United States: Bill To Study And Amend Rule 10b5-1 Introduced In Senate

Last week, in a bipartisan move, Senators Chris Van Hollen and Deb Fischer reintroduced the "Promoting Transparent Standards for Corporate Insiders Act." According to the  press release, the legislation is designed to address concerns that some insiders "may be abusing loopholes in this system, which hurts everyday investors and reduces confidence in the integrity of our capital markets."  The bill would require the SEC to conduct a study to determine whether Rule 10b5-1 should be amended, report back to Congress within 180 days and amend Rule 10b5-1 within a year consistent with the study's findings.

Rule 10b5-1 background. Corporate executives, directors and other insiders are constantly exposed to material non-public information, making it sometimes difficult for them to sell company shares without the risk of insider trading, or at least claims of insider trading. To address this issue, Congress developed the Rule 10b5-1 safe harbor. In general, Rule 10b5-1 allows an insider, when acting in good faith and not in possession of MNPI, to establish a formal trading contract, instruction or plan that specifies pre-established dates or formulas or other mechanisms—that are not subject to the insider's further influence—for determining when the insider can sell shares, without the risk of insider trading. To be effective, the contract, instruction or plan must also conform to the specific requirements set forth in the Rule.  In effect, the Rule provides an affirmative defense designed to demonstrate that a purchase or sale was not made "on the basis of" MNPI.  If a 10b5-1 contract, instruction or plan is properly established, the issue is not whether the insider had MNPI at the time of the purchase or sale of the security; rather, that analysis is performed at the time the instruction, contract or plan is established.

After the plan has been established, there is no requirement for a delay or cooling-off period prior to trading—that, is the plan can provide for immediate trades. In addition, the insider can modify it, so long as he or she is not aware of MNPI at the time of the modification, and can terminate it at any time—even if the insider is in possession of MNPI at the time. Why is that? Because the termination (and related cancellation of any planned trades) is not "in connection with the purchase or sale of any security." Plans can be used for a single trade, and there is no requirement that multiple trades be spaced apart. An insider can also adopt multiple plans that operate at the same time.  Although there are requirements that insiders report transactions on Forms 4 and 144, there is no independent public reporting requirement for 10b5-1 plans (other than the requirement on Form 144 to provide the date of plan adoption if the sale was under a 10b5-1 plan).  However, some insiders do provide that information voluntarily. The wide berth the Rule gives executives to conduct transactions under these plans, together with the absence of public information requirements, has long fueled controversy about Rule 10b5-1 plans.  In particular, some view the ability to adopt multiple plans and to amend or cancel the plans as providing opportunities to exploit the Rule. 

The Proposed Legislation.  Under the bill, the SEC would be required to look at whether Rule 10b5-1 should be amended to limit the ability of issuers and insiders to adopt 10b5-1 plans only in open trading windows; limit the ability of issuers and insiders to adopt multiple 10b5-1plans;  establish a cooling-off period, a mandatory delay between the adoption of the trading plan and the first trade under the plan; depending on the findings of the SEC, impose the same cooling-off period for plans adopted during an open trading window as opposed to outside of an open window and allow exceptions to the cooling-off period; limit the frequency with which issuers and insiders may modify or cancel 10b5-1 plans; require filing with the SEC of 10b5-1 plans upon adoption, amendment, termination and transaction under a 10b5-1 plan; and require boards of companies that have adopted 10b5-1 plans to adopt policies governing 10b5-1 plan practices, monitor transactions made under the plan, and ensure that the policies address the use of the plan in the context of equity hedging, holding and ownership.

In conducting the study and considering amendments, the SEC is required to take into account how the amendment may enhance existing prohibitions against insider trading; the impact of the amendment on a company's ability to attract executives and directors; the impact that the amendment may have on capital formation and the willingness of a company to remain public; and any other issue the SEC considers necessary and appropriate for the protection of investors. A  similar bill has already passed in the House.

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