The Securities and Exchange Commission’s Investor Advisory Committee (the “IAC”) is considering recommendations from its Owner Subcommittee urging the Commission to tighten the affirmative defense and disclosure requirements for SEC Rule 10b5-1 trading plans.  These recommendations follow recent statements by SEC Chair Gary Gensler signaling the agency’s intention to review and toughen rules governing those plans.

The Subcommittee’s recommendations – which the IAC appears poised to adopt at its September 9, 2021 meeting – include (i) requiring a “cooling off” period of at least four months between the adoption or modification of a trading plan and the execution of the first trade, (ii) prohibiting overlapping trading plans, (iii) requiring electronic filing and enhanced public disclosure of trading plans and insiders’ transactions, and (iv) extending Form 4 reporting requirements to all companies – including non-U.S. issuers – with any securities listed on a U.S. exchange.

The recommendations appear to respond to studies suggesting that corporate insiders have benefited in a statistically disproportionate manner from stock sales preceding the disclosure of bad news.  However, the recommendations do not address insiders’ ability to cancel Rule 10b5-1 plans and associated trades at any time, although existing law discourages modifications of plans because of the risk that regulators or courts might then question the plans’ legitimacy.  Standard trading plans established by brokerage firms generally allow modifications only during open trading windows.

SEC Rule 10b5-1

The SEC adopted Rule 10b5-1 in 2000, recognizing that compensation in many industries involves significant amounts of equity-based pay.  Recipients of that compensation often receive material, nonpublic information (“MNPI”) in the normal course of business, but they also have legitimate needs to sell their stock-based compensation to pay their expenses, diversify their portfolios, and raise cash.

Under Rule 10b5-1, the SEC considers a stock transaction to have been made “on the basis of” MNPI if the trader was “aware” of the MNPI at the time of the transaction.  However, the Rule provides an affirmative defense if the transaction was made pursuant to a trading plan that satisfies three conditions:

  • The plan was adopted in good faith before the insider became aware of MNPI;
  • The plan (i) specifies the amount, price, and date of the transactions, (ii) provides written instructions or a formula that triggers the transactions, or (iii) does not allow the insider to influence how, when, or whether transactions take place once the plan is established; and
  • The transaction occurs pursuant to the plan.

Insiders in theory may modify a trading plan if they are not aware of MNPI at the time of modification, although modifications are rare.  Insiders also may terminate a legitimate plan even while in possession of MNPI.  In our experience, however, terminations are infrequent and typically occur only during open trading windows, as most standard plans specify that any modification can occur only when the insider lacks MNPI.

In the past two decades, various investors, academics, lawmakers, and others have raised concerns that Rule 10b5-1 might be enabling insiders to benefit from MNPI, especially to avoid losses.  The Owner Subcommittee sought to address at least some of those concerns.

The Owner Subcommittee’s Recommendations

The Owner Subcommittee made six recommendations to the IAC:

  1. Require a “cooling off” period of at least four months between the adoption or modification of a Rule 10b5-1 plan and the execution of the first trade under the new or modified plan. A four-month waiting period would ensure that insiders cannot trade during the fiscal quarter in which the plan is adopted.
  2. Prohibit overlapping trading plans. A single person or entity should not be allowed to have more than one Rule 10b5-1plan at any time.
  3. Require electronic submission of Forms 144, which are filed when insiders at U.S.-listed issuers plan to sell $50,000 or more in restricted stock in the following three-month period. Forms 144 currently may be filed in paper form, and more than 99% of them are filed in that manner, so they are difficult for investors to access.
  4. Require additional public disclosure of Rule 10b5-1 plans, including:

a) Proxy-statement disclosure of the number of shares covered under trading plans by each Named Executive Officer;

b) Proxy-statement disclosure of the total number of shares covered under corporate trading plans; and

c) Form 8-K disclosure of the adoption, modification, or cancellation of trading plans, and the number of shares covered, on a timely basis.

  1. Enhance disclosure of Rule 10b5-1 transactions, including modification of Form 4 to include:

a) Checkbox to show whether a specific trade was made pursuant to a trading plan and

b) A new field to show the date on which the plan was adopted or modified.

  1. Require all companies with securities listed on U.S. exchanges (including ADRs and ADSs filing Forms 20-F) to be subject to Form 4 reporting requirements.

Implications

The Subcommittee’s recommendations appear to be a substantial step toward addressing criticisms that have been raised about transactions under Rule 10b5-1 trading plans.  The recommendations would also extend Form 4 reporting requirements to non-U.S. issuers with U.S.-listed securities, thereby closing a gap in the visibility of certain insiders’ securities transactions.

The recommendations concerning enhanced public disclosure of trading plans and associated transactions – while imposing some additional burdens on insiders and issuers – could be useful to defendants in securities litigation.  Securities plaintiffs usually examine whether insiders sold stock before “bad news” was disclosed, and they cite any such transactions to try to show the insiders’ scienter.  If the stock sales were made pursuant to Rule 10b5-1 trading plans established to meet regulatory standards, and if those plans and associated transactions were publicly disclosed in SEC filings, defendants will have a better chance of persuading a court to take judicial notice of those plans and transactions to rebut the plaintiffs’ scienter allegations on a motion to dismiss, rather than later in the proceedings.  If the plans and transactions are not public, however, defendants will likely have a harder time making such an argument at the pleading stage.

It is interesting that the Subcommittee chose not to address insiders’ potential use of MNPI to terminate trading plans and any transactions scheduled under them.  But perhaps the Subcommittee did not do so because the industry has generally limited plan modifications to time periods when the insiders lack MNPI and because such modifications have generally not led to perceived abuses.  Nor did the Subcommittee address the interrelationship between insiders’ trading plans and corporate stock-repurchase programs, although SEC Chair Gensler had previously raised that issue.