On December 14, 2022, the Securities and Exchange Commission adopted amendments[1] to Rule 10b5-1 of the Securities Exchange Act of 1934 (“Exchange Act”), and to Regulations S-K and S-T. The final rules substantially expand the insider trading safe harbor requirements of Rule 10b5-1, and impose new reporting and disclosure requirements for directors, officers, issuers, and other persons who implement 10b5-1 trading plans. The final rules became effective February 27, 2023.[2] Smaller reporting companies[3] have an additional six months to comply, until August 27, 2023.[4]
Changes to the Insider Trading Safe Harbor Requirements
Rule 10b5-1(c)(1) provides an affirmative defense to liability under Section 10(b)[5] of the Exchange Act and Rule 10b-5 thereunder. The defense creates a “safe harbor” for insiders who execute trades while in possession of material nonpublic (i.e., inside) information. The safe harbor is available only under certain circumstances, including when the alleged insider trade is executed pursuant to a written plan, contract, or instruction, adopted when the trader was not aware of material nonpublic information (a “10b5-1 Plan” or “Plan”).
SEC Chair Gary Gensler commented that this amendment became necessary to fill gaps in the existing rules, through which, over the 20 years since the original safe harbor was implemented, “insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information.”[6] New conditions to the safe harbor rules include: cooling-off periods, additional certification statements, restrictions on use of overlapping and single-trade plans, and new reporting and disclosure requirements.
A “cooling-off” period refers to the time between adoption of a 10b5-1 Plan and the first trade executed under the Plan, during which period the safe harbor is not available. Substantive modification (i.e., number of shares, price, timing, or different formula) of an existing plan will trigger a new cooling-off period, but administrative changes (i.e., stock split adjustment) will not. [7]
For directors and officers, the final rules impose a cooling-off period of either (a) 90 days or (b) two business days following a Form 10-Q or 10-K filing for the quarter in which the Plan was adopted, whichever is later, with a maximum of 120 days. For other persons who are not issuers, the cooling-off period will be 30 days.[8] Issuers are not yet subject to a cooling-off period.[9]
The Rule 10b5-1 safe harbor will be unavailable for trades by directors, officers, and other non-issuer persons who maintain multiple overlapping Plans.[10] This would prevent individuals from selectively cancelling some Plans, and keeping others, to opportunistically manipulate their trading after receiving material nonpublic information. A Plan that executes through contracts with multiple broker-dealers or other agents nevertheless counts as a single Plan.[11] An individual may maintain two concurrent Plans if they do not overlap in the timing of trades, such that one Plan concludes or expires before the next is authorized to trade.[12] A “sell to cover” Plan, which instructs the sale of securities to satisfy income tax withholding obligations at the same time an equity award vests, does not count as a prohibited overlapping Plan.[13]
Similarly, the SEC adopted a limitation on single-trade Plans, meaning Plans designed to affect a purchase or sale of securities on the open market in a single transaction. The Rule 10b5-1 safe harbor will be unavailable to non-issuer persons for a single-trade Plan if the person has adopted a single-trade Plan in the prior 12-month period.[14]
As a condition to the updated safe harbor, a director or officer of the issuer of the securities who adopts a Rule 10b5-1 Plan must include certification statements to the effect that (a) they are not aware of material nonpublic information about the issuer or its securities, and (b) 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 Rule 10b-5.[15] Previously, the safe harbor required Plans be entered into in good faith. Now, the person must “act in good faith with respect to the plan,” which extends the good faith requirement throughout the duration of the plan.[16]
New Reporting and Disclosure Requirements for Issuers
Amendments to Regulation S-K will require issuers to make certain disclosures, in Inline XBRL format,[17] regarding the use of Rule 10b5-1 Plans and other “non-Rule 10b5-1 trading arrangements:”[18]
On Form 10-Q or 10-K, the issuer must provide quarterly disclosure of:
Whether any director or officer has adopted, modified, or terminated any Plan or trading arrangement; and
Provide the material terms of the Plan or trading arrangement, other than the price terms.[19]
On Form 10-K or in the annual meeting proxy statement, the issuer must disclose:
Whether it has adopted insider trading policies and procedures that are reasonably designed to promote compliance with insider trading laws, rules, regulations, and standards. If so, it will include such policies as an exhibit. If not, it must explain why not.[20]
Information regarding the timing of awards and options in close proximity to the release of material nonpublic information by the company, including (i) how the board determines the timing of award grants, (ii) whether and how the board takes into account material nonpublic information when determining timing and terms of an award, and (iii) whether the disclosure of material nonpublic information was timed to affect the value of executive compensation.[21]
In a new table,[22] the issuer must disclose any options award to a Named Executive Officer (“NEO”)[23] that is granted within four business days before, or one business day after, a triggering event.[24]The table must provide the following information:
Name of the NEO;
Grant date;
Number of securities underlying the award;
Per-share exercise price;
Grant date fair value; and
Percent change in the market price of the underlying securities between the trading day before and the trading day after the disclosure of material nonpublic information.[25]
Many of these updated rules codify pre-existing industry standards. Nevertheless, issuers should evaluate whether their current policies and procedures provide for each of the disclosures summarized above.
[1] Insider Trading Arrangements and Related Disclosures, Final Rule, Rel. No. 33-11138 (December 14, 2022).
[3] “Smaller reporting company” is defined in Regulation S-K Item 10(f)(1) to mean a reporting company with either (a) public float of less than $250 million, or (b) annual revenues below $100 million, and no public float or public float less than $700 million.
[5] It is unlawful to “use or employ, in connection with the purchase or sale of any security” a “manipulative or deceptive device or contrivance in contravention of [SEC] rules and regulations.” 15 U.S.C. § 78j(b).
[12] Although, if the earlier plan is cancelled before its natural expiration date, the cooling off period of the later plan begins again from that cancellation date. Id., at 57.
[14] A Plan is not a single-trade Plan if (a) the agent has discretion whether to execute the trade in multiple transactions, (b) the agent’s future acts will depend on events or data not known at the adoption of the Plan, or (c) it is reasonably foreseeable at the Plan’s adoption that it might result in multiple transactions. Id., at 60-61.
[18] “Non-Rule 10b5-1 trading arrangement” is defined in Regulation S-K Item 408(c), and includes certain pre-planned trading arrangements that do not meet the requirements of the Rule 10b5-1 safe harbor.
[19] Such material terms include: (i) the name and title of the director or officer, (ii) date of adoption or termination, (iii) duration of the Plan or arrangement, and (iv) total number of securities to be sold or purchased. Final Rule, at 76. See Regulation S-K Item 408(a).
[20] Final Rule, at 84. See Regulation S-K Item 408(b).
[21] There is no requirement to adopt policies and procedures on the timing of award grants if it has not already done so. Final Rule, at 101. See Regulation S-K Item 402(x)(1).
[22] Under the current executive compensation disclosure rules of Regulation S-K Item 402, compensation-related equity interests must be represented in a tabular format.
[23] Named Executive Officers (NEOs) include the Principle Executive Officer, Principle Financial Officer, top three compensated officers other than the PEO and PFO, and up to two additional individuals who were NEOs, but were not servicing as NEOs at fiscal year-end. See Regulation S-K Item 402(a)(3).
[24] A triggering event is either (a) the filing of a Form 10-Q or 10-K, or (b) the filing of a Form 8-K that contains material nonpublic information. Final Rule, at 103.
Many employees have faced this situation. You have accepted a new position with a new employer. On your first day, you are handed a stack of forms and documents and asked to review and sign them. It is your first day at the new job and your head is swimming.
Aside from tax withholdings, health insurance, and myriad other new employee selections and forms, you most likely are asked to review and sign an Employment Agreement. You are not a lawyer and don’t want to start off on the wrong foot in your new job. You sign the agreements given to you. But if the Employment Agreement contains a non-solicitation and/or non-compete provision, what do you do? Call a lawyer and schedule a meeting the first day of the new job or just sign what you are handed? And if you do sign a non-compete, non-solicitation agreement, will you be bound by what you signed if and when your new employment ends? What are you signing that you may be “stuck with?”
An Employment Agreement is a contractual understanding between the employer and employee that typically controls the parties’ rights and obligations during the employment relationship. Often, however, Employment Agreements also seek to control the employees’ behavior even after the termination of the employment relationship. The typical ways Employers routinely attempt to control former employee behavior through contract are: (1) non-solicitation clauses; and (2) non-compete clauses.
A non-solicitation clause is a provision in the agreement, whereby, for a time, the employee agrees not to use the company’s clients, customers, and contact lists upon leaving the company, and agrees not to solicit business from, service, or contact the former employer’s current customers or employees.
A non-compete clause, on the other hand, prohibits a departing employee from “competing” with the former employer by entering a similar profession or trade in competition against the employer, usually for a set time and/or in a certain geographical area.
Although many states still enforce reasonable non-solicitation and non-compete clauses, California courts are unlikely to enforce either of these types of agreements. California has a strong, longstanding, and well-settled public policy favoring open competition and worker mobility. In fact, it is the law in California that, with very narrow, and limited statutory exceptions, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”[1] A broad proscription making California one of the few states that imposes a rebuttable presumption that any anti-competitive contract is void.
As the California Supreme Court stated in the seminal case, Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937:
Under the common law, as is still true in many states today, contractual restraints on the practice of a profession, business, or trade, were considered valid, as long as they were reasonably imposed. [Citation omitted]. This was true even in California. (Wright v. Ryder (1868) 36 Cal. 342, 357 [relaxing original common law rule that all restraints on trade were invalid in recognition of increasing population and competition in trade].) However, in 1872 California settled public policy in favor of open competition, and rejected the common law “rule of reasonableness,” when the Legislature enacted the Civil Code…. Today in California, covenants not to compete are void….”
Moreover, “California courts ‘have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility.’ . . . . Section 16600 expresses California’s strong public policy of protecting the right of its citizens to pursue any lawful employment and enterprise of their choice.” Id. at 946. Under Section 16600, contracts, of whatever form, that seek to prevent an employee from competing against his former employer are simply illegal and void. Kolani v. Gluska (1998)64 Cal. App. 4th 402, 407. The agreement does not need to outright prohibit competitive employment to be invalid under section 16600, it only needs to restrain it[link] . Edwards, 44 Cal.4th at 946.
Section 16600 applies equally to independent contractors and employees. The California Supreme Court recently clarified “section 16600 applies to business contracts,” and is not limited to employment contracts. Ixchel Pharma, LLC v. Biogen, Inc. (2020) 9 Cal. 5th 1130, 1149–50.
There are only three, very limited exceptions for a Court to hold a non-compete clause valid in California: (1) sale of goodwill or interest in a business;[2] (2) dissolution of a partnership;[3] or (3) dissolution or sale of a limited liability company.[4]
California courts have interpreted the non-compete exceptions, in particular the term “sale of the business,” very narrowly and in favor of open competition. “[I]n order to uphold a covenant not to compete pursuant to section 16601, the contract for sale of the corporate shares may not circumvent California’s deeply rooted public policy favoring open competition. The transaction must clearly establish that it falls within this limited exception.” Hill Med. Corp. v. Wycoff (2001) 86 Cal.App.4th 895, 903. “[T]he Legislature, in amending section 16601, intended to permit non-competition agreements only in situations in which the transfer of ‘all’ of the owner’s shares involves a substantial interest in the corporation so that the owner, in transferring ‘all’ of his shares, can be said to transfer the goodwill of the corporation.” Bosley Med. Group v. Abramson (1984) 161 Cal.App.3d 284, 290.
California’s courts have been on the forefront of a trend towards finding restrictive covenants in Employment Agreements void. Following this trend, on January 5, 2023, the Federal Trade Commission (“FTC”) proposed a federal rule that would prohibit employers from imposing non-compete clauses on workers.[5] The FTC proposal has been over a year in the making as the White House shared it would direct the FTC to propose such a rule back in July 2021[link]. Whether the rule will pass and in what form is yet to be seen.
Nevertheless, many employers still choose to include such clauses in their Employment Agreements hoping to deter competition from employees who do not understand their rights. As stated by the Court in Robinson v. U-Haul Co. of California (2016) 4 Cal.App.5th 304, “Why would you possibly put something in a contract where the law says it’s void? You do that so you can cause somebody to think that that clause is, in fact, valid when it isn’t.” Id. at 312. And many national employers routinely ask California based employees to sign their “national,” “standard” employment agreements even though these non-solicitation, non-competition provisions violate California law and are unenforceable.
Our firm regularly advises employees and employers on non-solicitation and non-compete clauses, including during broker and advisor transitions. If you have a situation you’d like to discuss, feel free to contact us for a confidential initial consultation. We can help you take necessary steps to protect yourself and your livelihood.
[1] California Business and Professions Code § 16600.
[2] California Business and Professions Code § 16601.
[3] California Business and Professions Code § 16602.
[4] California Business and Professions Code § 16602.5.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisers, IARs, broker-dealers, registered representatives, and businesses. We can be reached in the firm’s San Diego office at (619) 696-9500.
Starting on January 1, 2023, an update to the California Insurance Code took effect requiring certain insurance license holders to include their license number on each email they send that involves their licensed activities. These changes will impact investment advisers, broker-dealers, and other financial professionals who provide insurance services as part of their overall client offerings.
Before, the rule required license numbers printed on business cards, written price quotations, and print advertisements. Now, every licensed person and agency that appears in an email must also list their license number within the email. The rule applies to all emails “that involve an activity for which a license is required.”[1]
Affected Licenses. The licenses affected are as follows:
Public insurance adjusters (Cal. Ins. Code section 15006)
Life and disability insurance analysts (Cal. Ins. Code sections 1831 through 1849)
Prominent Placement. The license number must be listed in a type size no smaller than the largest of any street address, email address, or telephone number of the licensee. For example, if a 10-point, 11-point, and 12-point are used for such information, the license number must be at least 12-point. Further, the license number must be on the same line, or the line below, the licenses name or title in the email.
Non-Resident Licensees. If a CA licensee is based in another state which already requires insurance-related emails contain license numbers, the licensee must comply with both sets of disclosure rules. Out-of-state licensees can no longer omit their CA license number in emails, even if the license of another state already appears on the email. If the name of any CA insurance license holder appears in an email involving “an activity for which a license is required,” so must their CA insurance license number.
Official Examples. The following are examples provided by the California Insurance Commissioner’s office.
John Doe, Claims Adjuster, CA license #2C00000 Jane Doe, Qualified Manager, CA license #2A00000 Adjuster Insurance Services, CA license #2B00000
If you have any questions, or if you want assistance developing policies and procedures to ensure compliance with the new rule, we are here to help.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisers, IARs, broker-dealers, registered representatives, and businesses. Attorneys Robert R. Boeche, Robert D. Conca, and Andrew Steiger can be reached in the firm’s San Diego office at (619) 696-9500.
