As a result of recent academic research (refer here and here) and other recent developments, Rule 10b5-1 trading plans have attracted critical attention, including SEC scrutiny (refer here). Allegations of alleged misuse of Rule 10b5-1 trading plans have even made their way into shareholder litigation. For example, allegations of Andrew Mozillo’s alleged misuse of his Rule 10b5-1 plans are a central part of the Countrywide shareholders’ derivative complaint (refer here).


An August 18, 2008 Latham & Watkins memorandum entitled "Rule 10b5-1 Plans: Recommended Guidelines for Managing Risks in the Current Environment" (here) takes a look at the heightened scrutiny currently surrounding Rule 10b-1 trading plans and presents a set of "better practices to consider" in developing and deploying the plans.


Among other things, the authors examine the Rule’s various requirements, and in particular the Rule’s provision specifying that an individual may "in good faith" modify a prior plan, so long as he or she is not aware of material nonpublic information at the time of the modification. The authors correctly note that "the good faith requirement is an important constraining, and problematic, factor because it is inherently subjective. Modifications that do not have a good faith justification will lose the benefit of the affirmative defense. Frequent modifications may be especially hard to justify."


The authors review other questions that have been raised in connection with Rule 10b5-1 plan structure and implementation. They suggest that to avoid these kinds of problems or questions companies can adopt certain guidelines to "limit opportunities for their insiders to engage in abusive practices, and more importantly, to avoid the appearance of practices that might be viewed as abusive based on later developments."


The authors make a number of good, practical suggestions that should go a long way toward avoiding some of the issues that have raised questions in connection with Rule 10b5-1 plans. The suggestions that appear particularly important in light of recent questions is the authors’ suggestions that "companies should prohibit insiders from entering multiple overlapping 10b5-1 plans," and that companies should promptly disclose insiders’ adoption of Rule 10b5-1 plans through a press release or 8-K filing. The authors also suggest tight restrictions on plan modifications and terminations, as well as on "fast sales," suggesting instead a requirement for a cooling off period.


The recent questions surrounding alleged Rule 10b5-1 plan misuse haveraised concerns about the protective value these plans may offer. But as the authors make clear, properly structured plans may continue to provide valuable protection. It is true that insiders who are starting or stopping plans, or running multiple plans, may find themselves unable to rely on the Rule’s safe harbor. But trading plans structured and implemented according to the original intent of the Rule should still afford the protection for which the Rule was designed.


Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the Latham & Watkins memorandum.


Rating Agencies and Subprime Litigation: As I noted in a prior post (here), the SEC recently released a report critical of rating agencies’ "shortcomings" in connection with their provision of ratings on mortgage-backed securities and other instruments now at the cent of the subprime meltdown. As also discussed in a separate prior post (here), claimants in a recent securities lawsuit have also raised allegations against the rating agencies, alleging conflicts of interest and other alleged misconduct.


According to an August 12, 2008 article entitled "Rating Agencies: A New Front in Subprime Litigation" (here), by Larry Ellsworth and Ishan Bhabha of Jenner & Block, the recently filed lawsuit naming rating agency defendants "may just be the tip of the iceberg." The authors suggest that regulatory investigations and other developments may portend further claims against the rating agencies.


However, the authors also note that the "agencies are not without defenses." In particular the rating agencies may be able to rely on case authority developed in connection with the Orange County and Enron cases that their rating activities are protected by the First Amendment.


The authors question whether the rating agencies will actually be able to rely on these defenses in the circumstances surrounding their rating of the subprime mortgage-backed assets and other related instruments. The authors note that "the agencies only rated those securities for which they were paid, and furthermore had substantial and ongoing involvement with the banks in order to structure the offerings." (For further discussion of the availability of the rating agencies’ potential defenses, refer here.)


In addition, the authors also note that "to the extent the rating agencies were actively working with issuers to help them package products in order to get a higher rating the agencies may be especially vulnerable to charges of self-dealing and conflicts of interest, and, if the agencies did not reveal these relationships, these actions might be investigated as material omissions."


The authors conclude by noting that these issues are "sure to generate contentious and interesting litigation for years to come."