On Sept. 21, 2022, the Securities and Exchange Commission (SEC) announced that it brought an enforcement action against two executives of Cheetah Mobile, a publicly traded Chinese app developer, for selling the company’s securities pursuant to a 10b5-1 plan that they entered into while in possession of material nonpublic information. Cheetah Mobile’s CEO, Sheng Fu, and then-Chief Technology Officer Ming Xu, settled the action without admitting or denying the SEC’s findings and agreed to cease-and-desist orders and civil penalties.
In 2015, Fu and Xu learned that Cheetah Mobile’s largest advertising partner was changing its algorithm for determining ad placement fees and that the change could halve Cheetah Mobile’s revenues unless it improved the quality of its ad placements. Cheetah Mobile was unable to solve this problem, resulting in declining revenues starting in December 2015. In March 2016, a time when material information related to the declining revenues had not been disclosed, Fu and Xu entered into a 10b5-1 plan to sell their shares of Cheetah Mobile American Depository Shares, which trade on the NYSE. The SEC found that the executives avoided over $300,000 in collective losses by selling their shares pursuant to the 10b5-1 plan. Because Fu and Xu knew the material nonpublic information when they entered into the plan, Rule 10b5-1 was not a defense against the securities fraud charges.
This enforcement action comes on the heels of the SEC’s increased efforts to rein in misuse of material nonpublic information by insiders of publicly traded companies. Rule 10b5-1 provides issuers, directors, officers and others with a defense to insider trading transactions made pursuant to a 10b5-1 plan, so long as the plan is not entered into at a time when the insider is aware of material nonpublic information. In December 2021, the SEC proposed changes to Rule 10b5-1 that would impose new requirements on insiders invoking the rule as a defense to securities fraud charges. The proposal would require issuers, directors and officers to administer (not just enter into) 10b5-1 plans in good faith; report all adoptions, terminations or modifications of 10b5-1 plans; and abide by significant waiting periods during which no trades could be made pursuant to the 10b5-1 plans. A detailed report of the SEC’s proposed changes to Rule 10b5-1 can be found here.
Going forward, we expect the SEC to continue to closely scrutinize 10b5-1 plans. The Cheetah Mobile enforcement action underscores the need for issuers, directors, officers and others to carefully assess whether they possess any material nonpublic information at the time they enter into or modify any 10b5-1 plan.