On Sept. 9, the Investor Advisory Committee (the IAC) of the U.S. Securities and Exchange Commission (the SEC) announced recommendations for changes to the rules with respect to Rule 10b5-1 trading plans, those trading plans adopted pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (Rule 10b5-1 plans). The recommendations suggest changes to how Rule 10b5-1 plans may be adopted, modified, and terminated or cancelled. These recommendations were published by the IAC on Aug. 26 based on calls by SEC Chair Gary Gensler to "freshen up" Rule 10b5-1 and provide for updates to the applicable rules. According to Chair Gensler, Rule 10b5-1 plans "have exposed potential gaps in [the SEC's] insider trading enforcement regime."


The SEC adopted Rule 10b5-1 as a means to provide company "insiders," namely, company directors, officers and other individuals who may be in a position to possess material nonpublic information (MNPI) on an ongoing basis, the ability to trade in company securities without violating insider trading laws. Insiders regularly come into possession of MNPI in the normal course of their duties, which makes it difficult to transact in securities of their employer without running afoul of insider trading prohibitions. This issue is especially prevalent for companies that provide directors, officers, and certain employees with equity-based compensation. When an insider purchases or sells securities while aware of MNPI, they are considered to have traded "on the basis of" MNPI and will become subject to insider trading scrutiny. Adopting a valid Rule 10b5-1 plan allows insiders to establish an affirmative defense to insider trading.

In order to trade under a valid Rule 105b-1 plan, an insider must follow certain conditions, specifically:

  • The insider must have adopted the plan in good faith prior to becoming aware of MNPI;
  • The Rule 10b5-1 plan must specify the amount, price, and date of securities to be purchased or sold; provide written instructions or a formula that would trigger purchase or sale of securities, including the amount, price, and date of any trades; or not allow the insider to influence how, when, or whether trades are made once a plan is established, provided that the plan is established when the insider is not aware of MNPI; and
  • The purchases or sales of securities must be executed pursuant to the plan only.

Rule 10b5-1 allows insiders to amend their plans so long as they are unaware of MNPI when they are making any such modifications. In contrast, insiders may terminate a plan while in possession of MNPI, so long as the terminated plan was originally entered into in good faith. Modifications and terminations are generally advised to be done in limited circumstances to ensure the availability of the affirmative defense.

Companies themselves can also enter into Rule 10b5-1 plans, for example when they begin a stock repurchase program, and must follow the same restrictions noted above.

Proposed Recommendations

The purpose of the IAC recommendations is for the SEC to "take the necessary steps to establish meaningful guardrails around the adoption, modification, and cancellation of Rule 10b5-1 trading plans" in an effort to seal some of the "cracks" that Gensler has said have perpetrated the SEC's insider trading regime.

In recommending changes to Rule 10b5-1, the IAC is looking to address two areas of possible reform: plan design and appropriate use of the affirmative defense and information asymmetries between Rule 10b5-1 plan participants and the broader market.

The recommendations would apply to both insider Rule 10b5-1 plans and may apply to company Rule 10b5-1 plans, which has been criticized as not being appropriate because the uses of the plans differ. The IAC's recommendations are described in detail below.

  • Minimum Cooling-off Period of Four Months

To address concerns about entry into Rule 10b5-1 plans while in possession of MNPI, current best practice is to include a "cooling-off" period of some length between a plan's adoption and the first trade pursuant to the plan (though this practice is more common when it comes to insider-executed plans than company-executed plans). The length of the cooling-off period, however, often varies and is sometimes as short as two weeks. In order to avoid opportunistic trading, the IAC has proposed a minimum cooling-off period of four months to ensure that a Rule 10b5-1 plan's adoption and the first trade cannot occur in the same quarter. This minimum cooling-off period would be an additional criterion to qualify for the affirmative defense against insider trading.

The view of the IAC is that setting a minimum cooling off period of four months better aligns with the intent of the rule which was to provide for the ability for insiders and the company to transaction in company securities while protecting against insider trading. While the cooling-off period for insiders can decrease the perception and possibility that a Rule 10b5-1 plan was entered into to take advantage of a market condition prior to a company's next earnings release, this has not been raised as a concern for company Rule 10b5-1 plans.

  • Prohibit Overlapping Rule 10b5-1 Plans

The second recommendation from the IAC for companies and insiders to qualify for the affirmative defense is the prohibition against overlapping plans. The IAC's view is that having just one Rule 10b5-1 plan in place signals to the market that it was entered into in good faith. The IAC believes that requiring one plan to terminate before entering into a new one, combined with a minimum cooling-off period of four months, likely provides sufficient protections from trades that would create profits or avoid losses based on knowledge of MNPI.

  • Rule 10b5-1 Trading Plan Reporting and Disclosure

Finally, the IAC proposed certain Rule 10b5-1 plan-related reporting and disclosure requirements to increase transparency. Namely, these proposals aim to provide more information regarding plan activity to the market and the SEC, consisting information regarding adoption, modification, or cancellation of a Rule 10b5-1 plan. The IAC's recommended disclosure requirements, which have not yet been proposed by the SEC, include:

  • Disclosure in the company's proxy statement regarding:
    1. the number of shares covered (i.e., scheduled for sale) under Rule 10b5-1 plans, if any, by each of a company's named executive officers; and
    2. the total number of shares covered (i.e., scheduled for sale) under company Rule 10b5-1 plans (i.e., Rule 10b5-1 plans established by the company for the purpose of selling treasury shares);
  • Disclosure in Current Reports on Form 8-K of the adoption, modification, or cancellation of Rule 10b5-1 plans, and the number of shares covered, on a timely basis (i.e., change Form 8-K rules to include changes to plans by affiliates as MNPI requiring a Form 8-K);
  • Enhance disclosure of trades made pursuant to Rule 10b5-1 plans, including the changes to Forms 4 to include new fields for: a checkbox to indicate whether a specific trade was pursuant to a Rule 10b5-1 plan, and the date of associated Rule 10b5-1 plan adoption or modification;
  • Electronic submission of Forms 144 as opposed to the current practice of paper submission, with the hopes that electronic disclosure would lead to greater transparency; and
  • Ensure that all companies (even foreign private issuers) with securities listed on U.S. exchanges be subject to Form 4 reporting requirements.

The IAC's position is that these additional reporting requirements and disclosures would increase market efficiency by making information more accessible, thereby better allowing the market to assess risk and assist the SEC with actively and efficiently monitoring the adoption, modification, or cancellation of plans for enforcement purposes.

The Upshot

Rule 10b5-1 plans have for many years been common for insiders and companies alike because they provide a relatively straightforward route to an affirmative defense against insider trading. As a result, although the SEC is still in the early stages of the rulemaking process, it behooves insiders and companies to keep abreast of possible forthcoming changes that would create more restrictions on Rule 10b5-1 plans. While some commentators view the IAC's recommendations as necessary tailoring of the rules, others might argue that the SEC is jumping the gun to solve a hypothetical problem where there is limited evidence of abuse.

Originally published by The Legal Intelligencer - Law.com.

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