Get Ready: SEC Scrutinizing 10b5-1 Trading Plans

When insiders like directors and officers want to sell their shares of a company, they can do so through the Securities and Exchange Commission's Rule 10b5-1. A Rule 10b5-1 trading plan creates a safe harbor when it comes to concerns about being accused of selling stock based on material nonpublic information by providing an affirmative defense.

The premise of the rule is that an insider is not manipulating the market if the trade occurs automatically according to a predetermined plan established before the insider possessed the material nonpublic information.

Not everyone is a fan of the rule in its current form, however. The newly appointed Securities and Exchange Commission Chair Gary Gensler says there needs to be more regulation of 10b5-1 trading plans.

In remarks given at the CFO Network Summit in June, Chair Gensler said he asked staff to make recommendations for the SEC’s consideration “on how we might freshen up Rule 10b5-1” because he believes that in the current form these plans have “led to real cracks in our insider trading regime.”

SEC Chair Gensler’s Remarks on 10b5-1 Trading Plans

In his speech, Gensler detailed several areas of 10b5-1 trading plans he believed should be modified.

A “Cooling Off” Period

Chair Gensler highlighted the possible need for a “cooling-off” period:

... when insiders or companies adopt 10b5-1 plans, there’s currently no cooling off period required before they make their first trade. I worry that some bad actors could perceive this as a loophole to participate in insider trading.

Chair Gensler pointed to the prior SEC Chair’s support on this matter. Chair Gensler also cited Stanford research that shows “a subset of executives use 10b5-1 plans to engage in opportunistic, large-scale selling of company shares,” and that plans with a short cooling-off period can cause opportunistic use of 10b5-1 plans.

Cancelling 10b5-1 Trading Plans

Next, Chair Gensler discussed the fact that there are not any limitations on when 10b5-1 plans can be canceled:

As a result, insiders can cancel a plan when they do have material nonpublic information. This seems upside-down to me. It also may undermine investor confidence. In my view, canceling a plan may be as economically significant as carrying out an actual transaction. That’s because material nonpublic information might influence an insider’s decision to cancel an order to sell. Thus, I’ve asked staff to consider limitations on when and how plans can be canceled.

Mandatory Disclosure Requirements

The third item Chair Gensler discussed was mandatory disclosure requirements around 10b5-1 trading plans—or lack thereof, stating, “I believe more disclosure regarding the adoption, modification, and terms of Rule 10b5-1 plans by individuals and companies could enhance confidence in our markets.”

The potential issue here is highlighted in the Stanford research I linked to earlier, which states that “from 2016 to 2019, 99 percent of Form 144 filings (over 90,000 filings) were filed by mail and are not publicly available through EDGAR.”

And that as a result, “Comprehensive data on the structure and use of 10b5-1 plans is not widely available either to the public or to the Commission.”

Further, the research paper highlights the fact that company executives “are not required to indicate whether the trades they report on Form 4 are made pursuant to such plans. Executives are only required to notify the SEC if a 10b5-1 plan is used to sell restricted stock through Form 144, and if so, provide the date the plan was adopted.”

Limits on 10b5-1 Plans

Chair Gensler’s final point of discussion focused on the fact that “there are no limits on the number of 10b5-1 plans that insiders can adopt.”

With the ability to enter into multiple plans, and potentially to cancel them, insiders might mistakenly think they have a “free option” to pick amongst favorable plans as they please. I have asked staff to consider whether there should be a limit on the number of 10b5-1 plans.

Make no mistake: As the rule stands today, cancelling or amending any 10b5-1 plans calls into question whether they were entered into in good faith. If insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense.

Takeaways

Insider trading is a serious allegation (Remember Equifax, anyone?) and is one factor that can lead to massive derivative lawsuits settlements.

I have long recommended that insiders are best protected when they only sell shares pursuant to Rule 10b5-1. Scrutiny surrounding this rule has been going on for years, with notable research dating back to the early 2000s that shows how these plans can be abused.

The majority of recommendations made by Chair Gensler are certainly sensible, and are “best practices” suggestions I have myself made in the past to insiders who want to be on the up and up when it comes to 10b5-1 trading plans.

While the SEC has not modified the rule yet, it is wise for directors and officers to 1) keep an eye on the developments surrounding 10b5-1 and 2) adhere to best practices around 10b5-1 trading plans, regardless of whether or not the SEC updates the rule.

For more on what those best practices are, see my 2013 article on 10b5-1 trading plans, which still gives solid advice on plan recommendations, including:

• Public disclosure
• 60-day gap between disclosure and trading
• Reporting plan sales on Form 4
• Limited modification to 10b5-1 trading plans
• Minimal terminations
• Small sales over time
• Isolation of trading plan broker
• No trading outside the plan