The U.S. Securities and Exchange Commission (“SEC”) is considering greatly limiting the affirmative defense that protects corporate executives against SEC prosecutions for insider trading claims when they buy or sell their own company’s stock.
In 2000, the SEC adopted Rule 10b5-1 under the Securities Exchange Act of 1934 to address the issue that corporate insiders have a need to trade shares of their company’s stock, but unavoidably have material information unavailable to the public. Rule 10b5-1 provides an affirmative defense to insider trading claims for insiders who set up trading plans, known as 10b5-1 plans, to schedule future trades of their own company’s stock in good faith, before becoming aware of material nonpublic information.
On Monday, SEC Chair Gary Gensler said these 10b5-1 plans “have led to real cracks in our insider trading regime” and called on SEC staff to recommend ways to “freshen up” Rule 10b5-1.[1] Chair Gensler, who was sworn into office in April,[2] offered the following four criticisms of Rule 10b5-1. First, the current 10b5-1 plans do not require a cooling-off period before insiders can make their first trades, which some bad actors may perceive as a loophole to participate in insider trading. Citing research findings that 14% of restricted stock sales in 10b5-1 plans occur within the first month of plan adoption, and 40% occur within the first two months, Chair Gensler proposed mandating a cooling-off period of four to six months.[3] Second, there are no limits on when 10b5-1 plans can be canceled, which has an “upside-down” effect of enabling insiders to cancel plans based on material nonpublic information. Thus, Chair Gensler asked SEC staff to consider limitations on when and how plans can be canceled.[4] Third, there are no mandatory disclosure requirements regarding 10b5‑1 plans. Chair Gensler suggested that more disclosure by insiders regarding the adoption, modification, and terms of 10b5‑1 plans could enhance investor confidence in the markets.[5] Fourth, there are no limits on the number of 10b5-1 plans that insiders can adopt, enabling them to enter into multiple plans, pick among favorable plans, and cancel unfavorable plans as they please. Chair Gensler asked SEC staff to consider whether there should be a limit on the number of 10b5-1 plans.[6]
The Chair warned that “[i]f insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense,” and that the SEC staff will use all the tools in its toolbox to ensure it identifies and punishes abuses of 10b5-1 plans.[7] These remarks and the underlying sentiments may signal that the SEC will scrutinize current 10b5-1 plans to determine whether they have been entered into and implemented in good faith.
We recommend that companies and executives subject to Rule 10b5-1 plans consult with their counsel for advice on how to ensure compliance when adopting, executing, or changing 10b5-1 plans, and to proactively respond to these proposed changes.
[1] Gary Gensler, Chair, U.S. Sec. & Exch. Comm’n, Prepared Remarks at the CFO Network Summit (June 7, 2021), available at https://www.sec.gov/news/speech/gensler-cfo-network-2021-06-07.
[2] Jonathan R. Barr, John J. Carney, Kevin R. Edgar, Jimmy Fokas, Teresa Goody Guillén, Bari R. Nadworny, Michelle N. Tanney, BakerHostetler, The Future of SEC Enforcement Under the Biden Administration (Apr. 16, 2021), available at https://www.bakerlaw.com/alerts/the-future-of-sec-enforcement-under-the-biden-administration.
[3] Gary Gensler, Chair, U.S. Sec. & Exch. Comm’n, Prepared Remarks at the CFO Network Summit (June 7, 2021), available at https://www.sec.gov/news/speech/gensler-cfo-network-2021-06-07.
[4] Id.
[5] Id.
[6] Id.
[7] Id.
