Many thanks to thecorporatecounsel.net blog for posting this memorandum to the ABA's Joint Committee on Employee Benefits from three members of that committee regarding their informal discussions with SEC staff about a couple of questions that have arisen about the scope of the exception for "sell-to-cover" transactions under Rule 10b5-1.
As you may recall, in December 2022, the SEC adopted new amendments to the rules regarding Rule 10b5-1 plans. (See this PubCo post.) These amendments added new conditions to the affirmative defense of Rule 10b5-1(c) designed to address concerns about abuse of the rule by opportunistic trading on the basis of material non-public information. Among a number of other changes, Rule 10b5-1(c)(1) was amended to limit the ability of persons other than the issuer to use multiple overlapping Rule 10b5-1 plans and to limit the use of single-trade plans by persons other than the issuer to one single-trade plan in any 12-month period. However, as an exception to those prohibitions, in Rule 10b5-1(c)(1)(ii)(D)(3), the amendments permitted certain "sell-to-cover" transactions, that is, transactions in which the insider instructs the agent to sell "only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award" and the insider does not otherwise exercise control over the timing of the sales.
But what does "only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award" really mean? Is the definition limited to only the amount required to satisfy statutory minimum tax withholding rates or does it allow an amount of sales to cover a higher expected effective tax rate designated by the employee as the rate at which their employer will withhold taxes? And what about non-employee directors, for whom there are no tax withholding obligations? Can they rely on the exception for "eligible sell-to-cover" transactions as well?
The three committee members posed those questions to the SEC staff—more elegantly of course. As to the first issue, the members learned that the reference to "only such securities as are necessary to satisfy tax withholding obligations" is "not intended to mean only the number of shares required to satisfy minimum tax withholding requirements and that the rule is not intended to use technical tax language or to disrupt practice with respect to legitimate tax arrangements." Rather, the sell-to-cover arrangement "can take into account the expected effective tax rate and is not focused on only the required tax withholding rate." The members emphasized, however, that this interpretation "does not apply if any of the proceeds from the sale are intended to satisfy taxes relating to income from sources other than the vesting of a compensatory award. The SEC Staff thus cautioned that persons could not characterize a sale as an 'eligible sell-to-cover' transaction where shares are sold with the intent of covering taxes for events unrelated to the vesting event."
A similar response was elicited with regard to sell-to-cover arrangements for non-employee directors. Even though non-employee directors are not subject to tax withholding obligations, the staff agreed that a non-employee director may establish an "eligible sell-to-cover" transaction that provides for the sale of shares in an amount necessary to satisfy the director's expected effective tax rate at vesting of a compensatory award. Again, as above, the sale would not qualify as an "eligible sell-to-cover" transaction if it were intended to also cover taxes for events or sources of income other than the vesting event.
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