[ad_1]
On June 7, 2021, in prepared remarks for the CFO Network SummitSecurities and Exchange Commission (SEC) Chairman Gary Gensler identified several areas of concern for SEC personnel related to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (Exchange Act). These comments provide insight into possible future regulations.
Rule 10b5-1, passed in 2002, provides a mechanism for individuals and entities to execute scheduled transactions over a period of time, provided that the plan directing those transactions is entered into at a time when the person or entity has no material holds non-public information about the company or the securities traded under the plan. Trading under an effective Rule 10b5-1 plan can benefit from an affirmative defense against an insider trading challenge. Rule 10b5-1 plans have become common features of issuer buyback programs and are used by many company insiders and other individuals who want to structure transactions over time and avoid the risk of being unexpectedly prevented from trading because of holding of material non-public information.
Chairman Gensler specifically identified four problems with Rule 10b5-1 plans under current law and practice:
1. Rule 10b5-1 does not require a cooling off period between the time the plan is entered into and the time of the first trade.
While a cooling off period or waiting period is a common feature of many Rule 10b5-1 plans, and a common requirement of issuers adopting insider guidelines using Rule 10b5-1 plans, the length of such period varies, and there are is not a requirement under the existing rule for a waiting period. Chairman Gensler noted that recommendations to require a four- to six-month waiting period have received bipartisan support from a former SEC chairman and current commissioners, and that such recommendations deserve renewed consideration. Notably, a wait of four to six months is longer than what many practitioners consider current best practice.
Chairman Gensler also noted that not having a cooling off period could be seen as a “loophole to engage in insider trading.” His comments do not address how a loophole is created by the lack of a cooling off period, when the trading decision and instruction is made at a time when the individual or entity has no material nonpublic information. The SEC has been clear that an insider cannot be “cleansed” of possession of material nonpublic information by the release of that information prior to the first transaction under a Rule 10b5-1 plan. Many practitioners and companies therefore believe that a waiting period offers favorable optics, but possibly limited content protection. Chairman Gensler cited recent empirical research suggesting that more favorable returns result from trades under plans with little to no cooling off period.1
2. Rule 10b5-1 plans may be terminated even when the entity or person terminating the plan has material nonpublic information.
Chairman Gensler expressed concern that Rules 10b5-1 plans could be canceled by an entity or person in possession of material nonpublic information, calling the possibility “upside down” as “cancelling a plan can be as economically important as executing an actual transaction.”
Prior SEC guidelines, including in Compliance and Disclosure Interpretations issued by the Division of Corporation Finance, noted that Exchange Act Section 10(b) and Rule 10b5-1 apply to fraudulent conduct “in connection with the purchase or sale of securities.” “, and therefore a securities transaction is required for liability to exist. By definition, termination of a trading plan does not lead to such a securities transaction. As Chairman Gensler points out, and practitioners have long advised, even if a termination is permitted, a termination can be used as evidence of a lack of good faith in establishing the plan, thereby creating a possible way to defend the affirmative defense of Rule to challenge 10b5-1. For this reason, many practitioners advise caution and restraint when terminating Rule 10b5-1 plans.
3. Rule 10b5-1 does not require disclosure of such plans.
Chairman Gensler notes that “greater disclosure regarding the approval, amendment and terms of Rule 10b5-1 plans by individuals and companies could increase confidence in our markets.” While some issuers and individuals voluntarily disclose the approval of a Rule 10b5-1 plan (for example, in an individual’s Form 8-K or Form 4), and Schedule 13D filers may be required to do so, detailed disclosure about the terms of Rule 10b5-1 plans are rare. If an issuer were required to disclose the maximum at which it will repurchase its shares, or if an insider were required to disclose the minimum price for a sale, the market could view these limits as reflecting a long-term view of the shares, and such a requirement disclosure may discourage use of Rule 10b5-1 plans.
4. There are no limits to the number of 10b5-1 plans an insider can take.
Chairman Gensler noted that “[w]With the ability to enter into multiple plans and potentially cancel them, insiders may mistakenly believe they have a “free option” to choose from favorable plans at their discretion.”
Rule 10b5-1 in its current form does not allow multiple plans to cover the same stock, or allow the cancellation of one plan to affect trading under another plan. In addition, an insider may have legitimate reasons for using multiple plans, such as having one longer-term direct selling plan sufficient to cover the tax liabilities upon vesting of stock grants, and another plan to negotiate certain separate transactions. cover for diversification purposes.
Next steps
Proposals regarding reforms of Article 10b5-1 have surfaced regularly since its adoption 20 years ago,2 including proposals highlighting many of the same issues identified by Chairman Gensler, as well as the intersection of the rule with share buybacks. Several of these issues also feature in recent legislation passed in Congress that would require the SEC to study Rule 10b5-1.3 Given the increased oversight of Rule 10b5-1’s activity, we expect SEC staff to act quickly to make recommendations to the committee and to provide a regulatory proposal and a request for public comment.
_______________
1 See David F. Larcker, Bradford Lynch, Phillip Quinn, Brian Tayan and Daniel J. Taylor,”Gaming the System: Three ‘Red Flags’ of Potential 10b5-1 Abuse(Jan 19, 2021).
2 Behold, e.g., our discussion of regulatory proposals submitted to the SEC by the Council of Institutional Investors addressing some of the same concerns in our client warning”Back to Basics with Rule 10b5-1 Trading Plans” (Apr 9, 2013).
3 Behold, e.g., the Promoting Transparent Standards for Corporate Insiders Act (HR 1528) passed by the U.S. House of Representatives on April 20, 2021, which would instruct the SEC to study, report and regulate possible revisions to Rule 10b5-1. that is consistent with the results of such a study, and the Insider Trading Prohibition Act (HR 2655) passed by the US House of Representatives on May 18, 2021, which would codify the definition of illegal insider trading under the securities laws.
[ad_2]
picture credit