SEC Proposes Mandatory Disclosure of Rule 10b5-1 Trading Plans

Originally published on this site April 28, 2002


As yet another result of Enron, on April 12, 2002, the Securities & Exchange Commission proposed new disclosure obligations for stock transactions by directors and executive officers -- including mandatory disclosure of the adoption, modification, or termination of Rule 10b5-1 trading plans. Proposed Rule: Form 8-K Disclosure of Certain Management Transactions, Release No. 33-8090 et al. (the "Release"). The proposals are subject to written comments through June 24. This article sets forth the basic elements of the proposal, in advance of written comments to the SEC I will provide.

Why disclosure? According to the Release, the purpose of the proposed amendments "is to provide investors with prompt disclosure of this information, so that investors will be able to make investment and voting decisions on a better-informed and more timely basis."

One reason for requiring speedier disclosure is that speedier disclosure is possible: "Technological developments that significantly reduce timeframes for the capture and analysis of information necessitate a new consideration of the timing of mandated disclosure to the markets."

Another reason for requiring speedier disclosure is that it would be useful for investors: "We believe it would enable investors to make investment and voting decisions on a more timely and better informed basis, provide more timely information regarding management's view of company performance or prospects, protect investors, and promote fair dealing in company equity securities if companies were required to report additional information related to these subjects on a more current basis . . . We believe that these proposed reports would protect investors and promote fair dealing in the company's securities by enabling investors to make informed decisions on a more timely basis."

The SEC cites two reasons why the general type of information to be disclosed on a speedy basis would be probative to investors:

1.  Disclosure "might in some cases reveal shifts in the alignment between management's and shareholders' economic interests. Such reports, particularly with respect to derivative securities used by directors and executive officers for hedging purposes, also could disclose in some cases transactions . . . that might be construed as severing the link between executive compensation and company equity securities performance."

2.  Disclosure "would provide public investors timely disclosure of potentially useful information as to management's views of the performance or prospects of the company. Many public investors take the position that timely disclosure of these transactions is necessary for them to make informed investment decisions."

Most importantly for Rule 10b5-1 purposes, the SEC opined that required disclosure of trading plan information "may provide investors with more extensive disclosure of potentially useful information as to management's views of the performance and prospects of the company." In particular, the SEC claims, a termination or modification of a trading plan "may indicate a change regarding the company's prospects, and thus may be valuable information to investors." Here, the SEC may be criticized for undermining the rationale for trading plans. A key purpose for recognizing trading plans is to allow officers, directors, and other insiders to plan their stock transactions without the fear that they will be accused of insider trading (and, in my opinion, securities fraud). The SEC should not suggest that an insider's adoption, modification, or termination of a trading plan implies that the insider is acting based on his or her assessment of the company's performance and prospects.

Disclosure of current reports of company (or company affiliate) loans and guarantees of third-party loans "would inform investors of financial arrangements not generally available to shareholders that may result in the receipt of de facto additional compensation by the director or executive officer." Such financial arrangements "involve the use of company assets for arrangements that are not available to shareholders generally. Further, forgiveness of a loan (or the company's payment on its guarantee) effectively results in the company's payment to the director or executive officer of additional compensation."

What form of disclosure? The SEC proposes disclosure under a new item, Item 10, of Form 8-K, a non-periodic type of report used to disclose information on an immediate basis. As noted above, the SEC asks for this speedy disclosure because it can be done, and it would be helpful if it was done. In addition, in yet another refreshing recognition of the value of Internet-accessible disclosure, the SEC is turning to Form 8-K because those forms are filed electronically: "Section 16(a) requires disclosure that may be filed too slowly for the public to obtain the maximum benefit from the information, and the reports are not always readily accessible because they are not required to be filed electronically." Finally, as with many elements of Form 8-K, Item 10 would be subject to General Instruction B.3 to Form 8-K, which provides that "if substantially the same information required by Form 8-K has been previously reported by the company, an additional report need not be made on Form 8-K." Thus, if a company already had disclosed stock transactions or trading plans in a press release, as some companies have done, then they need not also file a Form 8-K.

Who discloses, and about whom? Issuers with securities registered under Section 12 of the '34 Act will be required to file a report if any director or executive officer engages in one of the transactions or events described below. The obligations do not apply to transactions by all Section 16 officers, only "executive officers"; nor to principal shareholders who are not directors or executive officers. In not extending the reporting obligations to transactions by principal shareholders, the SEC noted that these persons "may not be subject to the same fiduciary duties to the company as directors and executive officers"; "do not receive compensation from the company,"' and may have a relationship to the company that "in some cases may even be hostile" and which "does not necessarily facilitate current reporting by the company."

The divorce between who must disclose -- the issuer -- and the person whose transactions must be disclosed -- a director or executive officer -- means that companies will be obligated to pay even closer attention to their executive officers' and directors' stock-related transactions, in order to be able to disclose the information on a very tight schedule (see below). The SEC acknowledges this burden, and proposes a limited safe harbor for issuers:

"As a practical matter, a company would need to institute procedures and systems to assure Item 10 compliance. The general instruction would include a Commission finding that it is not in the public interest to impose any sanction on a company, notwithstanding a violation, that demonstrates that: (1) at the time of the violation, it had designed procedures and a system for applying such procedures sufficient to provide reasonable assurances that Item 10 events are timely reported; (2) at the time of the violation, the company followed those procedures; and (3) as promptly as reasonably practicable, the company made a filing to correct any violation."

However, "[r]epeated or systemic violations or those that otherwise are not isolated would suggest deficiencies in procedures or their application that would be inconsistent with availability of" the safe harbor. Moreover, the SEC nevertheless could proceed against a director or executive officer, although civil plaintiffs could not ("a private right of action would not arise"). Furthermore, the Release invites comment on whether companies should be be required to disclose any director's or executive officer's failure to comply with the company's procedures to insure Item 10 compliance.

There is one important additional element with respect to the scope of disclosure. As proposed, the trading plan disclosure "would apply based on the director's or executive officers' pecuniary interest in the securities subject to the contract, instruction or written plan." Thus, a trading plan "held by a member of an executive officer's immediate family, as defined in Exchange Act Rule 16a-1(e) [17 CFR 240.16a-1(e)], sharing the same household as the executive officer would be reportable." This is reflected in Instruction 3 to the proposed Item.


What must be disclosed? The following events must be disclosed under the proposed Item 10:

Item 10 paragraph (a): Transactions in company equity securities (including derivative securities transactions and transactions with the company). This includes any transaction "that is the economic equivalent of a sale," such as a pledge of company equity securities pursuant to a non-recourse loan (or it "there is otherwise an expectation on the part of the director or executive officer that the loan will be repaid by foreclosure or other recourse to the securities, even if there is no formal arrangement.").

Item 10 paragraph (b):"[A]rrangements for the purchase or sale of company equity securities intended to satisfy the affirmative defense conditions of Rule 10b5-1(c)" -- i.e., trading plans. This includes the "adoption, modification or termination of a contract, instruction or written plan . . ." under Rule 10b5-1(c). The SEC acknowledges that the required disclosure of this information is new: "Section 16(a) filings do not report two categories of information -directors' and executive officers' arrangements under Exchange Act Rule 10b5-1 and their receipt of loans from, or guaranteed by, the company or an affiliate of the company -- that we believe also are of significant informational value and should be reported on a current basis." Form 8-K disclosure would not be required to establish availability of the trading plan (10b5-1(c)) affirmative defense; rather, the purpose of the disclosure rule is disclosure.

Item 10 paragraph (c): Loans of money made or guaranteed by the company or an affiliate of the company.

As proposed, the company would not need to report trust transactions that would not be reportable by the director or executive officer under Section 16(a).


When disclosure? The timing requirements are very strict, and depend on the type of information about a director or executive officer to be disclosed:

Reports of actual securities transactions and loans with an aggregate value of $100,000 or more would be due within two business days. The Release characterizes these events as "events that would be of heightened significance to investors." The "accelerated deadline" required for disclosure "is intended to provide investors with rapid disclosure of the most significant events, while allowing the company sufficient time to compile the required information." The Release invites, and surely will receive, comments as to whether this deadline should be shorter or longer.

Reports of Rule 10b5-1 trading plans generally would be due by the close of business on the second business day of the following week.

Reports of transactions and loans between $10,000 and $100,000; and grants and awards pursuant to employee benefit plans, also would be due by the close of business on the second business day of the following week

Reports of transactions and loans with an aggregate value less than $10,000 would be deferrable until the aggregate cumulative value of those unreported events for the same director or executive officer exceeds $10,000.

The date of a reportable event is the date on which the parties enter into an agreement.


How much disclosure? With respect to an acquisition or disposition of company equity securities (Item 10 paragraph (a) above), the company would be required to report:

The name and title of the director or executive officer;

The date of the transaction;

The title and number of securities acquired or disposed of;

The per share acquisition or disposition price, if any;

The aggregate value of the transaction;

The nature of the transaction (e.g., open market sale or purchase, sale to or purchase from the registrant, gift); and

Any other material information regarding the transaction.

The Release invites comment on whether, "[i]f the transaction is pursuant to a Rule 10b5-1 arrangement, should this be noted?" It then asks whether the Rule 10b5-1 arrangement should be identified, so as to "enable investors to better analyze the possible 'market signal' value of the reported transactions?"


With respect to trading plans, when the director or executive officer enters into the plan, the company must report:

The name and title of the director or executive officer;

The date on which the director or executive officer entered into the contract, instruction or written plan; and

A description of the contract, instruction or written plan, including its duration, the aggregate number of securities to be purchased or sold, and the name of the counterparty or agent.

When the director or executive officer later terminates or modifies a plan, the company would report:

The date of the termination or modification; and

A description of the modification, including any modification to the duration, the aggregate number of securities to be purchased or sold, the interval at which securities are to be purchased or sold, the number of securities to be purchased or sold in each interval, the price at which securities are to be purchased or sold, and the identity of the counterparty or agent.

Thus, the SEC does not propose to require disclosure of the prices and intervals at which transactions would occur, or the number of securities to be purchased or sold per interval, when a trading plan is entered into; however, such information would be disclosed when a plan is modified, as reported in general terms ("such as an increase in the applicable limit order price, or a decrease in the number of shares to be sold periodically under the arrangement, without requiring disclosure of the specific price, number of securities, or duration of interval."). The Release invites comment as to whether disclosure of any particular terms would "invite market manipulation" or implicate privacy concerns.

In practice, the Release includes a "Sample Disclosure" presenting the following example of trading plan disclosures:


(b)(1) Rule 10b5-1 Plans

On February 20, 2002, Tom Johnson, the Chief Financial Officer of the registrant, entered into a plan with ABC Brokerage Firm, pursuant to which ABC will undertake to sell 25,000 shares of the common stock of the registrant currently owned by Johnson at specified intervals through the end of 2002.

On February 22, 2002, Donald Cummings, the registrant's Vice-President for sales, modified a previously reported sales plan with XYZ Brokerage Firm to decrease the number of shares of registrant common stock subject to sale on a monthly basis pursuant to the plan, and to decrease the limit order price at which the shares may be sold under the plan. These modifications will reduce to 18,000 the aggregate number of shares that may be sold by Mr. Cummings pursuant to the plan.

On February 22, 2002, Patricia Brown, the registrant's vice-president for administration, terminated her previously reported sales plan with LMN Brokerage Firm.

Implementation. The SEC expects that the proposal would become effective 60 days following Federal Register publication of the final rule. Significantly, trading plans and loans "entered into before the effective date [and] remaining in effect on the effective date" would be grandfathered into the disclosure requirements, and hence would be reported "on (or within a short period after) the effective date." Here, the Release invites comment as to whether this would implicate privacy interests in place at the time the plans were entered into. There would be additional implementation time for transactions in derivative securities: "because companies may need to establish procedures to capture and report information about derivative securities transactions on an accelerated basis, we would expect to delay for an additional 60 days compliance with the obligation to report these transactions within two business days if the transaction's aggregate value is $100,000 or more. For the first 60 days after the effective date, derivative securities transactions would be reportable not later than the close of business on the second business day of the week following the week in which the transaction occurred, without regard to aggregate value."

© David Priebe 2016