A Rule 10b5-1 trading plan is a prearranged plan for selling and/or buying company stock under SEC Rule 10b5-1 that provides an affirmative defense against charges of insider trading if you later trade stock while you possess MNPI. Many companies now either require or strongly encourage their executives and directors to set up 10b5-1 plans. The SEC has just finalized important additional rules for 10b5-1 plans that affect those who use them, as we summarize in this article.
SEC Has Long Suspected Misuse Of Rule 10b5-1 Trading Plans
First, some background. The law prohibits you from trading stock on the basis of material nonpublic information (MNPI), i.e. information that will move the company's stock price when it is made public. You can commit insider trading accidentally as well as intentionally, even if the MNPI that you possess did not influence your decision to trade. Avoiding insider trading is a major concern for executives, directors, and employees with company stock who need to sell shares to diversify or generate cash but also frequently know MNPI. Those could be shares you purchased on the open market or from a stock option exercise, restricted stock unit (RSU) vesting, or employee stock purchase plan (ESPP).
The SEC has been building up to its new rules for 10b5-1 plans over the past several years. A growing body of evidence suggests 10b5-1 plans have occasionally been abused to commit insider trading rather than prevent it. The SEC has been scrutinizing 10b5-1 plans in the wild for some time and is bringing more enforcement actions for abuses.
For example, earlier this year the SEC announced it had settled an enforcement proceeding involving alleged insider trading by Cheetah Mobile's CEO and its former president; this case and the related SEC Order involved the misuse of a 10b5-1 plan. The SEC's statement on the matter quotes Joseph G. Sansone, Chief of the SEC Enforcement Division's Market Abuse Unit, who explains that "while trading pursuant to 10b5-1 plans can shield employees from insider-trading liability under certain circumstances, these executives' plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it."
SEC Adopts Additional Rules For 10b5-1 Plans
In response to its findings, the SEC has taken action to tighten up the rules for 10b5-1 plans. On December 14, the agency adopted final amendments for 10b5-1 plans, a year after these additional rules were proposed.
For corporate officers, directors, and employees seeking to use 10b5-1 plans as an affirmative defense against insider-trading liability when they sell or buy company stock, these rule changes include:
1. A "cooling off" (i.e. waiting) period before trades can start after the plan's adoption or modification:
- For directors and officers, the later of (1) 90 days or (2) two business days after the disclosure in SEC Form 10-Q or 10-K of the company's financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days). The proposed rules had a 120-day cooling-off period before any trading could start after the plan's adoption or modification.
- For people other than directors and officers, 30 days. This is an important difference from the proposed rules, which did not clearly specify a cooling-off period for regular employees and managers.
2. A requirement to certify in the plan itself when adopting or modifying it that you are not aware of material nonpublic information about the company. This certification requirement is just for directors and officers.
3. No overlapping 10b5-1 plans for open-market trades. One exception would be another plan set up just to allow sales of stock (i.e. sell-to-cover) for tax withholding when restricted stock/RSUs vest.
4. A limit on single-trade plans to one per 12-month period.
These final rules are effective 60 days after publication of the adopting release in the Federal Register. Existing plans appear to be grandfathered unless modified.
Companies must also now annually disclose their insider-trading policies and procedures. For more details on the additional requirements, including the need to check a box on SEC Form 4 and Form 5 when a reported stock transaction is made under a 10b5-1 plan, see the SEC Fact Sheet on the rule changes.
The related FAQ at myStockOptions explains the background of this development, including the SEC's long-running scrutiny of 10b5-1 plans and research suggesting that abuses of 10b5-1 plans do occur, and has a growing curated list of detailed commentaries on the rule changes from law firms.
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