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SEC Changes Rules to Address Opportunistic Trading by Insiders

December 16, 2022

The SEC on Dec. 14, 2022, unanimously voted to adopt rule changes around stock trading plans. The final rules also require more disclosures intended to address insider trading problems. The rules, which not only cover executives but also companies, include a mandatory cooling-off period.

This comes as some investor protection advocates said that executives could abuse trading plans in Rule 10b5-1 of the Securities Exchange Act of 1934 for opportunistic trading. A prominent example of the rule’s abuse occurred in 2017 when Intel Corp. CEO Brian Krzanich sold shares and exercised options worth $39 million shortly before the public was informed that the company’s chips had security flaws.

The rule bans trading in public company stocks by executives, employees, directors, or other people with access to significant, or material, confidential information about a company’s business unless the trade was part of planned transactions covered by a written agreement with the company. But over the years, critics have argued that some executives have been stretching the rule’s limits in a way that is almost akin to insider trading, and they asked the commission to revisit Rule 10b5-1, which was adopted in August 2000.

Rule 10b5-1(c) has provided affirmative defenses for corporate insiders to buy and sell stocks as long as their trading plans were adopted in good faith, before becoming aware of sensitive information. And the final rule amends Rule 10b5-1(c).

“Over the past two decades, though, we’ve heard from courts, commenters, and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information,” said SEC Chair Gary Gensler. “We are concerned that the affirmative defense is not being used as intended and that insiders may be trading under the rule in ways that harm investors and undermine the integrity of the securities markets.”

He said the rule changes will help address the abuses.

Details of Final Rule

In particular, the SEC is imposing a cooling off period of 90 days for directors and officers or two days after the release of financial statements, whichever is longer. But this timeframe will not exceed 120 days. The cooling off period will give the public the benefit of seeing the next periodic report before the insider is able to trade under a 10b5-1 plan.

“Why do such cooling-off periods matter? Academic research has identified abnormal returns for company insiders trading under 10b5-1 plans, particularly when those trades are close in time to the adoption of the plan,” Gensler said.

A 30-day cooling-off period will also apply to all other persons on 10b5-1 plans.

Moreover, directors and officers must certify at the time the plans are adopted or modified that they are not aware of material nonpublic information and that they are doing it in good faith.

The SEC is also imposing a limitation on the ability of any person to use multiple overlapping plans.

“Currently, with the ability to enter into multiple plans, insiders might seek to pick amongst favorable plans as they please,” Gensler said.

Further, the market regulator is limiting the ability of any person to rely on the affirmative defense for a single trade plan to one such plan during any consecutive 12-month period. The SEC said that the rule changes also create new disclosure requirements, including quarterly disclosures about the use of trading plans.

While the decision to adopt the rules were unanimous among the five commissioners, not everyone agrees that the changes were needed.

“Although I do not think that this rulemaking was necessary, 10b5-1 plans have been political targets for some time, and this gives Gensler a win,” said Dave Brown, a partner at Alston & Bird LLP. “These rules will require significant updates and adjustments to the trading practices of insiders as well as additional disclosure obligations of the issuer.”

Nevertheless, Brown said that the market will get more insight into insider trading policies, and how insiders may be planning on trading.

For example, the Council of Institutional Investors (CII), which has long been pressing for rule changes, applauded the SEC’s move.

“The new rules close gaps in the SEC’s enforcement regime that allow executives to use 10b5-1 plans as cover for insider trading,” CII Executive Director Amy Borrus said in a statement. “The SEC amendments will better protect public investors from misuse of these plans and strengthen confidence in corporate management teams and the capital markets generally.”

In the meantime, Alston’s Brown credited the SEC for being willing to make changes in response to concerns expressed to the proposal.

“Fortunately, it appears that the SEC listened to the comment letters and did not subject issuers to a cooling off period prior to entering into 105b-1 plans,” he said. “This would have caused a significant burden on issuers and would have put pressure on share repurchase programs for zero benefit. It is a hopeful sign for future rulemakings that the SEC is willing to make at least some adjustments to proposed rules in response to comment letters.”

The final rules are in adopting Release No. 33-11138, Insider Trading Arrangements and Related Disclosures. The rules become effective 60 days following publication in the Federal Register.

“Companies should begin now to review insider trading programs and policies with a view towards the new disclosure requirements and establish new policies and procedures regarding the use of 10b5-1 plans by insiders,” Brown said.

The SEC finalized the rules exactly a year after issuing a proposal in Release No. 33-11013, Rule 10b5-1 and Insider Trading.


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