The Democratic and Republican leaders of the House Committee on Financial Services announced last week the introduction of a bipartisan bill to try to ensure that issuers and their insiders cannot indirectly engage in illegal insider trading through adopting or changing their trading plans. On Friday, January 18, Chairwoman Maxine Waters (D-Calif.) and Ranking Member Patrick McHenry (R-N.C.) introduced H.R. 624, the Promoting Transparent Standards for Corporate Insiders Act, to require the Securities and Exchange Commission (SEC or Commission) to explore and possibly implement amendments to SEC Rule 10b5-1 concerning what are commonly called Rule 10b5-1 trading plans.

It is rare for the chair and ranking member of a committee to sponsor legislation together. When they do, they dramatically increase a bill’s prospects for enactment. We expect this bill will move through the House of Representatives quickly. Chairwoman Waters said the bill will “play a critical role in holding corporate executives accountable and improving SEC Rule 10b5-1.” And Ranking Member McHenry said, “[c]racking down on fraud and abuse within our financial system is apolitical.”

Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) (17 C.F.R. 240.10b5–1) defines when a purchase or sale constitutes trading “on the basis of” material nonpublic information for insider trading cases brought under Section 10(b) of the Exchange Act. In relevant part, the rule provides an affirmative defense to charges of illegal insider trading where, before becoming aware of material nonpublic information, a person entered into a written plan, binding contract or instruction to purchase or sell shares using a predetermined amount, price and transaction date. As one example of how this rule is applied, executives often adopt written plans to buy or sell their company’s securities, referred to as a Rule 10b5-1 trading plan. H.R. 624 seeks to address reported incidents of corporate executives manipulating such trading plans to avoid insider trading charges.

The bill requires the SEC to conduct a study of, and report within one year to Congress on, possible amendments to the rule, as well as analysis of the impact of potential amendments on issuers, capital formation and “any other consideration that the Commission considers necessary and appropriate for the protection of investors.” The bill also instructs the Commission to consider “how any such [Rule 10b5-1] amendments may clarify and enhance existing prohibitions against insider trading.” Once the study is completed, the SEC shall, subject to notice and comment, revise Rule 10b5-1 consistent with the study’s findings.

In particular, the proposed legislation calls for a study of whether Rule 10b5-1 should be amended to place several restrictions on the ability of issuers and their insiders to adopt, modify or cancel trading plans. For example, the SEC’s study would explore whether to limit the ability to adopt a trading plan to a time during issuer-adopted trading windows, limit the ability to adopt multiple trading plans and limit the frequency that a plan may be modified or cancelled. Another contemplated amendment would be to establish a mandatory delay between the adoption of a trading plan and the execution of the first planned trade.

The bill also considers amendments to Rule 10b5-1 that would impose additional filing requirements and oversight obligations on issuers and their boards of directors. Specifically, the SEC would study whether to require issuers and insiders to file with the Commission trading plan adoptions, amendments, terminations and transactions. Where an issuer’s board has adopted a trading plan, the SEC’s study would investigate whether to require such boards to “(i) adopt policies covering trading plan practices; (ii) periodically monitor trading plan transactions; and (iii) ensure that issuer policies discuss trading plan use in the context of guidelines or requirements on equity hedging, holding, and ownership.”

Concerns over Rule 10b5-1 trading plans have emerged from time to time since the Commission adopted the rule in 2000. For example, in an October 2007 speech, then Director of the SEC’s Division of Enforcement Linda Thomsen addressed evidence suggesting that executives were abusing 10b5-1 plans, reporting that the SEC was examining issues relating to the existence of overlapping 10b5-1 plans and asymmetrical disclosures around plans, such as the lack of timely disclosure of related plan modifications or terminations. On March 25, 2009, the SEC’s Division of Corporation Finance issued new and revised interpretations regarding the operation of Rule 10b5-1(c) and the availability of its affirmative defense, including guidance concerning cancelling or establishing a replacement trading plan and the impact of separate discretionary transactions on an existing plan. More recently, commentators, including Commissioner Robert J. Jackson Jr., have raised concerns about corporate executives abusing their knowledge of buyback plans to profit from selling their shares under the safe harbor of a Rule 10b5-1 plan. Of course, Rule 10b5-1(c) already includes provisions designed to prevent abuse through trading plans, such as requiring that a person may adopt such a plan only “[b]efore becoming aware of” material nonpublic information.

In considering the likelihood and timeline for action by the SEC, it is important to note that the study and report required within one year after enactment of the legislation are structured to encourage action by the agency. The study and report, unlike many, are not open-ended. The SEC must reach conclusions on the issues the report identifies. If the SEC answers any of the questions posing possible amendments to the rule, it must engage in rulemaking to amend the rule. Thus, the bill lands in a place between requiring a kick-the-can style agency study and the kind of directed rulemaking required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. That legislative posture, if adopted, is likely to lead to rulemaking. How long will rulemaking take? Ordinarily, the proposal and adoption of a rule amendment from beginning to end could reasonably be completed within two years, assuming a majority of Commissioners support the rule. Here, if the rulemaking follows a report by the Commission recommending adoption of an amendment, that support can be presumed.