Taxes

Prevent Insider Trading By Following New SEC Rules For 10b5-1 Plans

Insider trading is a notorious form of white-collar wrongdoing that most people are familiar with. The law prohibits you from trading stock when you know material nonpublic information (MNPI) about a company, i.e. information that will move the company’s stock price when it is made public.

Fewer people know that you can violate the insider-trading rules accidentally as well as intentionally. Examples include inadvertently tipping others about MNPI or simply possessing MNPI at the time of an otherwise innocuous trade, even if the information had nothing to do with your trading decision.

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).

A Rule 10b5-1 trading plan is a prearranged plan provided for under SEC Rule 10b5-1 for selling and/or buying company stock. Properly created in advance and when you do not know MNPI, a 10b5-1 plan offers you 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 executives, directors, and key employees to set up 10b5-1 plans. The SEC has just finalized important additional rules for 10b5-1 plans that affect those who use them.

SEC Has Long Suspected Misuse Of Rule 10b5-1 Trading Plans

The SEC has been building up to the new rules for several years. A growing body of research 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 by creating new conditions for their proper use. 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.

Before entering into these pre-set trading plans, consult with lawyers experienced with SEC law, including Rule 10b5-1 and other SEC filing requirements. You need expert legal, financial, and tax advice on both the SEC’s rules and your company’s requirements to ensure you are setting up the plan properly. An FAQ at myStockOptions.com includes a growing curated list of detailed commentaries on the rule changes from law firms.

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