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It's Time to Review Procedures for Insiders' Rule 10b5-1 Trading Plans

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

December 17, 2012

Recent news reports make it clear that now is a good time for public company compliance officers to review their company’s procedures for approval of insiders’ Rule 10b5-1 trading plans. If you are not looking at your practices in this area, it’s possible that a regulatory authority or media reporter will soon be taking a close look.

Rule 10b5-1, adopted in 2000, provides insiders with an affirmative defense to charges of insider trading if the trades are made pursuant to a so-called 10b5-1 trading plan. The plan must be entered into at a time when the insider has no material nonpublic information about the company and must either provide specific instructions about the trades or must turn the decision making over to a third party who does not possess material non-public information. Since its adoption, the rule has facilitated countless trades by public company officers and directors.

Recently, the Wall Street Journal has led the charge in scrutinizing insiders’ transactions in their companies’ stock, either within 10b5-1 plans or outside of such plans:

On November 28, 2012, in Executives’ Good Luck in Trading Own Stock (subscription required), the Journal’s reporters Susan Pulliam and Rob Barry detailed numerous examples of executives making sales, generally under Rule 10b5-1 plans, shortly before corporate announcements of negative news. These trades thus permitted the insiders to take advantage of higher sale prices than would have been the case had they sold after the news was made public.

On December 11, in Insider-Trading Probe Widens, the Journal reported that the November 28 article had triggered a criminal investigation by the Manhattan U.S. Attorney’s office of trades by seven executives, and an SEC investigation of another. On December 12, in Big Sales by Big Lots Brass, the Journal gave more detail on the some of the trades. One of the problematic practices cited: insiders making trades outside of Rule 10b5-1 plans fairly close in time to trades within the plan. While there is no requirement that all trades be made under the Rule (which is only a safe harbor), frequent trades outside the plan can raise questions about whether the insider is acting in good faith.

On December 14, in Trading Plans Under Fire, the Journal reported that Congress is investigating whether Rule 10b5-1 provides adequate protections against insider trading, a development that could put pressure on the SEC to increase scrutiny on insider trades even further.

All of this attention means that companies should focus on making sure that their own insider trading policies are adequately enforced and prevent, not only illegal activity, but even the appearance of impropriety. In connection with 10b5-1 trading plans, companies should focus on the following areas:

  • Consider adopting or expanding a cooling off period between adoption or amendment of the 10b5-1 plan and the commencement of trading. This can make it easier to prove that the plan was actually adopted or amended before the insider learned of any material nonpublic information. In a September 2010 survey reported by Blog, respondents reported that their companies used the following cooling-off periods: two weeks or less-13%; one month-23%; two months-6%; a waiting period until the next open window-12%; none-37%. Such a cooling off period has become a best practice, even though it would not have prevented all of the problems outlined in the recent Journal articles.
  • Consider encouraging insiders to sell shares only pursuant to a 10b5-1 plan. In the 2010 survey cited above, 31% of the respondents said that their companies "strongly encouraged" insiders to sell only under a Rule 10b5-1 plan, and another 4% said their companies actually require that trades be made only under such a plan.
  • Examine other aspects of your process for approving 10b5-1 plans and amendments and make sure they are up to date and adequately enforced and documented. For example, make sure it is possible to document that all 10b5-1 plans and amendments were actually adopted or amended at a time when the insider was not in possession of material non-public information.
  • Avoid multiple trading plans by the same insider at the same time, which can permit the insider to exercise discretion by terminating one or more of the plans. This was the manipulative technique used by former Countrywide Financial CEO Angelo Mozilo, resulting in a record settlement of $67.5 million with the SEC in 2010. 


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