As noted in blog, the Chair of the House Financial Services Committee, Maxine Waters, has introduced H.R. 624, the “Promoting Transparent Standards for Corporate Insiders Act,” which could require some significant tweaks to Rule 10b5-1 plans and disclosure about them. Co-sponsored by the Ranking Republican Member on the Committee, Patrick McHenry, the legislation would require the SEC to conduct a study of whether specified amendments to the rules governing 10b5-1 plans should be adopted, report back within a year and then adopt rule amendments consistent with the findings of the study. The high-level bipartisan sponsorship of the legislation suggests that there is a reasonable chance that it could move forward, but certainly does not guarantee that it will survive in the Senate. You might recall that the JOBS and Investor Confidence Act of 2018 (the erstwhile JOBS Act 3.0), which included similar provisions regarding Rule 10b5-1, passed the House by a vote of 406 to 4, but made no progress in the Senate. (See this PubCo post.) The new leadership must think that the chances for enactment are better with a standalone bill.

In general, Rule 10b5-1 allows an insider, when not in possession of material non-public information, to establish a formal trading contract, instruction or plan that specifies pre-established dates or formulas or other mechanisms—that are not subject to the insider’s further influence—for determining when the insider can sell shares, without the risk of charges of insider trading. To be effective, the contract, instruction or plan must also conform to the specific requirements set forth in the Rule. In effect, the Rule provides an affirmative defense designed to demonstrate that a purchase or sale was not made “on the basis of” material nonpublic information. If a 10b5-1 contract, instruction or plan is properly established, in theory at any rate, the issue is not whether the insider had material non-public information at the time of the purchase or sale of the security; rather, that analysis is performed at the time the instruction, contract or plan is established.

Sounds good right? The problem is—and of course there’s a problem—that academic studies uncovered a statistical link between the timing of executive sales under Rule 10b5-1 plans and negative corporate news, finding that executives using 10b5-1 plans generated significantly better returns than other executives at the same company. SEC Enforcement took note, signaling that sales under 10b5-1 plans would then be under scrutiny. As reported in the Washington Post, in remarks delivered in 2007, then-SEC Enforcement Chief Linda Thomsen expressed concern that “executives are taking advantage of a legal safe harbor to sell their stock and profit before their companies report bad news….[A]cademic studies suggest that the rule may be a cover for improper activity, Thomsen said. ‘We’re looking at this hard….If executives are in fact trading on inside information and using a plan for cover, they should expect the ‘safe harbor’ to provide no defense.’” (See this Cooley News Brief.) She later added that one additional factor the SEC may take into account is the existence of “asymmetric” disclosure, that is, disclosure of entry into the plan without corresponding disclosure of amendments or termination of the plan (which is often the stage at which the alleged abuse occurs). In connection with a subsequent widely reported scandal and fraud charges by SEC Enforcement involving a 10b5-1 plan, the SEC indicated that it would be looking at improper disclosure, excessive exercise of discretion and the appearance of unusually favorable dates for purchase or sale transactions. A few years later, a study conducted by the WSJ seemed to indicate fortuitous results from trading by insiders under 10b5-1 plans that appeared to be more than serendipitous. The article identified a number of problems with 10b5-1 plans, including the absence of public disclosure about the plan or changes to it and the absence of rules about how long the plans must be in place before trading under the plans can begin. (See this Cooley News Brief.)

In 2013, largely in response to the WSJ study, the Council of Institutional Investors filed a rulemaking petition with the SEC regarding Rule 10b5-1. Specifically, the petition requested that the SEC “consider pursuing interpretative guidance or amendments to Rule 10b5-1 that would require Rule 10b5-1 plans to adopt the following protocols and guidelines:

  • “Companies and company insiders should only be permitted to adopt Rule 10b5-1 trading plans when they are permitted to buy or sell securities during company-adopted trading windows, which typically open after the announcement of the financial results from a recently completed fiscal quarter and close prior to the close of the next fiscal quarter;
  • Companies and company insiders should be prohibited from adopting multiple, overlapping Rule 10b5-1 plans;
  • Rule 10b5-1 plans should be subject to a mandatory delay, preferably of three months or more, between the adoption of a Rule 10b5-1 plan and the execution of the first trade pursuant to such a plan; and
  • Companies and company insiders should not be allowed to make frequent modifications or cancellations of Rule 10b5-1 plans.”

No action to amend the Rule was taken by the SEC at the time, but some of the concepts in the CII petition are captured in the new bill. (See this Cooley News Brief.)

Under the new bill, the amendments to be considered by the SEC in its study include:

  • Limiting issuers and insiders to adopting 10b5-1 plans only in permitted open trading windows;
  • Limiting the ability to adopt multiple overlapping trading plans;
  • Establishing mandatory delays between plan adoption and first trades (including consideration of whether the delay should be the same if the plan was adopted during an open window and any appropriate exceptions to the delay rule);
  • Limiting the frequency of plan modifications and cancellations;
  • Requiring that plans, amendments, terminations and transactions be filed with the SEC; and
  • For issuer plans, requiring that boards monitor plan transactions and adopt relevant policies, including policies that address trading in the context of guidelines or requirements on equity hedging, holding and ownership.

In conducting the study, the SEC would be required under the bill to consider how any amendments to the Rule might “clarify and enhance existing prohibitions against insider trading,” as well as the impact of any amendments on capital formation, willingness to retain public company status, the ability of companies to attract executives, directors and other insiders and any other consideration the SEC considered necessary and appropriate for investor protection.