When the SEC brought civil enforcement charges against former Countrywide Financial CEO Angelo Mozilo in June 2009, a critical part of the agency’s allegations was that Mozilo had manipulated his Rule 10b5-1 trading plans to permit him to reap vast profits in trading his shares in company stock while he was aware of increasingly serious problem in the company’s mortgage portfolio.


Among other things, the SEC alleged that pursuant to these plans and during the period November 2006 through August 2007, and shortly after he had circulated internal emails sharply critical of the company’s mortgage loan underwriting and the “toxic” mortgages in the company’s portfolio, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.


In October 2010, Mozilo agreed to settle the SEC’s enforcement action for a payment of $67.5 million dollars, including a $22.5 million penalty and a disgorgement of $45 million. The financial penalty was at the time (and I believe still is) the largest ever paid by a public company’s senior executive in an SEC settlement.


As if all of this were not enough to cast a cloud over Rule 10b5-1 trading plans, the trading plans are once again back in the news, and once again the news about the plans is negative. A front page November 28, 2012 Wall Street Journal article entitled “Executives’ Good Luck in Trading Own Stock” (here), reports on the newspaper’s analysis of thousands of trades by corporate executives in their company’s stock. Among other things, the newspaper reports on numerous instances where executives, trading in company shares pursuant to Rule 10b5-1 plans, managed to extract trading profits just before bad news sent share prices down or to capture gains with purchases executed just before unexpected good news.


The article catalogues a number of deficiencies of at least some plans that undermine the Rule’s goal of allowing insiders to trade in their company shares without creating the impression that the executives were trading because they knew something about the company that other investors did not.


Among other plan features that can cause problems, the article shows, is the ability of executives to alter or cancel plans at their own discretion. The article notes that “there is very little in the system to prevent an executive who foresees good news about the company from canceling a scheduled share sale, or an executive who foresees bad news from canceling a scheduled share purchase” 


Another weakness is that some plans allow executives to trade immediately after the plan has been set up, creating the impression that the executive set up the plan (and then traded) in anticipation of the undisclosed developments. The article notes that “there is no rule about how long the plans must be in place before trading under the plans can begin.”


An additional shortcoming about the plans cited by several commentators in the article is that neither executives nor their companies are required to disclose the existence of their plans, which among other things leave executives free to change or even cancel their plans. The article notes that though there are a number of companies that do disclose that the executives have trading plans, “they rarely disclose the provisions, since they don’t want outside investors to be able to anticipate forthcoming trades.”


There is more than a small amount of irony in these concerns about Rule 10b5-1 plans. The Rule was established more than a decade ago in order to provide a way for executives (whose wealth often is entirely locked up in company shares) to be able to trade in the company’s stock without incurring possible liability under the securities laws.


There are in fact a number of cases in which courts have held that the inference of scienter that might otherwise arise from insider sales is rebutted when the sales were executive pursuant to Rule 10b5-1 trading plans. Refer here and here for a discussion of recent cases where defendants were able to rely on the Rule 10b5-1 trading plan in order to have the securities claims against them dismissed.


In other words, though Rule 10b5-1 plans can cause problems, if done right they can prove to be very valuable. Which of course raises the question — what does it mean for a trading plan to be done right?


First of all, there should only be one plan, not multiple plans. If nothing else, Mozilo’s actions show what a problem it can be if an executive tries to maintain multiple plans.


Second, the plan should clearly provide for well-defined trades at well-defined times or under well-defined circumstances. Ideally, the plan would specify that the executive will trade at specified times and at specified amounts.


Third, the protective value of the plan is severely undermined if the executive retains any discretion about trade execution, including in particular the ability to alter or cancel the plan. As the SEC noted it its April 2009 guidance about Rule 10b5-1 plans, the cancelation of a transaction under a plan affects the availability of the affirmative defense under the Rule, because the cancellations represent an alteration of or deviation from the plan


Fourth, to avoid the types of concerns noted above, the plan should be put in place well before the first trade under the plan. Preferably, the first trade would take place only after an interval of a quarter or longer.


Finally, in order to address the kinds of concerns noted in the Journal article, companies whose executives have trading plans should consider disclosing both the plans existence and intended trading schedule in the company’s periodic filings with the SEC.


The Deal Journal blog has a number of related suggestions in a November 28, 2012 post (here) about how to structure and implement the kinds of problems cited in the Journal article.


Because the point of a Rule 10b5-1 trading plan is to try to allow executives to trade in their company securities without incurring potential liability under the securities laws, it is worth taking a look at a trading plan that a court found to provide that very protection. As discussed here, in October 2008, the Eighth Circuit affirmed the lower court’s dismissal of a class action securities lawsuit that had been brought against executives of the Centene Corporation. The appellate court expressly affirmed the lower court’s ruling that because the executives’ trades had been executed pursuant to a Rule 10b5-1 plan, the trades did not support an inference of scienter.


The Eighth Circuit stated that the individual defendants’ trading plans "lay out in advance the dates at which the trade will be made in advance and give control of the trades to a broker." The District Court’s dismissal opinion stated further that the plaints "provided for automatic sales on certain dates if the stock price was above $25." The only sales made under the plans, which were instituted in December 2005, were two in February and April 2006. "There were no later sales, not because defendants halted the program, but because the stock price never reached the $25 mark."


The critical aspects of the plan appear to have been, first, that the officials entered the plan in advance; second, that the plan specified the trading dates, but subject further to a specified trading price: three, that the trading on those dates, if the price criterion was met, was automatic; and fourth, that a broker controlled the trades. It does not seem to have mattered that the officials did not trade regularly under their plans because of the minimum share price requirement.


It is  important to note that the plan lacked many of the attributes that have attracted criticism. That is, the Centene officials’ plans were not changed, nor were the plans stopped and started; and the individuals were not running multiple plans.


Given the negative publicity surrounding Rule 10b5-1 plans, the Eighth Circuit’s opinion is a useful reminder that Rule 10b5-1 plans can and should be a part of a coordinated securities litigation loss prevention program. The negative publicity should not deter companies or the executives from creating and implementing thoughtfully constructed trading plans.


The Bill Gates School of Deposition Deportment: The credit crisis-related litigation continues to grind through the court system, and many of the cases have moved into active discovery. Among the many high profile cases remaining is the lawsuit monoline insurer MBIA filed against BofA, as successor in interest to Countrywide. MBIA alleges that mortgages underling many of the financial securities that the insurer was asked to guarantee were not made pursuant to the mortgage company’s stated underwriting guidelines.


In May 2012, as discovery of the case has gone forward, MBIA finally had a chance to depose BofA CEO Brian Moynihan. Moynihan’s deposition, according to the Rolling Stone’s Matt Taibbi’s November 27, 2012 article entitled “Bank of American CEO Brian Moynihan Apparently Can’t Remember Anything” (here) “will go down as one of the great Nixonian-stonewalling efforts ever, and one of the more entertaining reads of the year.” As the article (and the deposition transcript to which the article links) shows, Moynihan really doesn’t remember much of anything about Countrywide, even though the business has been one of the bank’s biggest problems since Moynihan took over as BofA’s CEO.


As Taibbi puts it, “In an impressive display of balls,” Moynihan essentially testified that Bank of America is a big company, and it is unrealistic to ask the CEO to know about all of its parts, “even the ones that are multi-billion-dollar suckholes about which the firm has been engaged in nearly constant litigation from the moment it acquired the company.” Taibbi concludes that throughout the deposition, Moynihan “presents himself as a Being There-esque cipher who was placed in charge of a Too-Big-To-Fail global banking giant by some kind of historical accident beyond his control, and appears to know little to nothing at all about the business he is running.”


Moynihan is not the first CEO to take this deposition approach. Readers will likely recall that then-Microsoft CEO Bill Gates took much the same approach in his deposition in the massive antitrust case against the company, which according to the BusinessWeek article about Gates’s deposition testimony, showed him “slouching behind a table on a videotaped deposition, rocking as he reads documents, and often telling government prosecutors that he can’t recall having written E-mails to Microsoft execs on key company issues.”  (The loyal reader who sent me the link to the Rolling Stone article suggested that Moynihan may have also been borrowing a page from another President named Bill, whose deposition performance may have set an unbreakable world record for deposition obfuscation.)


Clawback at the SEC?: In a recent post (here), I discussed a recent federal district court decision upholding the right of the SEC under Section 304 of the Sarbanes Oxley act to clawback bonus compensation from corporate executives whose companies later restated the financials on which the bonus compensation was based, even though the executives were not involved in or even aware of the misconduct that led to the restatement . In affirming the policy justifications for the SEC’s clawback authority, the district court judge noted that the executive “should have been monitoring the various internal controls to guard against such misconduct” and that it was there failure to ensure that proper controls were in place that allowed the misconduct to occur. The court added that “where, as here …corporate officers are asleep on their watch,” they are liable for a penalty that is limited to the amounts of their bonus compensation.


In a November 28, 2012 post on his eponymous blog, UCLA Law Professor Stephen Bainbridge makes the provocative suggestion that in light of these principles perhaps the compensation of departing SEC chair Mary Schapiro should also be clawed back. Schapiro’s announcement that she is stepping down “raises the question of why she gets a free ride on precisely the same sort of conduct for which corporate executives are subject to having their pay clawed back.”


In support of this suggestion, Bainbridge cites the findings of the Government Accountability Office, which “consistently found that the SEC’s internal controls are seriously flawed.” Bainbridge also cites recent whistleblower allegations of misconduct at the agency. Bainbridge asserts that “at the very least, Mary Shapiro has been asleep at the switch while the SEC has continually failed to remediate serious internal control deficiencies that the SEC would never tolerate in a private company.” Bainbridge concludes by asserting that:


If clawing back executive pay is necessary to give corporate executives "an incentive for (officials) to be diligent in carrying out" their duties over corporate internal controls, maybe clawing back government official pay when they "are asleep on their watch,” would give future SEC chairs the necessary incentive to avoid Schapiro’s manifold failures to fix the SEC’s internal problems


Readers may also be interested in Bainbridge’s take on the Wall Street Journal trading plan article I discussed above; Bainbridge writes about the Journal article “In what may be the dumbest piece of reporting I’ve seen in a while, the Wall Street Journal offers up a breathless "expose" showing that corporate insiders often beat the market when trading in their own company’s stock. This is "news"?”