Friday, September 10, 2021

Advisory committee recommends enhancing transparency in 10b5-1 trading plans for company insiders

By Amanda Maine, J.D.

The SEC’s Investor Advisory Committee (IAC) approved a draft recommendation aimed at improving transparency behind Rule 10b5-1 trading plans for corporate insiders. The IAC recommended that the SEC expand the "cooling off" period for trades under a 10b5-1 plan to four months and encouraged the Commission to take steps to improve disclosure around these plans, including requiring the electronic submission of Form 144 and enhancing the disclosures related to 10b5-1 plans in proxy statements and Forms 8-K.

Rule 10b5-1 plans. Rule 10b5-1 was adopted in 2000 when compensation among executives and employees in many industries was trending away from fixed salaries and toward equity-based pay. Because insiders are privy to material nonpublic information (MNPI) in the normal course of business, trading in the company’s shares put them at risk of violating insider trading rules.

Corporate insiders who trade pursuant to plans adopted under Rule 10b5-1 (10b5-1 plans) have an affirmative defense to insider trading liability, subject to certain conditions, including that the plan is adopted in good faith prior to the insider becoming aware of the MNPI; the plan includes certain metrics regarding the amount, price, and date of securities to be bought or sold, or other written instructions on trades; or the purchase or sale of securities was pursuant to the plan.

The recommendation as drafted by the IAC’s Investor as Owner Subcommittee notes that the rationale behind the rule and 10b5-1 plans was well intentioned; however, investors, academics, lawmakers and other market participants have raised concerns that these plans help shield opportunistic insider trading from scrutiny and have suggested that the rule be strengthened. SEC Chair Gary Gensler has spoken about placing limits on 10b5-1 plans, signaling possible Commission action.

Recommendation. The recommendation, which stemmed from a discussion during a meeting of the IAC in June, asks the Commission to consider strengthening the requirements for the affirmative defense under Rule 10b5-1 and to improve plan reporting and disclosure.

Regarding the Rule 10b5-1 affirmative defense, the IAC recommends that the SEC adopt requirements that extend the "cooling off" period to at least four months between the adoption or modification of a 10b5-1 plan and the execution of the first trade under a newly adopted or modified plan. This restriction would ensure that insiders could not adopt a plan that could execute a trade in that same quarter. The Commission should also prohibit "overlapping plans" that allow a single person or entity to have more than one 10b5-1 plan at a time.

In support of this segment of their recommendation, the subcommittee’s draft cited a study by Stanford University and The Wharton School which identified three red flags of 10b5-1 plans that were associated with opportunistic trading behavior. These include plans with a short cooling-off period of 30 days and 30 to 60 days. Other red flags include plans that entail only a single trade (that almost always resulted in loss-avoidance) and plans adopted in a given quarter that begin trading before that quarter’s earnings announcement.

The IAC also made recommendations to enhance reporting and disclosure of 10b5-1 plans. The SEC should require the electronic submission of Form 144, which contains the most comprehensive source of information currently available about Rule 10b5-1, according to the recommendation. Over 99 percent of these forms are filed on paper, are not digitized, and are kept in the SEC’s public reading room in Washington, D.C. This results in deeper-pocketed investors having access to potentially critical market data, unlike other company data that is freely available on a service such as the SEC’s EDGAR filing system, the committee explained.

The SEC should also require enhanced public disclosure about 10b5-1 plans and 10b5-1 trades. Regarding 10b5-1 plans, proxy statements should disclose the number of shares covered under these plans by named executive officers, and a company’s Form 8-K should disclose on a timely basis the adoption, modification, or cancellation of Rule 10b5-1 plans and the number of shares covered. For 10b5-1 trades, Form 4 should be modified to require fields for a checkbox indicating whether a specific trade was pursuant to a 10b5-1 plan and a field to indicate the date of a 10b5-1 plan adoption or modification.

Recommendation approved. The committee voted unanimously to approve the draft recommendation. However, after some discussion, the committee agreed to amend the recommendation with a footnote to clarify that the recommendation was intended to apply to trading plans associated with insiders, and not issuer buybacks.