Since it was first instituted nearly 21 years ago, SEC Rule 10b5-1 has provided corporate executives with a way to trade in their company’s securities while avoiding potential liability under the federal securities laws. However, the Rule has been dogged by controversy and questions of potential abuse have been raised for years. Now, in remarks published earlier this week on the Wall Street Journal (here), SEC Chair Gary Gensler has said that the SEC is drafting a proposal to revise the Rule’s requirements to target some of the perceived abuses. The Cooley law firm’s PubCo blog has a detailed account of Gensler’s remarks in a June 8, 2021 post (here).


Rule 10b5-1 permits company insiders – who often hold a significant portion of their wealth in company stock – to sell their shares without incurring liability under the federal securities laws. The Rule permits insiders who have traded in company shares to rebut the inference of scienter by showing that the trades were pre-scheduled and not suspicious. In light of the frequent criticisms of the Rule, it is important to note that In many cases defendants have  relied on the existence of a Rule 10b5-1 trading plan in order to have the securities claims against them dismissed (for example,  here and here).


To be sure, there is no doubt that the Rule has been abused. For example, 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.


More recently, several academics published a paper in which they concluded that corporate insiders may be using insider trading plans “to game the system.” The academics looked at trading data related to over 20,000 insider trading plans. In their paper, the academics reported what they described as ““opportunistic, large-scale selling that appears to undermine the purpose of Rule 10b5-1.” The academics also identified three “red flags”: plans with a short “cooling off” period (that is, the plan went into effect shortly after adoption);  plans involving a single trade; and plans adopted in a quarter shortly before the quarter’s earnings announcement. The plans that allowed for a single trade on average, allowed the executives to avoid losses of 4%, defined as the stock’s performance relative to industry peers during the six months following the first sale.


In his remarks published in the Journal, SEC Chair Gensler said “In my view, these plans have led to real cracks in our insider-trading regime.” He said that he understands that the agency needs to “ensure we are identifying and punishing abuses of 10b5-1 plans” under the current rule. One specific weakness Gensler cited in the current regime is that insiders are permitted to cancel the plans after adopting them. “Insiders can cancel a plan when they actually do have material nonpublic information,” Mr. Gensler said. “This seems kind of upside-down to me. It also may undermine investor confidence.”


According to the PubCo blog post to which I linked above, the new limitations Gensler proposed to try to address the perceived abuses include: the requirement of a cooling off period (that is, a time lag between the adoption of a plan and when it goes into effect); limitations on cancellation; mandatory disclosure (as it stands now, companies whose executives have trading plans do not have to disclose the existence or provisions of the plans); and limitations on the number of plans. (One of the many abuses involved with Angelo Mozillo’s arrangements was that he had multiple plans.) Gensler also reportedly has asked the SEC staff to look at potential abuses involved with company’s adoption of Rule 10b5-1 trading plans in connection with stock buybacks.


There have been prior proposals to reform Rule 10b5-1’s requirements. For example, in December 2012, the Council of Institutional Investors submitted a rulemaking proposal to the SEC. And there also have been reports for many years about the Rule’s apparent abuse (for example, here). Yet notwithstanding the Rule’s perceived abuse and despite prior calls for reform, the Rule’s weaknesses remain unchanged.


It remains to be seen whether or when Gensler’s reform proposal will lead to revisions to the Rule. In addition, the changes to be made to the Rule, if any, also remain to be seen.


While reform proposals appear highly justified, there is also another consideration that also needs to be taken into account. That is, the Rule has actually worked in some important cases. What I mean is that corporate insiders who traded in their shares of company stock pursuant to a written trading plan have been able to rely on the Rule’s protection in order to defend themselves against alleged securities law violations.


For example, as discussed in greater detail here, in the Eighth Circuit’s 2008 opinion in the Centene securities class action lawsuit, the appellate court, in affirming the district court’s finding that the plaintiffs had not adequately pled scienter, specifically considered the fact that the individual defendants’ stock sales on which the plaintiffs sought to rely had been made pursuant to a Rule 10b5-1 trading plan. In another instance, discussed here, the defendants were able to rely on the fact that their trades in company securities had been made pursuant to a written trading plan in support of their motions to dismiss the securities class action lawsuit that had been filed against them.


My point is that while trading plans adopted pursuant to Rule 10b5-1 can be abused, the adoption of trading plans is still a good idea. Moreover, the concept behind rule – that is, to provide corporate insiders with a way to trade in their company securities – is still valid, as well. Of course, there are aspects of the Rule’s requirements that need to be addressed. But nothing about the need for reform should take away from the fact that adopting a plan is a smart way for corporate executives to try to protect themselves from potential liability under the federal securities laws.


Indeed, a written trading plan is one of the important practical steps that companies and their executives can take as part of securities litigation loss prevention program. Well-advised companies and their executives that adopt plans that avoid the kinds of abuses that the academics and Gensler identified will have an important tool in their arsenal if they are called upon to defend themselves in a securities suit. Nothing about the calls for reform changes any of that.