As I noted at the time, earlier this year SEC Chair Gary Gensler spoke publicly about the need for revisions to Rule 10b5-1, the regulatory provision that allows corporate executives, subject to certain requirements, to trade in their holdings of their companies’ securities. Rule 10b5-1 has long been criticized because of perceived abuses. On December 15, 2021, the SEC released proposed revisions to the Rule. Among other things, the proposed revisions strengthen the requirements to access the affirmative defenses afforded under the Rule, and also enhance disclosure requirements for companies whose executives enter into trading plans pursuant to the Rule. The proposed changes are subject to a 45-day comment period after the proposed amendments are published in the Federal Register.
The SEC’s December 15, 2021 press release about the proposed changes can be found here. The proposed amendments themselves can be found here. The SEC’s fact sheet about the proposed changes can be found here.
Rule 10b5-1, first put in place in the year 2000, allows corporate executives – who often have a significant amount of their wealth tied up in their personal holdings in the companies’ securities – to safely trade in their companies’ securities without incurring securities law liability. The Rule permits insiders who have traded in company securities to rebut the inference of scienter by showing that the trades were pre-scheduled as part of a formal written trading planning entered into before the trades took place.
The Rules have long been subject to criticism because of perceived abuses. 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, who reviewed trading data relating to over 20,000 insider trading plans, reported what they described as “opportunistic, large-scale selling that appears to undermine the purpose of Rule 10b5-1.” The academics identified three trading plan “red flags”: plans with a short “cooling off” period (that is, allowing trading shortly after the plan went into effect); plans involving a single trade; and plans adopted shortly before a quarterly earnings announcement.
The Proposed Amendments
The proposed revisions to Rule 10b5-1 seek to address many of these perceived abuses. The proposed amendments reflect two categories of changes: changes to alter the pre-requisites for a traded to qualify for the affirmative defense afforded under the Rule; and changes to disclosure requirement for companies whose executives have adopted trading plans.
With respect to the proposed additional requirements to qualify for the affirmative defense, the proposed amendments introduce the following: a 120-day “cooling-off period” after a plan’s adoption before trading can commence under the trading arrangement; a requirement that directors and officers must certify that they are not aware of any material non-public information about the company when adopting or modifying a plan; a specification that the affirmative defense does not apply to multiple overlapping trading plans; a specification that trading arrangements to execute a single trade are limited to one plan per 12 month period; and a specification that trading arrangements must be entered into and operated in good faith.
With respect to the enhanced disclosure requirements, the proposed amendments would add the following: a requirement for an issuer to disclose in its annual reports whether or not (and if not why not) the issuer has adopted insider trading policies and procedures (with the added requirement that if an issuer has adopted such policies, to disclose the policies and procedures); a requirement for an issuer to disclose in its annual reports its option grant policies and practices; a requirement for an issuer to disclose in its quarterly reports the adoption and termination of trading plans; a requirement for officers to disclose in their SEC trading forms whether a reported transaction was made pursuant to a Rule 10b5-1 trading plan.
Interestingly, the proposed amendments were adopted by a very unusual unanimous vote of Commission’s five commissioners. Clearly, addressing trading abuses has bi-partisan support.
The proposed amendments address several of the “red flag” abuses that the academics identified in their article, to which I linked above. The 120-day cooling off period before a trading plan goes into effect allow a material amount of time to pass before trading can commence under the plan, which should address the concern about the adoption of plans just prior to a quarterly earnings release; the cooling off period would diminish the concern that an executive adopting a plan is doing so as a form of “front running” in advance of good news.
While there is no doubt that steps did need to be taken to address possible abuses of the Rule, the Rule has not been completely off target. In some instances, it has allowed executives to trade securities and to have the protection of the Rule’s affirmative defense.
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 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. Critics correctly have identified ways that the Rule could be abused. But nothing about the need for reform takes 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. The proposed amendments will allow well-advised companies to take advantage of the Rule’s protection while assuring that the insider trading plans are not abused.