SEC Chairman Speaks on Need for Greater Regulation of 10b5-1 Trading Plans
Speaking at The Wall Street Journal’s CFO Network event on June 7, 2021, SEC Chairman Gary Gensler said that he has asked the staff to propose recommendations for the Commission’s consideration with respect to “freshening” up Rule 10b5-1 and the requirements for trading plans adopted in connection therewith.
Background: 10b5-1 Trading Plans Can Permit Insiders to Trade While in Possession of Material Nonpublic Information
Exchange Act Section 10(b) and Rule 10b-5 prohibit, among other things, the purchase or sale of a security on the basis of material nonpublic information about that security or its issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.
Under Exchange Act Rule 10b5-1, a purchase or sale of a security is defined to be “on the basis” of material nonpublic information if the person making the purchase or sale was aware of the information when making the purchase or sale, whether or not the information played any role in the decision to trade. However, the rule also contains an affirmative defense to Rule 10b-5 insider trading liability if the person making the purchase or sale can demonstrate that before becoming aware of the information (and subject to other conditions specified in the rule), such person had: (i) entered into a binding contract to purchase or sell the security, (ii) instructed another person to purchase or sell the security for the instructing person’s account, or (iii) adopted a written plan for trading securities. Trading plans that satisfy the Rule 10b5-1 affirmative defense conditions are commonly referred to as “Rule 10b5-1 trading plans.”
Mr. Gensler’s Recommendations
Mr. Gensler suggested consideration of a number of changes that in his view would help close what he sees as “cracks” in Rule 10b5-1:
1. Cooling-Off Period: As there is no mandated cooling-off period prior to the first trade under Rule 10b5-1 trading plans, Mr. Gensler is concerned that “bad actors” may see this as a loophole to engage in insider trading. He has asked the staff to consider a required cooling-off period (four to six months was suggested) to address this concern.
2. Limitation on Cancelling Plans: There are currently no limitations on when Rule 10b5-1 trading plans may be cancelled, which may result in the cancellation of such plans by insiders when they are in possession of material non-public information. Mr. Gensler noted that the determination to cancel a plan may be just as economically significant as a determination to trade, and has asked the staff to consider limitations on how and when such plans may be cancelled.1 He stressed, however, that under the current rule, amending or cancelling a Rule 10b5-1 trading plan may call into question whether such plan was implemented in good faith. If the plan was not adopted in good faith, the affirmative defense is not available.
3. Mandatory Disclosure Requirements: There are no mandatory disclosure requirements with respect to Rule 10b5-1 trading plans. In order to enhance confidence in the market, Mr. Gensler has asked the staff to consider disclosure requirements with respect to the adoption, modification and terms of such plans.
4. Limit on Number of 10b5-1 Plans: There is no limit on the number of Rule 10b5-1 trading plans that an insider can adopt. When combined with the potential ability to cancel, Mr. Gensler feels that insiders may mistakenly feel that they can choose among the most favorable of such plans. He has therefore asked the staff to consider whether the number of plans an insider can enter into should be limited.
Although Mr. Gensler’s recommendations are not yet reflected in SEC rules, many are consistent with current best practices with respect to the implementation of Rule 10b5-1 trading plans, including the inclusion of cooling-off periods and limitations on the ability to modify or terminate such plans. As the SEC is increasing its scrutiny of such plans, executives and issuers should consult with their legal advisors both at the time of adoption of a Rule 10b5-1 trading plan, and whenever any changes to such plans are under consideration.
© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
As Exchange Act Section 10(b) authorizes the SEC to prohibit manipulative or deceptive devices or contrivances in connection with the purchase or sale of any security, and the cancellation of a Rule 10b5-1 trading plan (i.e., not engaging in planned securities transactions) does not constitute such a purchase or sale, the SEC’s authority to simply prohibit plan cancellations is open to question. As a result, the SEC may need to frame any relevant proposal in terms of the effect of cancellation on purchases and sales.