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Best Practices Employee Conflicts of Interest Insider Trading MNPI & Enterprise Conflicts Regulations

Financial Regulatory Compliance: What to Know For 2023 – Part 1

As we head into 2023, Steve Brown, Managing Director at StarCompliance, assesses the state of financial services compliance and provides an overview of the key regulatory developments that regulated firms need to be aware of and prepare to comply with in the year ahead. In the first of his two-part blog series, Steve takes a look at insider trading and what the amendments to SEC Rule 10b5-1 mean for publicly traded companies (i.e. corporate issuers of securities).  

While compliance with market abuse regulations has long been a key focus for financial services firms, it has largely been in the peripheral vision of corporate issuers of securities, which have typically been more concerned with bribery, data protection, and supply chain compliance issues, among others.

In December 2022, the SEC adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934. Rule 10b5-1 was adopted over two decades ago to provide an affirmative defense against allegations of insider trading for engaging in transactions in securities, even while in possession of material nonpublic information at the time of trading, through plans that are set up in advance.

Since the adoption of the rule, academic studies have suggested that insiders with Rule 10b5-1 plans may achieve better returns than those not trading pursuant to Rule 10b5-1 plans. Those studies, as well as situations where insiders appeared to conduct especially profitable transactions pursuant to Rule 10b5-1 plans, created regulatory questions about the use of Rule 10b5-1 plans by issuers and insiders, which resulted in calls for change to the rule.

The following newly adopted amendments are designed to address those concerns and prevent corporate insider trading through 10b5-1 plans opportunistically on the basis of MNPI:

1. New cooling-off periods
Previously under Rule 10b5-1 plans, a corporate insider was not required to wait between adopting a new 10b5-1 Plan and making the first trade under such plan. The amended rule now mandates a “cooling-off” period between the adoption of a 10b5-1 plan and when trades may begin, although no cooling-off period is required for issuers.

2. Limitations on overlapping plans
Interestingly, the affirmative defense under Rule 10b5-1(c)(1) will not be available for any trades by persons, other than the issuer, that have established multiple overlapping trading arrangements. The rule precludes separate, overlapping arrangements even where each relates to a different class of securities of the same issuer. The rule will not restrict a person from maintaining separate trading arrangements at the same time, so long as trades under the later-commencing plan do not commence until the completion or expiration of the earlier plan. 

3. New representations 
Directors and officers are required to certify at the time of the adoption of a new or modified 10b5-1 Plan, that: (1) they are not aware of MNPI about the issuer or its securities, and (2) they are adopting the 10b5-1 Plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5. All other persons entering into a 10b5-1 plan must also certify they are acting in good faith when entering into such a 10b5-1 plan.

4. Enhanced disclosure 

  • Disclosure of trading arrangements: The amended Rule requires an issuer to disclose in a Form 10-Q or 10-K whether any director or officer has adopted, modified, or terminated any 10b5-1 Plan during the registrant’s last fiscal quarter.
  • Disclosure of insider trading policies and procedures: The amended Rule requires annual disclosure of an issuer’s insider trading policies and procedures, including disclosure regarding whether issuers have adopted such policies and procedures.
  • Option awards: The amended Rule requires an issuer to provide a discussion of its policies and practices regarding the timing of the awards of stock options and similar instruments in relation to the potential possession of MNPI by recipients, including how the board determines when to grant such awards and if the potential possession of MNPI by the recipient has been considered. 
  • CEO and CFO Liabilities: Note that certain of the new 10b5-1 related disclosures may not also be subject to the certifications required of the Sarbanes-Oxley, which require CEOs and CFOs to certify, amongst other things, that based on their knowledge, the form 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. As a result, these executives may have additional liability, which provides the SEC with a cause of action against CEOs and CFOs that make false certifications.

5. Reporting transactions and gifts 
In the proposing release, the SEC noted that the delayed reporting of gifts on Form 5 may allow Section 16 reporting persons to engage in what it perceives as problematic practices involving gifts of equity securities, such as making stock gifts while in possession of MNPI or backdating stock gifts to maximize the tax benefits associated with such gifts. The SEC sought to address these practices by requiring that all “bona fide” gifts of stock by Section 16 directors and officers be reported on Form 4 by the end of the second business day following the date of any such gift.

The amendments to Rule 10b5-1 significantly expand the requirements for public companies and insiders. As such, public companies may wish to consider taking the following actions:

  • Policies & Procedures: Review insider trading policies and procedures for directors and officers while allowing corporate insiders to achieve their liquidity goals. This may include reviewing and amending:
    • Pre-clearance requirements
    • Cooling-off periods
    • Limitations on overlapping plans
    • Restrictions on the number of single-trade plans
  • Training: Educate directors, officers, and corporate insiders on changes to the policies and procedures.
  • Monitoring and Notification: Processes for Compliance to receive necessary detailed information to monitor 10b5-1 plans to comply with trade execution, disclosure obligations and filings, and trading modifications and cancellations.
  • Gifts: Adopt disclosure and monitoring controls relating to the reporting of gifts on Form 4.
  • Reporting & Disclosures: provide board reporting on additional disclosure requirements regarding granting of stock options and other compensation programs in relation to SEC filings and events.

Automating as many manual compliance processes as possible is pivotal to remaining compliant in the evolving regulatory landscape. Compliance teams increasingly need to ‘do more with less’, which makes financial compliance software invaluable for increasing efficiency and driving growth, eliminating errors, reducing costs, and freeing up compliance officers to focus on critical tasks.

A technology solution designed to meet the stringent compliance requirements of regulated firms can effectively monitor and track employee compliance with the firm’s key policies. It will automate tedious, time-consuming, and error-prone manual processes and allow you to understand if the business is complying with regulatory requirements.

In addition to providing a 360-degree view of employee activity – with nothing falling through the cracks – financial compliance software helps ensure the security of sensitive information, ultimately protecting the firm’s reputation.  

Fireside Chat - Terry & Steve Brown_Blog CTA 2

Interested in learning more? Join Steve Brown, Gary Muchmore, and Terry Dawson for a virtual fireside chat and interactive Q&A on Wednesday, February 15, 2023, at 9AM ET, for a deeper dive into these topics and to address the latest regulatory shifts in 2023.