The U.S. Securities and Exchange Commission adopted proposed amendments to Rule 10b5-1 to enhance disclosure requirements and investor protections against insider trading. According to the SEC release, "the final rules aim to strengthen investor protections concerning insider trading and to help shareholders understand when and how insiders are trading in securities for which they may at times have material nonpublic information."
Since he began his tenure as SEC chair, Gary Gensler’s remarks have sent clear signals that firms should be prepared for increased regulatory scrutiny around material nonpublic information (MNPI) and insider trading under his administration. Both the SEC’s Annual Agenda for 2021 and Annual Agenda for 2022 included proposed intent to address concerns about the use of the affirmative defense provisions of Rule 10b5-1. Gensler had previously indicated that his administration is looking to “freshen up” Rule 10b5-1 and in a June 2021 speech at the CFO Network Summit, he noted that 10b5-1 trading plans have led to “real cracks” in the SEC’s insider trading regime.
SEC Rule 10b-5 targets securities fraud, prohibiting the employment of manipulative and deceptive practices, by act or omission, in connection with the purchase or sale of any security. SEC Rule 10b5-1 was enacted in 2000 to address the issue of when insider trading liability arises in connection with a trader's "use" or "knowing possession" of MNPI.
Rule 10b5-1 provides affirmative defenses to allow persons to trade in certain circumstances where it is clear that material non-public information was not a factor in the decision to trade. To satisfy the affirmative defense provision, a person must:
- Be able to demonstrate that they entered into a binding contract, provided trade execution instructions, or adopted a written plan prior to becoming aware of any insider information.
- Be able to demonstrate that the contract, instructions, or plan either specified the purchase amount, price, and date, provided a formula or algorithm for obtaining the amount, price and date, or did not provide the person any subsequent influence over purchase and sale.
- Be able to demonstrate that the purchase or sale that occurred was pursuant to the prior contract, instruction, or plan.
Critics have claimed that Rule 10b5-1 was easily circumvented due to a lack of clarity, regulation, and enforcement. The changes to the rule update the conditions that must be met for the 10b5-1 affirmative defense, including:
Requiring a 120-day cooling off period for 10b5-1 trading arrangements entered into by corporate issuers or directors before any trading can commence after adoption, including the adoption of a modified trading arrangement. A 30-day cooling off period will be required for 10b5-1 trading agreements entered into by issuers.
Requiring directors and officers to certify that they are not aware of material nonpublic information about the issuer or its securities.
Restricting trading arrangements to end overlapping plans, including multiple overlapping 10b5-1 trading arrangements for open market trades in the same class of securities.
Limiting the ability to rely on the affirmative defense to one single-trade plan per twelve-month period for all persons other than issuers.
Requiring that 10b5-1 trading arrangements are entered into and operated in good faith and not as part of a scheme to evade the conditions of the rule.
According to the final rule, there are currently no mandatory disclosure requirements concerning the use of 10b5-1 trading arrangements or other trading arrangements by issuers or corporate insiders. The updated rules address this gap by mandating disclosure requirements, including:
- Required disclosures on annual reports around the issuer’s insider trading policies and procedures
- Required disclosures in the issuer’s quarterly reports on 10b5-1 trading arrangements by directors, officers and the issuer including adoption, modification or termination of a Rule 10b5-1 plan or non-Rule 10b5-1 trading arrangement
- Required disclosures of the timing of granting options and related company grant policies and procedures in relation to the disclosure of access to MNPI
- Required disclosure of bona fide gifts of securities by corporate insiders subject to the reporting requirements of the Exchange Act Section 19
In March of 2023, the SEC alleged that the chairman of a healthcare company sold off millions of dollars of company stock while in possession of undisclosed insider information that the firm's relationship with its largest customer was tenuous. The executive avoided more than $12 million in losses by selling shares through Rule 10b5-1 trading plans before the stock's value sharply declined. The complaint alleges that the executive adopted the Rule 10b5-1 plans when fully aware of material nonpublic information and as part of a scheme to evade insider trading prohibitions, so therefore the executive cannot take advantage of any affirmative defense available to corporate insiders under the rule.
The U.S. Department of Justice filed a parallel action. In a speech to the American Bar Association’s National Institute on White Collar Crime in Miami, Assistant Attorney General Kenneth Polite, Jr. described the details of the case and warned "So take note. Because I expect other such cases will follow."
Managing MNPI and Insider Trading is a concern across all levels of the organization, not just for the C-Suite. Section 204A of the Advisers Act requires firms to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by the firm or any of its associated persons. Read more about how MNPI remains a high-risk area for compliance.
To stay compliant and mitigate risk it’s critical that firms keep an accurate record of MNPI and insider information. Firms need to track what information is off limits, and whom that info should be off limits to. That information will constantly shift based on what’s going on in the market and the business. Static spreadsheets won’t help – compliance teams need a dynamic solution that can keep up with the rapid pace of change.
Organizations must maintain insider lists and be prepared to supply the lists to regulators upon request. MCO’s Insider and MNPI Management solution makes insider list management easier by enabling users to create insider lists including individuals and roles/rights assignments, individual accessibility timeframes, and a cross-referenceable hierarchical database of securities listings and company information covering tens of thousands of entities.
The powerful MyComplianceOffice platform facilitates the surveillance and monitoring of potential conflicts of interest across multiple legal entities, business lines and jurisdictions. Firms can reduce their risk of misconduct by identifying and mitigating conflicts of interest across firm transactions, employees and third-party relationships. Contact us today to learn more.