SEC to Increase Scrutiny on Good Faith in Rule 10b5 1 Insider Stock Plans

This month, newly-appointed SEC Chair Gary Gensler delivered remarks regarding how the SEC might “freshen up” Rule 10b5-1, which permits corporate insiders and others to buy and sell stock pursuant to trading plans adopted in good faith prior to learning material non-public information. Gensler’s focus on Rule 10b5-1 continues in the footsteps of his predecessor, Jay Clayton, who was appointed by the previous administration. In September of last year, Clayton wrote a letter to U.S. Representative Brad Sherman (D Ca), Chairman of the House Financial Services Subcommittee on Investor Protection, expressing concerns about interest alignment and fairness of law compliant Rule 105b 1 plans under the current SEC regulations. Congress has acknowledged the SEC’s concerns. Just this week Senators Chris Van Hollen (D-Md) and Deb Fischer (R-Neb) reintroduced the latest version of the Promoting Transparent Standards for Corporate Insiders Act, which formally directs the SEC to explore amendments to Rule 105b 1 and, within three months, provide Congress with a report discussing possible abuses of the Rule.

Rule 10b5-1 plans provide a “safe harbor” for insiders, commonly directors and officers, in possession of a company’s material non-public information (MNPI), to purchase or sell stock of that company without running afoul of insider trading laws. The Rule relies on the premise that if an insider agrees to a trading plan in good faith before possessing MNPI, then the insider will not be making decisions based on subsequently acquired MNPI at the time the transaction occurs in the future.

The increasingly widespread use of Rule 10b5-1 plans has led to what Gensler characterized as “cracks in our insider trading regime.” Gensler noted: 1) there is no required “cooling off” period before the first trade can occur, 2) plans can be canceled at any time, 3) there are no disclosure requirements, and 4) insiders can adopt more than one Rule 10b5 1 plan. Gensler further noted the SEC would consider reforms related to share buybacks in connection with a Rule 10b5 1 plan. In early 2016, as the popularity of Rule 10b5 1 plans continued to grow, the Harvard Law School Forum on Corporate Governance republished an article first published in Insights, that forecasted many of Gensler’s remarks. The article highlights the benefits of Rule 10b5 1 plans and provides suggestions on best practices that should be implemented to comply with the intent of the Rule’s safe harbor, including, amongst other recommendations: establishing only one plan, adopting the plan during an issuer’s open trading window, public disclosure of the plan, establishing a waiting period before the first trade, and avoiding multiple modifications, suspensions, and terminations.

With increased scrutiny of Rule 10b5 1 plans on the horizon, companies and their insiders should review their Rule 10b5-1 plans in light of anticipated SEC scrutiny and regulatory changes. A report published in January this year offers recommendations on how the SEC should regulate Rule 10b5-1 plans that rely on the safe harbor of the Rule, including: requiring minimum cooling-off periods of four to six months before the first trade can occur, eliminating single trade plans that effectively act as an option, eliminating plans in which the first trade occurs before the next earnings announcement, and requiring public disclosure by electronic filing when a plan is adopted, modified, suspended, or terminated, rather than a non-public filing only after the sale of restricted stock. These recommendations are consistent with the Chairs’ comments over the past year and are a good starting point for insiders when reviewing their Rule 10b5 1 plans.

Please contact your Carrington Coleman securities counsel should you have any questions related to Rule 10b5 1 plans, or any other securities related questions.