January 27, 2022
For years, institutional investors have been clamoring to tighten the rules governing plans that allow corporate executives to buy and sell their own companies’ stock without incurring insider trading liability. On December 15, 2021, the SEC finally answered those calls and announced proposed amendments to Rule 10b5-1, which govern such plans. The SEC Commission’s three Democrats and two Republicans all voted for the proposed amendments, although some did not approve of every single proposal.
“We welcome these proposed amendments, which we have long supported after seeing time and time again how corporate insiders have abused the current rule,” said Steven J. Toll, co-chair of Cohen Milstein’s securities litigation practice group. Julie G. Reiser, the practice group’s other co-chair, concurred. “Many of the proposed changes will strengthen institutions’ ability to confront illegal insider trading in the courtroom,” she said.
Rule 10b5-1 and Its Abuse
Rule 10b5-1, which was adopted over 20 years ago in 2000, provides corporate insiders protection from insider trading claims if their trades were exercised according to a written pre-arranged plan that was devised before the executive was aware of any material non-public information (“MNPI”). Although these plans are not a prerequisite to an executive’s sale of stock, they have become widespread because they provide an effective shield against securities fraud lawsuits.
Instead of preventing trading on MNPI, critics say these plans can enable such behavior due to design loopholes. In some circumstances, for example, insiders create multiple overlapping plans and then cancel certain plans if they learn of MNPI that likely will increase the stock price. Incredibly, the current rules allow for the cancellation of a 10b5-1 plan even if the cancellation is based on MNPI.
Written to address these types of problems, the proposed SEC amendments fall into two main categories: (1) restrictions to the plans themselves and (2) disclosure requirements for the plans.
Proposed Restrictions on the Plans
One of the most popular proposed amendment is to require a “cooling off period” for any trades to take place after a plan has been created. Supporters of such a restriction include former SEC Chair Jay Clayton, who was appointed by President Trump.
Currently, an insider can create a 10b5-1 plan and then execute a trade based on that plan the same day. Under the new proposal, corporate officers or directors could not trade until 120 days after establishing a 10b5-1 plan. If the trading plan is entered into by an issuer, i.e., the company itself, the cooling off period would need to be only 30 days.
Another important amendment would “eliminate the affirmative defense for any trades by a trader who has established multiple overlapping trading arrangements for open market purchases or sales of the same class of securities.” This would eliminate the ability of insiders to game the system by setting up multiple plans and then later deciding to cancel certain plans that would execute trades that would result in losses.
Moreover, there is a proposal to sharply curtail the use of plans that are limited to a single-trade. Unlike what many envision Rule 10b5-1 plans to be, which is a set plan to sell securities at multiple, prearranged dates over an interval of time whether the stock is up or down, single-trade plans are set up to execute just a single trade at one moment in time. Some have argued single-trade plans are not “plans” at all, but more equivalent to a date-triggered order and should be completely prohibited under Rule 10b5-1. A recent Stanford study from January 2021 found that single[1]trade plans generally avoided losses of some four percent, indicating their abuse.1 Therefore, the SEC now proposes to limit their use to only one plan per 12-month period. Although the SEC does not propose banning single[1]trade plans, partly because they envision legitimate, one-time liquidity needs for such a plan, they did invite the public to make the case for a ban when submitting their comments.
Finally, while current rules require that the plans be entered into in good faith, a proposed amendment would require them to be operated in good faith. According to the SEC, this amendment “is intended to make clear that the affirmative defense would not be available to a trader that cancels or modifies their plan in an effort to evade the prohibitions of the rule or uses their influence to affect the timing of a corporate disclosure to occur before or after a planned trade under a trading arrangement to make such trade more profitable or to avoid or reduce a loss.”
Proposed New Disclosure Requirements
On the disclosure front, the proposed amendments would require issuers to disclose their policies and procedures on insider trading. The disclosure of such policies would be required annually and must also “provide detailed and meaningful information,” such as how the issuer ensures compliance.
In addition, issuers would need to disclose their option grant policies and exhibit a tabular showing of all option grants they made within 14 days of the disclosure of nonpublic information, while also disclosing the market price of the security the trading day before and after such release of information. These disclosures would make it easier to detect likely links between knowledge of MNPI and manipulated trades.
Under the proposed rules, issuers would need to disclose each quarter any adoption or termination of Rule 10b5-1 plans by its directors, officers, or the issuer. Currently, issuers are not required to disclose such plans. In fact, executives do not even have to say whether the trades they report on SEC Form 4 were made pursuant to such a plan.
Public Response
The SEC has invited public comments to the proposed rules, which must be received within 45 days of their publication in the Federal Register. Although the proposed amendments were announced on December 15, 2021, they have yet to be published in the Federal Register, so the deadline clock has not yet started to tick.
So far, there have been very few substantive comments submitted through the formal process; most are terse statements from individuals. One of the most consequential comments comes from the Securities Industry and Financial Markets Association (“SIFMA”), which complained of the limited time allotted for public comments without providing any commentary on the proposed rules. SIFMA’s critique echoed one by Commissioner Elad Roisman the day the proposed amendments were announced. Roisman, one of the SEC’s two Republican members until he resigned effective January 21, said the 45-day limit was “shorter than our customary comment periods, which have typically been 90 or at least 60 days.” He also noted that the period for commentary falls over several major holidays.
Two Republican U.S. Senators followed with the same criticism in a letter to SEC Chairman Gary Gensler on January 10, 2022. Senators Pat Toomey (R[1]Pa.) and Patrick McHenry (R-N.C.) expressed dismay at the “unprecedented pattern” of issuing proposed rules with shorter comment periods, especially considering they were issued during the holiday season. They noted that customarily more time is allotted for public comments and that then-President Barack Obama recommended federal agencies allow at least 60 days and sometimes 120 days for commentary depending on the complexity of the issues. The SEC has so far refused to extend the 45-day period for comments, which starts after the proposed amendments are published in the Federal Register. In the past, the SEC would have published the proposed rules in the Federal Register by now, something that generally happens two to three weeks after an announcement.
The SEC, however, did reissue the proposed rule on January 13, 2022 without any substantive changes. It is not yet clear whether the delay in the proposed amendments’ publication in the Federal Register or its reissuance on January 13 is a way of extending the deadline without appearing to bend to outside pressure.
Although they have not yet provided a formal comment, the Council of Institutional Investors (“CII”) applauded the SEC for the proposed amendments, many of which were suggested in CII’s rule-making petition to the SEC nearly a decade ago.
1. See David F. Larcker, Bradford Lynch, Philip Quinn, Brian Tayan, and Daniel J. Taylor, Gaming the System: Three Red Flags” of Potential 10b5-1 Abuse, Stanford Closer Look Series, January 19, 2021.