The U.S. Securities and Exchange Commission has released expected proposed amendments to Rule 10b5-1 to enhance disclosure requirements and investor protections against insider trading. According to the SEC release, the amendments “aim to address critical gaps in the SEC’s insider trading regime 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. The SEC’s Annual Agenda for 2021 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 is easily circumvented due to a lack of clarity, regulation, and enforcement. The proposed amendments address these concerns by adding new conditions to the availability of the 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.
Restricting the ability for opportunistic canceling by limiting 10b5-1 trading arrangements to execute a single trade to one plan per 12-month period.
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.
The proposed rules also include enhanced disclosure requirements, including:
- Required disclosures on annual reports around the issuer’s insider trading policies and procedures
- Required disclosures on annual reports around the issuer’s option grant policies along with disclosure of grants made within 14 days of the release of MNPI
- Required disclosures in the issuer’s quarterly reports on 10b5-1 trading arrangements by directors, officers and the issuer
- Required disclosures by Section 16 officers and directors on 10b5-1(c) transactions
- Required disclosure of bona fide gifts of securities by corporate insiders subject to the reporting requirements of the Exchange Act Section 19
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.