Hanka, Does Insider Trading Impair Market Liquidity? Evidence from IPO Lockup Expirations, 39(1)

Journal of Financial and Quantitative Analysis,

25-46 (2004).

2. Certain Rule 10b5-1 plan

110

trading

practices may raise concerns about potential insider trading.

110

For purposes of this economic analysis, the terms “Rule 10b5-1 trading arrangements” and “Rule 10b5-1 plans” are used to refer to the trading arrangements reliant upon the affirmative defense of Rule 10b5-1(c)(1), in line with the use of these terms in the academic research on this topic.

Over the years concerns have been raised that persons have engaged in securities trading based on MNPI while availing themselves of the Rule 10b5-1(c)(1) affirmative defense.

111

Examples of practices that have raised concerns include the strategic cancellation of previously adopted plans or individual trades on the basis of MNPI,

112

as well as initiation or resumption of trading close in time to plan adoption or modification.

113

111

See, e.g., See

Recommendations of the Investor Advisory Committee Regarding Rule 10b5-1 Plans (Sept. 9, 2021), at

https://www.sec.gov/spotlight/investor-advisory-committee-2012/20210916-10b5-1-recommendation.pdf;

Letter from David Larcker, March 10, 2021,

available at https://www.sec.gov/comments/s7-24-20/s72420-8488827-229970.pdf;

Letter from Council of Institutional Investors (CII), April 22, 2021,

available at https://www.sec.gov/comments/s7-14-20/s71420-8709408-236962.pdf;

Letter from CII, March 18, 2021,

available at https://www.sec.gov/comments/s7-24-20/s72420-8519687-230183.pdf;

Letter from CII, September 25, 2020,

available at https://www.sec.gov/comments/s7-06-20/s70620-7843308-223819.pdf;

Letter from CII, December 13, 2018,

available at https://www.sec.gov/comments/s7-20-18/s72018-4766666-176839.pdf;

Letter from CII, July 11, 2018,

available at https://www.cii.org/files/July%2011%202018%20SEC%20Reg%20Flex%20Letter%20Final.pdf;

Letter from CII, February 12, 2018, available at

https://www.sec.gov/comments/s7-07-17/s70717-3025708-161898.pdf;

Letter from CII to The Honorable Jay Clayton, January 18, 2018,

available at http://www.cii.org/files/issues_and_advocacy/correspondence/2018/January%2018%202018%20Rule%2010b5-1%20(finalI).pdf;

Letter from CII, July 8, 2016,

available at https://www.sec.gov/comments/s7-06-16/s70616-49.pdf;

Letter from CII to The Honorable Mary Jo White, May 9, 2013,

available at http://www.cii.org/files/issues_and_advocacy/correspondence/2013/05_09_13_cii_letter_to_sec_rule_10b5-1_trading_plans.pdf;

CII Rulemaking Petition.

112

See, e.g.,

Jill E. Fisch, Testimony before the Investor Protection, Entrepreneurship, and Capital Markets Subcommittee, U.S. House Committee on Financial Services, Insider Trading and Stock Option Grants: An Examination of Corporate Integrity in the Covid-19 Pandemic, September 17, 2020,

available at https://docs.house.gov/meetings/BA/BA16/20200917/111013/HHRG-116-BA16-Wstate-FischJ-20200917.pdf,

at p. 5; Alan D. Jagolinzer, SEC rule 10b5-1 and Insiders' Strategic Trade, 55(2)

Management Science,

224-239 (2009) (finding “for a sample of 54 firms for which there is public disclosure of early sales plan terminations” that “early sales plan terminations are associated with pending positive performance shifts, reducing the likelihood that insiders' sales execute at low prices”); Stanley Veliotis, Rule 10b5-1 Trading Plans and Insiders' Incentive to Misrepresent, 47(2)

American Business Law Journal,

313-360, at 328-30 (2010) (discussing concerns related to selective cancellations); Taylan Mavruk and Nejat H. Seyhun, Do SEC's 10B5-1 Safe Harbor Rules Need to Be Rewritten,

Columbia Business Law Review,

133-183, at 165, 168-71 (2016) (discussing selective cancellation concerns, providing indirect evidence, and concluding that its findings are “consistent with the hypothesis that insiders intervene in their planned transactions to increase profitability”).

See also

Stephen L. Lenkey, Cancellable Insider Trading Plans: An Analysis of SEC Rule 10b5-1, 32(12)

Review of Financial Studies,

4947-4996 (2019) (concluding, in a theoretical framework, that “[b]ecause the conditions under which the insider elects to adopt a plan often coincide with the conditions under which the termination option reduces welfare, an alternative regulatory framework wherein the insider could adopt a non-cancellable plan (and, thereby, credibly commit to execute his planned trade) would improve the investors' welfare under a wide set of circumstances.”)

113

For a discussion of the evidence of returns following insider trades occurring close to plan adoption, s

ee infra

notes 123-131 and accompanying and preceding text.

But see infra

notes 132-138 and accompanying and following text. Existing disclosure does not provide data on plan cancellations or plan modifications (including cancellations of planned trades).

As discussed in detail in Section II above, the Commission is proposing several amendments to address these practices, including additional disclosure requirements for insider and issuer trading plans under Item 408 of Regulation S-K; additional disclosure of Rule 10b5-1 plan use in beneficial ownership forms; and modifications to the conditions of the affirmative defense under Rule 10b5-1(c)(1) (introducing cooling-off periods following the adoption of a new or modified plan; certification requirements; and restrictions on single-trade plans and multiple overlapping plans for open market trades in the same class of securities and single-trade plans). Disclosure requirements significantly affect the underlying behavior of insiders and issuers by drawing scrutiny of investors and other market participants to insider trading practices.

114

114

Studies have found evidence that changes in mandatory disclosure affect behavior.

See, e.g.,

Elizabeth C. Chuk, Economic Consequences of Mandated Accounting Disclosures: Evidence from Pension Accounting Standards, 88(2)

Accounting Review,

395-427 (2013); Alice Adams Bonaimé, Mandatory Disclosure and Firm Behavior: Evidence from Share Repurchases, 90(4)

Accounting Review,

1333-1362 (2015).

Combined, the proposed amendments are expected to reduce the potential for insider trading through Rule 10b5-1

plans and other trading arrangements by insiders and companies. As discussed above, deterring insider trading would result in benefits for investor protection, capital formation, and orderly and efficient markets. By deterring insider trading, the amendments would disincentivize insider behavior that is likely to harm the securities markets and undermine investor confidence.

3. Current levels of disclosure about insider and issuer trading plans limit the ability of investors to identify the risk of insider trading and consider the associated incentive conflicts and information asymmetries in their investment decisions.

Existing gaps in the disclosure framework limit the information currently available to investors and other market participants regarding the use of insider and issuer trading plans, and the extent to which trading based on MNPI potentially distorts insider incentives with respect to corporate decisions (and thus shareholder value). Besides limiting the ability of investors to correctly value the company's shares, and thus make informed investment decisions, such disclosure gaps limit the ability of the Commission staff to perform market surveillance with regard to Exchange Act Section 10(b) and Rule 10b-5, with the associated adverse consequences for investor protection.

The proposed disclosure amendments would provide greater transparency to investors and decrease information asymmetries between insiders and outside investors about insiders' and companies' trading arrangements and associated policies and procedures, enabling more informed decisions about whether to invest in the company's shares and at what valuation. This might result in more efficient capital allocation and more informationally efficient pricing. The proposed additional disclosure requirements might also indirectly yield potential capital formation benefits if they increase investor confidence in the company's governance.

4. The economic effects of the proposed amendments are in some cases uncertain.

The discussed economic effects of the proposed amendments may be uncertain or difficult to generalize.

An important factor contributing to the uncertainty about the magnitude of the benefits of the proposed amendments to Rule 10b5-1 is the potential for substitution between Rule 10b5-1 plans and other trading arrangements. The use of the Rule 10b5-1(c)(1) affirmative defense is voluntary. Insiders and companies may elect to pursue other trading arrangements if they perceive the costs of relying on that affirmative defense are too high. For example, companies may instead rely on the Rule 10b5-1(c)(2) affirmative defense. The application of the proposed disclosure requirements of new Item 408 of Regulation S-K to all officer, director, and company trading plans (including plans not under Rule 10b5-1) is expected to partly mitigate this concern.

The considerations presented above are generally applicable to the proposed amendments as a whole. In the sections that follow we provide a more detailed discussion of economic effects of the particular proposed amendments, including the expected costs and benefits relative to the market baseline, as well as reasonable alternatives.

B. Amendments to Rule 10b5-1(c)(1)

The Commission is proposing additional conditions that must be satisfied for a trading arrangement to be eligible for the Rule 10b5-1(c)(1) affirmative defense. These amendments are intended to protect investors by decreasing opportunities for officers, directors, and companies to profit from MNPI through such trading arrangements.

The proposed amendments would narrow the conditions under which the Rule 10b5-1(c)(1) affirmative defense would be available. First, the proposed amendments would establish mandatory cooling-off periods before any trading could commence under a Rule 10b5-1 trading arrangement by an officer, director, or issuer after the adoption of a new or modified trading arrangement. Second, the proposed amendments would eliminate the availability of the affirmative defense for multiple overlapping trading arrangements for open market transactions in the same class of securities, as well as limit single-trade plans to a maximum of one in a 12-month period. Third, the proposed amendments would impose a certification requirement as a condition of the Rule 10b5-1(c)(1) affirmative defense for trading arrangements of officers and directors. In addition, the proposed amendments would broaden the good faith provision, which is a condition of the 10b5-1(c)(1) affirmative defense.

1. Baseline and Affected Parties

We consider the economic effects of the proposed amendments in the context of the regulatory and market baseline. A lack of comprehensive disclosure of Rule 10b5-1 trading arrangements makes it more difficult to provide complete data on existing Rule 10b5-1 practices and affected plan participants. Our estimates are limited by the voluntary nature of the Rule 10b5-1 disclosure in beneficial ownership filings, where insider trades are reported, as well as the limited scope of Rule 10b5-1 trades for which Form 144 reporting is required.

115

Based on beneficial ownership filings (Forms 3, 4, and 5) during the 2020 calendar year, approximately 4,900 natural persons at approximately 1,400 companies reported trades under Rule 10b5-1 trading arrangements. This figure includes approximately 4,800 officers and directors at 1,400 companies; narrowing it to officers yields an estimate of approximately 3,900 officers at 1,200 companies.

116

Due to the data limitations mentioned above, the actual number of affected parties is likely to be larger.

115

Form 144 must be filed with the Commission by an affiliate as a notice of the proposed sale of (restricted) securities when the amount to be sold under Rule 144 during any three-month period exceeds 5,000 shares or units or has an aggregate sales price in excess of $50,000.

See https://www.investor.gov/introduction-investing/investing-basics/glossary/form-144.

Thus, Rule 10b5-1 plan trades below that threshold are not required to be reported on Form 144 and thus may not be in our data. Further, because the vast majority of Form 144 filings are made in paper form during the considered period, we rely on information from such paper filings extracted and processed by the vendor for the Thomson Reuters/Refinitiv insiders dataset.

116

The estimate is based on the data from filings on Forms 3, 4, and 5 for trades during calendar year 2020 that reported Rule 10b5-1 plan use (obtained from Thomson Reuters/Refinitiv insiders dataset). The estimate only captures natural persons with Rule 10b5-1 plans that have Section 16 reporting obligations, and thus likely represents a lower bound on the number of affected plan participants. Officers and directors are identified based on the role code (beneficial owners and affiliates are not included in the count). Combining data from Form 144 filings with planned sale dates in calendar year 2020 that reported Rule 10b5-1 plan use (also obtained from Thomson Reuters/Refinitiv insiders dataset) and the data from filings on Forms 3, 4, and 5 cited above, we estimate that approximately 5,800 natural persons at approximately 1,500 companies (which includes 5,000 officers and directors at 1,400 companies; or when limited to officers only, approximately 4,100 officers at 1,300 companies) reported trades under Rule 10b5-1. Due to gaps in the reporting regime, we cannot be certain whether the higher prevalence of plans reported for officers is due to their higher prevalence in general or due to greater disclosure of such plans.

Below we discuss the available evidence on Rule 10b5-1 plans of officers, directors, and other natural persons. A recent academic study analyzed Form 144 data on insider trades under Rule 10b5-1 plans during January 2016-May 2020.

117

The study

documents “[t]he mean (median) cooling-off period is 117.9 (76) days. Approximately 14 percent of plans commence trading within the first 30 days, and 39 percent within the first 60 days. These represent very short cooling-off periods. 82 percent of plans commence trading within 6 months.”

118

As a caveat, the available data do not indicate whether the trading time frames are due to an issuer's policies (

i.e.,

whether there is a “cooling-off period” is not known—only the time between plan adoption and the first trade, which could be viewed as the “effective cooling-off period”, is calculated).

117

See

David F. Larcker, Bradford Lynch, Philip Quinn, Brian Tayan, and Daniel J. Taylor, Gaming the System: Three Red Flags” of Potential 10b5-1 Abuse, Stanford Closer Look Series, January 19, 2021 (“Larcker et al. (2021)”) (2021). The study presents novel data “on all sales of restricted stock filed on Form 144 between January 2016 and May

2020 and the adoption date of any corresponding 10b5-1 plans. . . In total, we have data on 20,595 plans, which covers the trading activity by 10,123 executives at 2,140 unique firms. These plans are responsible for a total of 55,287 sales transactions totaling $105.3 billion during our sample period. Average (median) trade size is $1.9 million ($0.4 million) . . .” The analysis based on Form 144 data has the advantage of not being subject to voluntary reporting bias. However, as a caveat, planned resales reported on Form 144 represent a subset of all trades and may not be representative of all Rule 10b5-1 trades by insiders (

e.g.,

of purchases, or of sales of unrestricted stock). By comparison, Mavruk and Seyhun (2016) examine a larger sample of plan trades identified by a voluntary Rule 10b5-1 checkbox on beneficial ownership forms. They examine transactions for “an average of 14,211 insiders in 3875 firms for each year between 2003 and 2013.”

See

Taylan Mavruk and Nejat H. Seyhun, Do SEC's 10B5-1 Safe Harbor Rules Need to Be Rewritten,

Columbia Business Law Review,

133-183 (2016). Relatedly, Hugon and Lee (2016) utilize a sample of “voluntary disclosures of 10b5-1 plan participation in SEC Form 4 filed between October 2000 and December 2010.”

See

Artur Hugon and Yen-Jung Lee, SEC Rule 10b5-1 Plans and Strategic Trade around Earnings Announcements,

Arizona State University and National Taiwan University

(Working Paper) (2016).

See also See

Rik Sen, Are Insider Sales Under 10b5-1 Plans Strategically Timed?,

New York University

(Working Paper) (2008); Eliezer M. Fich, Robert Parrino, and Anh L. Tran, When and How Are Rule 10b5-1 Plans Used for Insider Stock Sales?,

Drexel University, University of Texas at Austin, and City University of London

(Working Paper) (2021) (also utilizing Form 4 data). Data on Rule 10b5-1 trades by issuers is not available.

118

See

Larcker et al. (2021).

Using Form 144 data provided by The Washington Service for a more recent period (January 2, 2018-October 19, 2021), we find that the median (mean) cooling off period is 72 (105) days, with 13.5 percent of first trades pursuant to a plan occurring within thirty days of the plan date and 40.7 percent occurring within 60 days of the plan date.

119

Shorter cooling off periods are also associated with higher trade sizes as trades occurring within 90 days of plan adoption have a median size of $670,000 compared with a median size of $378,000 for those trades occurring more than six months after plan adoption. Further, single-trade plans constitute approximately 40% of plans during the time period examined.

119

13.5 percent of trades occur within 0-30 days. 27.2 percent of trades occur within 31-60 days, and 22.6 percent within 61-90 days. In total, 63.3 percent of trades occur within 90 days of the plan date and 83.7 percent of plans commence trading within six months.

A 2016 industry survey also examined Rule 10b5-1 plan practices at public companies.

120

In the survey (i) 77 percent of the respondents had a mandatory cooling-off period of 60 days or less and a cooling-off period of 30 days was the most common cooling-off period among respondents (41 percent); (ii) 98 percent of the respondents reviewed and approved insiders' Rule 10b5-1 plans to some degree; (iii) 55 percent of the respondents allowed termination of plans and 40 percent of the respondents allowed modification of plans; and (iv) 18 percent of respondents allowed insiders to maintain multiple overlapping plans, while 82 percent disallowed multiple overlapping plans.

121

120

See

Defining the Fine Line: Mitigating Risk with 10b5-1 Plans, Morgan Stanley/Shearman & Sterling LLP,

available at https://advisor.morganstanley.com/capitol-wealth-management-group/documents/field/c/ca/capitol-wealth-management-group/Defining_the_Fine_LineLocked_Version.pdf.

The survey included public company members of the Society of Corporate Secretaries & Governance Professionals. The respondents and their practices related to Rule 10b5-1 plans are not necessarily representative of all companies subject to the proposed amendments and their Rule 10b5-1 plan policies and practices. Separately, the survey stated that that 51 percent of S&P 500 companies had Rule 10b5-1 plans in 2015.

121

Id.

Various studies have sought to examine the potential use of MNPI for trading under Rule 10b5-1 by looking at the returns around trades under such plans (with the caveats about data availability). Larcker et al. (2021) document abnormal profits following some Rule 10b5-1(c)(1) trades, which is indicative of potential informed trading by insiders under such plans. For example, the study shows abnormal industry-adjusted returns over a six-month period following the first sale to be −2.5 percent for plans with a cooling-off period of less than 30 days and −1.5 percent for plans with a cooling-off period of between 30 and 60 days, but no evidence of such a post-insider sale price drop when the cooling-off period was longer than 60 days. The study also finds that the abnormal return is between −2 percent and −3 percent for plans that execute a sale in the window between when the plan is adopted and that quarter's earnings announcement, but no price drop is found following sales after the earnings announcement. Similarly, they find that insider sales under all single-trade plans are associated with a share price decrease after the sale.

122

Negative abnormal returns after insider sales under Rule 10b5-1(c)(1) plans indicate potential informed trading by insiders ahead of negative news. A lack of such negative returns after insider sales under plans with longer cooling off periods is suggestive of inside information becoming stale during the cooling off period, though it could also indicate low statistical power. Similarly, a lack of negative returns when insider sales occur after the quarter's earnings announcement may suggest less potential for informed selling once the earnings information has been made public; while this result could also indicate low power, it is intuitive that information is more evenly shared following the earnings announcement.

123

122

The data does not show the dates of all scheduled trades, only the dates of executed trades. Thus, some “single-trade” plans may be multi-trade plans in progress, or multi-trade plans with all but one trade cancelled.

123

As a caveat, the tests of statistical significance of the differences are not shown, so we cannot assess whether the economic differences discussed above have statistical significance.

Several other studies document abnormal returns following trading by insiders who use Rule 10b5-1 plans. For example, a 2009 study of the use of Rule 10b5-1 plans finds that “[p]articipating insiders' sales systematically follow positive and precede negative firm performance, generating abnormal forward-looking returns larger than those earned by nonparticipating colleagues,” that “a substantive proportion of randomly drawn plan initiations are

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