This article was originally published by The Los Angeles Daily Journal, March 3, 2007.
In an October 2007 speech, the director of the Enforcement Division of the Securities and Exchange Commission remarked that the division is looking at whether 10b5-1 trading plans are being used as a "cover" for insider trading.The director also said the division is looking at disclosures surrounding 10b5-1 trading plans and whether the entry into such trading plans is being disclosed without disclosing related modifications or terminations and whether insiders are using multiple and overlapping trading plans. With the recent heightened regulatory scrutiny surrounding 10b5-1 trading plans, the time is ripe for companies to revisit existing corporate insider trading policies and develop 10b5-1 trading plan policies to prevent potential insider trading.
Although some may consider a 10b5-1 trading plan to be a matter of the insider's private affairs, given the recent heightened regulatory scrutiny, companies should consider developing 10b5-1 trading plan policies to ensure their insiders meet the conditions of the rule. Since the SEC's adoption of Rule 10b5-1(c) in 2000, Rule 10b5-1 trading plans have become increasingly popular with corporate insiders desiring to sell their company's stock. The purpose of a 10b5-1 trading plan is to provide insiders the opportunity to make prearranged trades without facing the prospect of insider trading liability. When an insider enters into a written 10b5-1 trading plan, at a time when he or she does not possess material nonpublic information, to make prearranged periodic sales or purchases of company stock in the future at specified prices or pre-scheduled dates, and meets certain other conditions of the rule, the insider is afforded the benefit of an affirmative defense to insider trading liability.
Even where a company has adopted a corporate insider trading policy to guard against insider trading, it should make sure that policy expressly addresses 10b5-1 trading plans and requires that the insider pre-clear such plans with the company before entering into them and/or that the insider enter into them only during the company's open trading windows. Requiring pre-clearance helps prevent the insider from entering into a 10b5-1 trading plan at a time when he or she possesses material nonpublic information. These policies should be included as part of the new hire package for insider employees and provided to nonemployee insiders, as well, to ensure systematic compliance.
As part of its 10b5-1 trading plan policies, the company should confirm the insider does not possess material nonpublic information on the date he or she proposes to enter into the trading plan. This can be done through an acknowledgment by the insider or a discussion between the insider and the company's compliance officer. As a precautionary measure, many companies do not allow their insiders to enter into 10b5-1 trading plans outside of the company's open trading windows. The company also should confirm the trading plan is in written form and expressly specifies the amount, price and date triggering trades under the trading plan, provides a written formula for determining amounts, prices and dates or does not permit the insider to exercise any subsequent influence over the trades.
Thought should be given to the length of time between the date on which the trading plan is entered into and the date after which trades may start under the trading plan, the duration of the trading plan itself and the frequency of trades under the trading plan. One condition of the affirmative defense is that the 10b5-1 trading plan was entered into in good faith, not as part of a scheme to evade the prohibitions of insider trading laws. Having a waiting period that is too short or having no waiting period may raise questions regarding the good faith aspect of the affirmative defense. Although no waiting period is required between entering into a 10b5-1 trading plan and starting trades under such plan, an interval of at least 30 days is common. Some companies require that the first trade not take place until the next open trading window after entering the trading plan, because of the appearance of a trade's being triggered just before the company's earnings release. Once the company determines the appropriate waiting period, it should be applied consistently to all insider employees to guard against potential claims of discrimination or abuse.
Entering into multiple, successive or overlapping trading plans with short durations may raise similar questions regarding the good faith aspect of the affirmative defense. The duration of 10b5-1 trading plans commonly ranges from six months to two years, with most being one year. Although 10b5-1 plans have no required trading frequency, trades are commonly provided for monthly. Any greater frequency would increase the number of Section 16 reports that need to be filed, which, for some companies, may not be desirable. A much lesser frequency, such as only one or two large trades shortly after entering into the trading plan, may raise questions regarding the good faith aspect of the affirmative defense.
To establish an affirmative defense, the insider also must demonstrate the trade occurred under his or her 10b5-1 trading plan entered into before the trade. In order to do so, the insider should not alter or deviate from the 10b5-1 trading plan after entering into it and also should not enter into or alter a corresponding or hedging transaction or position with respect to the securities. Therefore, it is equally important to communicate these limitations to insiders and administer 10b5-1 policies correctly and consistently for all insiders.
A 10b5-1 trading plan generally may be modified at a time when the insider does not possess material nonpublic information, but the modified trading plan will be deemed a new trading plan and therefore should be subject to all the same limitations applicable to entering into a new trading plan. Frequent modifications, however, should be avoided, because they may raise questions regarding the good faith aspect of the affirmative defense.
In order to ensure insiders adhere to the 10b5-1 policy, the company should implement a system that provides training to all insiders. This can include sessions that educate the insiders on the conditions and limitations of the rule and provide guidance on questions and reporting obligations. Many companies assist their insiders with their Form 4 filings, and some may even interface with their insiders' brokers regarding the
Form 144 filing, to report the insider's stock transactions. Any time a trade takes place under the insider's 10b5-1 plan, the company should confirm that the Form 4 and Form 144 filings for that insider disclose in a footnote the fact that the trade was made under the 10b5-1 plan.
The company also should reiterate its strict policies against all forms of illegal activity and outline reporting practices and procedures for those who have notice of such violations, including violations of insider trading laws. The company's general policies should identify the person to whom the complaint can be reported and outline the company's procedures for investigation. These policies also should clearly identify the company's strict no-retaliation policy with regard to individuals who participate in protected whistle-blower activity. This practice also allows the company to meet the requirements of the Sarbanes-Oxley Act and prevent liability related to potential whistle-blower claims.
In certain unusual circumstances, an insider may need to terminate his or her 10b5-1 trading plan early. Voluntarily terminating a 10b5-1 trading plan is not a problem per se, but it may raise questions regarding the good faith aspect of the affirmative defense if there is a pattern of terminating trading plans right before corporate announcements, for instance, and entering into new trading plans shortly thereafter. For this reason, companies might consider requiring pre-clearance of voluntary terminations of 10b5-1 trading plans, permitting voluntary terminations only in certain unusual circumstances and/or requiring that trading be suspended for at least 30 days before restarting trading or entering into a new 10b5-1 trading plan. It also is common to have automatic termination provisions built into a 10b5-1 trading plan based on events such as death, bankruptcy, employment termination, merger or regulatory restrictions that become applicable to the insider or the company's entry into a transaction that restricts its insiders' ability to sell their stock (that is, because of a lock-up). In this context, when such information is not public, caution regarding how the trading desk of the bank is notified of such events and when the actual termination of trading occurs is appropriate.
Many companies disclose the creation of 10b5-1 trading plans by their insiders in press releases or in periodic or current reports filed with the SEC. In the event of litigation, these disclosure steps may enable an insider to seek and obtain judicial notice of the public filings on a motion to dismiss insider trading claims. Companies should consider not only disclosing the creation of 10b5-1 trading plans by their insiders but also disclosing modifications or terminations of those 10b5-1 trading plans.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.