by Mikha Romero
On December 14, 2022, the Securities and Exchange Commission (SEC) adopted several amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) to increase investor protections against insider trading. The amendments enhance the disclosure requirements for issuers and revise the conditions of the Rule 10b5-1(c)(1) affirmative defense to insider trading liability under §10(b) and Rule 10b-5. The new conditions to the affirmative defense include: (1) cooling-off periods for directors, officers, and persons other than issuers (non-issuers); (2) director and officer representations; (3) restrictions on multiple Rule 10b5-1 plans; (4) limitations to single-trade arrangements; and (5) an expansion of the good faith requirement contained in the former rule. The amendments became effective on February 27, 2023.
I. Overview of the Rule 10b-5 Prohibition Against Securities Fraud
Congress initially enacted the federal securities laws to “[p]romote fair and transparent securities markets, avoid frauds, and . . . achieve a high standard of business ethics in the securities industry.” Insider trading and the fraudulent misuse of material, nonpublic information by corporate insiders (insiders) harm individual investors and undermine the securities markets by eroding investor confidence. Therefore, the regulations proscribing fraudulent practices are essential to maintaining fairness and integrity within the U.S. securities markets.
Traders primarily commit securities fraud through the use of insider trading practices. Insider trading is a term of art generally referring to any unlawful trading by persons possessing material, nonpublic information, regardless of whether the trader is truly an insider. Originally, Congress dealt with this problem by enacting § 16, which forces full disclosure on issuers, provides a scheme for reporting insider transactions, and bars short-swing trading for certain investors. However, those mechanisms did not address the full range of possible trading abuses. Today, the most important regulatory tool against insider trading is Rule 10b-5.
Rule 10b-5 is an SEC regulation that prohibits securities fraud. In 1942, the SEC promulgated Rule 10b-5 under § 10(b) of the Exchange Act, which authorizes the SEC to regulate securities fraud. Rule 10b-5 provides that it is unlawful to: (1) employ any device, scheme, or artifice to defraud; (2) make any untrue statement of a material fact or omit a material fact; and (3) engage in any fraudulent or deceitful act, practice, or course of business. The Supreme Court of the United States has recognized that the “manipulative or deceptive device[s]” prohibited by Rule 10b-5 include the purchase or sale of any security based on material, nonpublic information in breach of a duty owed to the issuer, the issuer’s shareholders, or any person who is the source of the information.
II. Overview of the Rule 10b5-1 Affirmative Defense
In 2010, the SEC adopted Rule 10b5-1 to clarify the meaning of “manipulative or deceptive device[s] or contrivance[s],” which are prohibited under § 10(b) and Rule 10b-5. Rule 10b5‑1(b) provides that a purchase or sale of a security is made on the basis of material, nonpublic information if the buyer or seller (trader) was aware of the material, nonpublic information when making the purchase or sale. Most notably, however, Rule 10b5-1(c) establishes an affirmative defense to liability under § 10(b) and Rule 10b-5 for insider trading. The affirmative defense “cover[s] situations in which a person can demonstrate that the material nonpublic information did not factor into the trading decision.” Thus, an investor has an affirmative defense to insider trading claims when he or she can show that material, nonpublic information did not factor into the decision to trade a specific security.
Originally, the Rule 10b5-1 affirmative defense provided that a trade was not based on material, nonpublic information if the trader could demonstrate, among other things, that the trade was made pursuant to: (1) a binding contract; (2) an instruction to another person to execute the trade for the instructing person’s account; or (3) a written plan (Rule 10b5-1 plan) for the trading of securities which was adopted when the person was not aware of material, nonpublic information. The SEC noted that this defense provides flexibility to traders who would like to plan securities transactions when they are unaware of material, nonpublic information. In that case, an investor may subsequently carry out those pre-planned transactions even if he or she later becomes aware of material, nonpublic information. However, despite the SEC’s intentions to enhance anti-fraud regulations, the original Rule 10b5‑1 affirmative defense was increasingly used to bypass securities regulation and disguise fraudulent securities trading.
A. Problems Under the Former Rule 10b5-1
Several SEC comment letters expressed the concern that insiders abuse the Rule 10b5-1 affirmative defense by using the rule to trade securities while relying on material, nonpublic information. Such use of material, nonpublic information “harm[s] investors and undermine[s] the integrity of the securities markets.” Courts, commentators, and members of Congress are likewise concerned that insiders often benefit from these liability protections while trading securities based on material, nonpublic information.
For example, several courts in securities actions have noted that clever insiders might use their knowledge of an impending stock price drop and seek to disguise their conduct under a Rule 10b5-1 plan. Additionally, academic studies have noted that insiders trading under Rule 10b5-1 consistently outperform the trades made by insiders without Rule 10b5-1 plans. Another concern relates to insiders adopting multiple, overlapping Rule 10b5-1 plans and later cancelling certain trades under the plans after gaining knowledge of material, nonpublic information.
In response to these concerns, in September 2021, the SEC’s Investor Advisory Committee (IAC) recommended that the SEC establish “necessary guardrails around the adoption, modification, and cancellation of Rule 10b5-1 trading plans,” by addressing the gaps in Rule 10b5-1 that allow insiders to exploit the affirmative defense. On January 13, 2022, the SEC proposed several amendments to Rule 10b5-1 to address these potentially abusive practices. After considering over 160 comment letters on the proposed amendments, the SEC issued the final rule on December 14, 2022. The final rule enacted several amendments to the conditions of the Rule 10b5-1 affirmative defense, in addition to creating new reporting obligations. This blog post’s primary focus is on the substantive amendments and additions to Rule 10b5-1 as opposed to the new reporting requirements that are contemplated under the revised rule.
B. The 2023 Amendments to Rule 10b5-1
The SEC adopted the following amendments to Rule 10b5-1 to reduce opportunities for insiders to misuse Rule 10b5-1 as a tool to trade on material, nonpublic information. The amendments to the Rule 10b-5 affirmative defense include: (1) cooling-off periods for directors, officers, and non-issuers; (2) director and officer representations; (3) restrictions on multiple Rule 10b5-1 plans; (4) limitations to single-trade arrangements; and (5) an expansion of the good faith requirement contained in the former rule. These amendments became effective on February 27, 2023.
1. Requisite Cooling-Off Periods
Under the final amendments, the Rule 10b5-1 affirmative defense now includes a cooling-off period that applies to directors and officers and a shorter cooling off period applicable to all non-issuers. Specifically, under the final rule, a director or officer who adopts a Rule 10b5-1 plan cannot rely on the affirmative defense unless trading under the plan begins after the later of the following time periods. The first time period is 90 days after adopting the Rule 10b5-1 plan. The second time period is two business days following the disclosure of the issuer’s fiscal results in a Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted. For persons other than directors, officers, or issuers, the amended rule imposes a 30-day cooling-off period.
The cooling-off period applicable to officers and directors should deter opportunistic trading and prevent directors and officers from using Rule 10b5-1 plans for fraudulent purposes. This cooling-off period provides a separation in time between the adoption of the plan and commencement of trading under the plan. The separation in time should minimize an insider’s ability to benefit from the knowledge of any material, nonpublic information.
Under the former rule, certain insiders, such as directors and officers, frequently earned profits that were unavailable to others. For example, insiders generally have access to preliminary financial data before it is released to the public. According to academic commentary, “[q]uarterly earnings announcements . . . offer the most important and frequent dates of material information disclosure by firms.” As a result, this cooling-off period will prevent an insider from trading under a Rule 10b5-1 plan while he or she is aware of material, nonpublic information, such as directional trends in quarterly results.
A potential issue with the director and officer cooling-off period is that it may deter parties from creating Rule 10b5-1 plans in the future. In some situations, the 90-day cooling-off period or the cooling-off period occurring two business days after the disclosure of the issuer’s financial results may be longer than needed to prevent opportunistic trading. Although this cooling-off period is notably shorter than the 120-day period the SEC originally proposed, many traders will still likely view this requirement as an added headache and, thus, are more likely to opt out of any Rule 10b5-1 plans in the future.
The cooling-off period applicable to persons other than officers, directors, or issuers is 30 days following the adoption or modification of a Rule 10b5-1 plan. Similar to the cooling-off period applicable to officers and directors, this cooling-off period provides a separation in time between the adoption of a Rule 10b5-1 plan and the commencement of trading under the plan. The purpose of this cooling-off period is to minimize opportunistic trading on the basis of material, nonpublic information. Notably, the amendments do not add a cooling-off period for issuer repurchases. However, the SEC should continue to consider whether action is needed to mitigate any risk of investor harm from the misuse of Rule 10b5-1 plans by issuers.
2. Mandatory Director and Officer Representations
The amendments also added a certification condition for directors and officers to avail themselves of the Rule 10b5-1 affirmative defense. Under the final rule, if a director or officer adopts a Rule 10b5-1 plan as an affirmative defense, then he or she must include a representation in the plan certifying the following information. First, the director or officer must certify that at the time of the adoption of a new or modified plan he or she is unaware of any material, nonpublic information about the issuer. Second, the officer or director must certify that he or she is adopting the contract, instruction, or plan in good faith and not as part of a scheme to evade the prohibitions against fraud contained in Rule 10b-5. This heightened condition reinforces directors’ and officers’ awareness of their obligation to refrain from trading or entering into trading plans while aware of material, nonpublic information about the issuer.
These mandatory representations create another liability shield for directors and officers to hide behind. For example, in an insider trading action, a director or officer may now argue that he or she was unaware that the information he or she disclosed was material or nonpublic. Thus, this change has ultimately created a new way for directors and officers to avoid liability for insider trading and securities fraud.
Additionally, the standard for the new director and officer representations is unclear and difficult to apply. Because officers and directors often have access to information about the issuer, it may be difficult for them to ascertain and personally certify whether they are aware of information that qualifies as material and nonpublic. The SEC reiterated that the issue of whether a director or officer has material, nonpublic information is an “inherently fact-specific analysis.” However, without clearly defined parameters, the enforcement of this new certification will likely be difficult and increasingly arbitrary.
3. Prohibition Against Multiple Rule 10b5-1 Plans
The amendment further limits the ability of non-issuers to use multiple, overlapping Rule 10b5-1 plans. Corporate insiders frequently gain access to sensitive information about issuers, such as confidential financial information and reports. Previously, insiders regularly created multiple Rule 10b5-1 plans with the intent to cancel most of the plans after obtaining material, nonpublic information that would affect stock prices. For example, under the old rule, insiders could achieve a desired trading outcome by initially adopting several plans to sell their company stock at varying prices exceeding the current share price. Then, the insiders would subsequently cancel the plans authorizing the lowest prices after learning material, nonpublic information that would substantially increase the share price.
An insider’s knowledge of material, nonpublic information does not result in the cancellation of the affected securities. In practice, such a rule is impractical. Requiring the SEC to ascertain the extent of the information made available to all corporate insiders would place a heavy burden on the SEC, and insiders likely would not voluntarily report such information if they knew that it would result in the cancellation of their stock. Thus, the SEC was tasked with finding another solution to prevent insiders from using Rule 10b5-1 plans as a mechanism of stock manipulation.
Under the final rule, non-issuers can only maintain one Rule 10b5-1 contract, instruction, or plan for the purchase or sale of the issuer’s securities during the same time period. The prohibition covers directors, officers, and other non-issuers who are likely to possess material, nonpublic information. Ideally, the new prohibition against multiple Rule 10b5-1 plans will further inhibit corporate insiders from using trading plans as a means to effectuate the unlawful manipulation of stock prices and sales.
The SEC carved out several exceptions under which multiple Rule 10b5-1 plans are permissible. First, a series of separate contracts, instructions, or plans maintained with different broker-dealers are treated as a single plan. Second, non-issuers can maintain two separate Rule 10b5-1 plans for open-market purchases or sales if trading under the later plan is not authorized to commence until all trades under the earlier plan are completed or expired.
The prohibition against multiple 10b5-1 plans for non-issuers will likely increase investor confidence in fair trading practices because investors are now aware that corporate insiders are restricted from wrongfully profiting from these plans. Going forward, the SEC should consider enacting a similar rule that limits issuers’ ability to trade under multiple Rule 10b5-1 plans. The reassurance that issuers are also restricted from wrongfully profiting from Rule 10b5-1 plans would further enhance investor confidence in individual issuers and the overall securities market.
4. Limitation on Single-Trade Arrangements
The amendments placed an additional limitation on the number of times non-issuers can rely on the Rule 10b5-1 affirmative defense. Specifically, the amendments provide that non-issuers cannot rely on the defense more than one time for a single-trade plan during any consecutive 12-month period. The final rule provides that if the contract, instruction, or plan is designed to “effect the open-market purchase or sale of the total amount of securities as a single transaction,” then it will not benefit from the affirmative defense unless the following requirements are satisfied. First, the person entering the contract instruction, or plan, has not, during the prior 12 months, adopted another contract, instruction, or plan that was designed to effect the open-market purchase or sale of the total securities subject to that plan in a single transaction. Second, such other contract, instruction, or plan was eligible to receive the affirmative defense.
A plan is designed to effect the purchase or sale of securities as a single contract, instruction, or plan, when such contract, instruction, or plan has the effect of requiring such a result. A plan is not designed to cause such an effect when the plan leaves the person’s agent discretion over executing the contract, instruction, or plan as a single transaction.A plan is also not designed to cause a prohibited effect when the contract, instruction, or plan provides that the agent’s future acts depend on events or data unknown at the time the plan is entered into. Furthermore, it must be reasonably foreseeable when entering into the plan that the contract, plan, or instruction may result in multiple transactions.
The SEC adopted the limitation on single-trade plans because trading under multiple Rule 10b5-1 plans provides increasingly profitable opportunities for insiders who trade with knowledge of material, nonpublic information. A recent study found that trades taking place under a single-trade plan avoid losses that uninformed traders cannot avoid. As with the cooling-off periods, the limitation on single-trade plans does not apply to issuers. However, the SEC should further consider limiting single-trade plans for issuers to make it more difficult for issuers to engage in opportunistic trading based on access to material, nonpublic information.
5. Enhanced Good Faith Requirement
Finally, the amendments add a condition requiring all traders entering into a Rule 10b5-1 plan to act in good faith regarding that plan. The concept of good faith has been a component of Rule 10b5-1 since its original adoption over 20 years ago. However, Rule 10b5-1(c)(1)(ii) now includes the condition that the trader who entered into the Rule 10b5‑1 contract, instruction, or plan, has “acted in good faith with respect to” the contract, instruction, or plan. The purpose of this heightened condition is to deter insiders from taking actions to benefit from material, nonpublic information the insider acquires after establishing a Rule 10b5-1 plan.
This condition does not affect the availability of the affirmative defense under an existing Rule 10b5-1 plan unless such plan is modified after the effective date of the amendments. However, the SEC’s decision not to retroactively apply the amendments to all pre-existing Rule 10b5-1 plans could cause confusion among traders. It will likely be difficult for traders to determine whether modified plans require the heightened good-faith condition, and they must be aware of the rules applicable to old versus new Rule 10b5-1 plans. Thus, it is advisable for companies to update their corporate policies regarding the execution of new Rule 10b5‑1 plans, and it is also necessary to pay close attention to the modification of any past Rule 10b5-1 plans.
III. Looking Forward: Corporate-Law Considerations Following the Amendments
The preceding amendments apply to any pre-existing Rule 10b5-1 plan that is amended after February 27, 2023, and all new Rule 10b5-1 plans entered into after February 27, 2023. The adoption of these amendments requires several corporate-law considerations to remain in compliance with Rule 10b5-1. Specifically, buyers and sellers of securities should consider whether the mandatory cooling-off periods will apply to their amended and future Rule 10b5-1 plans.
Additionally, affected persons should consider adding the required director and officer representations to their internal form Rule 10b5-1 plans. Looking forward, affected persons should also take a detailed accounting of their existing Rule 10b5-1 plans and determine whether they fall under an exception to the prohibition against multiple plans or the limitation on single-trade arrangements. Lastly, officers, directors, and other buyers and sellers of securities should seek legal counsel to assist them in determining whether they have knowledge of material, nonpublic information to effectively satisfy the heightened good-faith requirement.
Overall, the recent amendments made to Rule 10b5-1 were overdue, and there should be significantly less opportunity for insider trading within the securities markets. However, companies, firms, and buyers and sellers of securities should thoroughly review the new rules that apply to their practices. Any modifications to pre-existing Rule 10b5-1 plans will likely trigger application of the new amendments, and all Rule 10b5-1 plans implemented after February 27, 2023, must comply with the new amendments. Looking ahead, the SEC should consider adding similar conditions to Rule 10b5-1 for issuers to further inhibit fraudulent trading practices based on knowledge of material, nonpublic information.
 See Press Release, Securities and Exchange Commission, SEC Adopts Amendments to Modernize Rule 10b5-1 Insider Trading Plans and Related Disclosures (Dec. 14, 2022), at 1. The SEC also added several new disclosure requirements to Rule 10b5-1. Id.
 Fact Sheet, Securities and Exchange Commission, Rule 10b5-1: Insider Trading Arrangements and Related Disclosure (Dec. 14, 2022), at 1–3.
 Final Rule, Securities and Exchange Commission, Insider Trading Arrangements and Related Disclosures, Securities Act Release No. 33-11138, Exchange Act Release No. 34-96492 (Dec. 14, 2022), at 2.
 Id. at 5 (quoting Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 151 (1972)).
 Id. (citing In re Cady, Roberts & Co., 40 S.E.C. 907 (1961)). Insider trading
refers to the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed . . . to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.
Id. (citing 17 C.F.R. § 240.10b5-1 (2023)).
 Cox et al., Securities Regulation Cases and Materials 832 (10th ed. 2022).
 Rule 10b-5, Cornell L. Sch. Legal Info. Inst., https://www.law.cornell.edu/wex/rule_10b-5 [https://perma.cc/5JN7-D8CY] (last visited Mar. 10, 2023).
 Final Rule, supra note 4, at 6 (citing Salman v. United States, 580 U.S. 39, 44 n.2 (2016)).
 Id. (citing Selective Disclosure and Insider Trading, Securities and Exchange Commission, Securities Act Release No. 33-7881 (Aug. 15, 2000), at 51727).
 Id. at 7 (citing Selective Disclosure and Insider Trading, supra note 17, at 51729).
 Id. (citing Selective Disclosure and Insider Trading, supra note 17, at 51728).
 Id. (citing Selective Disclosure and Insider Trading, supra note 17, at 51728).
 Id. at 1.
 17 C.F.R. § 240.10b5-1 (2023).
 Final Rule, supra note 4, at 8 (citing 17 C.F.R. § 240.10b-5(b) (1934)).
 Id. (citing Alan D. Jagolinzer, SEC Rule 10b5-1 and Insiders’ Strategic Trade, 55 Mgmt. Sci. 224 (2009)).
 Id. (citing “Waters and McHenry Introduce Bipartisan Legislation to Curb Illegal Insider Trading,” U.S. House Committee on Financial Services, (Jan. 18, 2019)).
 Id. (citing In re Immucor Inc. Sec. Litig., 1:05-CV-2276, 2006 WL 3000133, at *18 (N.D. Ga. Oct. 4, 2006)).
 Id. at 9.
 Id. (citing Jagolinzer, supra note 26, at 235; Taylan Mavruk & H. Nejat Seyhun, Do SEC’s 10b5-1 Safe Harbor Rules Need to Be Handwritten?, 2016 Colum. Bus. L. Rev. 133 (2016)).
 Id. at 10.
 Id. at 1.
 Id. at 12.
 Fact Sheet, supra note 3, at 1.
 Final Rule, supra note 4, at 2.
 Id. at 10.
 Id. at 27. Officer is defined as “an issuer’s president, principal financial officer, principal accounting officer, . . . any vice-president of the issuer in charge of a principal business unit, division or function, . . . any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer.” 17 C.F.R. § 240.16a-1(f) (2023). Further, “[o]fficers of the issuer’s parent(s) or subsidiaries [are also considered] officers of the issuer if they perform such policy-making functions for the issuer.” Id. This is the cooling off period for domestic issuers. The cooling off period applicable to foreign private issuers is the later of: “(1) 90 days after the adoption of the Rule 10b5-1 plan[;] or (2) two business days following the disclosure of the issuer’s financial results . . . in a Form 20-F or Form 6-K that discloses the issuer’s financial results.” Final Rule, supra note 4, at 27–28.
 Final Rule, supra note 4, at 27.
 Id. at 34.
 Id. at 28.
 Id. See, e.g., Jagolinzer, supra note 26; M. Todd Henderson et al., Offensive Disclosure: How Voluntary Disclosure Can Increase Returns from Insider Trading, 103 Geo. L.J. 1275 (2015); Mavruk & Seyhun, supra note 31. For example, “insiders may [have been] aware of material nonpublic information related to . . . upcoming events, such as a potential merger, acquisition, or departure of a named executive officer, and . . . adopt a Rule 10b5-1 plan [with such knowledge] and trade under [the plan] before the information is made public.” Final Rule, supra note 4, at 29.
 Final Rule, supra note 4, at 28 (quoting U. Ali & D. Hirshleifer, Opportunism as a Firm and Managerial Trait: Predicting Insider Trading Profits and Misconduct, 126 J. Fin. Econ. 490, 491 (2017)).
 Id. at 34.
 Id. at 36.
 Id. at 11.
 Id. at 41.
 Id. The final rule does not “require these personal certifications [in situations] where a director or officer terminates an existing Rule 10b5-1 plan . . . .” Id. at 41 n.137.
 Id. at 42.
 Id. at 43.
 Id. at 11.
 Id. at 55.
 Id. at 53.
 Id. at 11.
 Id. at 60.
 Id. at 61.
 Id. at 62.
 Id. (citing David Larcker et al., Gaming the System: Three “Red Flags” of Potential 10b5-1 Abuse, in Stan. Closer Look Series (Jan. 2021)).
 Id. at 11.
 Id. at 66.
 Id. at 1.
 Press Release, supra note 1, at 1.