UPDATED! Has the SEC adopted new requirements for 10b5-1 plans? Are these plans controversial?
myStockOptions Webinar: 10b5-1 Trading Plans & Other SEC Rules Advisors Need To Know, available on demand, covers basics, best practices, case studies, and SEC developments in 10b5-1 plans at the time it was recorded (Sept. 2022). Details on topics, featured experts, and continuing education credits are available at the webinar registration page.
On December 14, 2022, the SEC adopted final amendments for 10b5-1 plans to combat suspected abuses. The additional rules were finalized a year after they were initially 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:
- A "cooling off" (i.e. waiting) period before trades can start after the plan's adoption or modification:
- 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.
- 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.
- A limit on single-trade plans to one per 12-month period.
• 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.
These final rules are effective from February 27, 2023, i.e. 60 days after the publication of the adopting release in the Federal Register on December 29, 2022. 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 related SEC Fact Sheet and alerts from the following law firms:
- Gibson Dunn
- Akin Gump
- Perkins Coie
- Wilmer Hale
- Foley & Lardner
- Morrison Foerster
- Morgan Lewis
- Nixon Peabody
- Cooley (Cooley PubCo blog written by attorney Cydney Posner)
The discussion below 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.
SEC Suspects Misuses Of Rule 10b5-1 Trading Plans
As part of its activities to root out insider-trading violations, the SEC has been looking into potential abuses of Rule 10b5-1 trading plans for several years. While best practices for 10b5-1 plans have developed over time, as detailed in another FAQ, the SEC has found that voluntary practices are not enough to prevent abuse. The agency has long been suspicious about whether some plan-holders truly did not know confidential inside information when they created plans. The SEC has also focused on plan modifications or terminations that may have been made in bad faith.
In 2021, SEC Chair Gary Gensler stated during a speech that abuses of Rule 10b5-1 trading plans "have led to real cracks in our insider-trading regime." In September 2021, the SEC Investor Advisory Committee came out with its own draft recommendations, which aligned with Gensler's concerns.
SEC Enforcement Intensifies
The SEC has started to bring enforcement actions when plans are not set up or run according to existing rules. For example, the SEC recently announced (September 21, 2022) that 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 Rule 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."
Expect more SEC enforcement actions relating to 10b5-1 plans. Bloomberg reports that the SEC and the Department of Justice are investigating whether executives have been "gaming" 10b5-1 plans to illicit advantage (see US Probes Insider Trading in Prearranged Executive Stock Sales). According to its article, government investigators are using "computer algorithms in a sweeping examination" of plans held by senior executives.
A commentary from the law firm Morrison & Foerster discusses this new enforcement trend (see The Rise Of Rule 10b5-1 Enforcement And How Companies Can Mitigate Risk Of DOJ And SEC Actions). Given the surge of federal investigations into Rule 10b5-1 plans, the firm recommends that companies and executives "should consider adopting best practices to avoid exposing themselves to risk." As a reminder, the firm's article warns that simply having a 10b5-1 plan on its own does not "insulate" an executive from insider-trading liability. Plans used in ways regulators consider "abusive" may invite scrutiny, explains the firm.
Research Infers Abuses Of 10b5-1 Plans
Potential abuses of 10b5-1 plans are a subject of academic research and helped to prompt the SEC's push for rule changes. For example, an academic paper published in 2021 identifies suspicious patterns of behavior that may indicate abuses of 10b5-1 plans (see Gaming The System: Three "Red Flags" Of Potential 10b5-1 Abuse). The paper is summarized and assessed in a commentary from the law firm Cooley.
Journalists have also spotted suspicious patterns. See, for example, three articles in The Wall Street Journal:
- CEO Stock Sales Raise Questions About Insider Trading
- Executives' Good Luck in Trading Own Stock
- Trading Plans Under Fire
In these articles, and in others they wrote later, the authors weigh examples and data that raise questions about the timing of trades by some executives before the announcement of good or bad corporate news.
Pressure From Congress
Legislative pressure also underlies the SEC's renewed scrutiny of 10b5-1 plans. In 2019, the US House of Representatives passed the Promoting Transparent Standards for Corporate Insiders Act, which requires the SEC to study specific features in Rule 10b5-1 trading plans and revise the rule based on its results. As stated in a commentary from the law firm Cahill Gordon & Reindel, the proposed law seeks to order the SEC to address perceived gaps and abuses in Rule 10b5-1.
In 2021, a letter from three Democratic members of the Senate Committee on Banking, Housing, and Urban Affairs urged the SEC to adopt specific reforms to prevent what they perceive as abusive 10b5-1 plan practices and to improve disclosure.
Big Penalty: Example Of SEC Enforcement Involving 10b5-1 Plan
In 2009, the SEC charged the former CEO of Countrywide Financial, Angelo Mozilo, with insider trading. The SEC alleged that he "established four executive stock sale plans for himself in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide's increasing credit risk and the expected poor performance of Countrywide-originated loans." He then later exercised options and sold company stock under these written trading plans.
Eventually, Mr. Mozilo agreed to pay the largest-ever SEC penalty by a public company executive, along with a $45 million disgorgement of these ill-gotten gains to settle the disclosure violation and the insider-trading charges.