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Rule 10b5–1 Trading Plans Offer Affirmative Defense to Insider Trading

Prepare your plan before you receive the dreaded “Wells” notice!

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The SEC promulgated Rule 10b5–1 in 2000, pursuant to Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Rule 10b-5 targets securities fraud by making it unlawful to trade a company’s shares on the basis of material insider information. More than 50% of S&P 500 companies have executives that use 10b5–1 plans.

Pre-authorized Rule 10b5–1 Plans

Plan Requirements

Although Rule 10b5–1 does not set a limit on the duration of a 10b5–1 plan. Most plans have a termination date scheduled around one year later. This allows for the routine reevaluation of circumstances and modifications before adoption of a new 10b5–1 plan. Plans with a shorter duration also help prevent situations whereby a 10b5–1 plan is terminated earlier than the scheduled termination date. Early termination of a 10b5–1 plan can raise suspicions that previous trades were not in compliance with SEC rules.

In order to reduce their own legal risks, most companies also have adopted their own insider trading policies. These policies often impose additional restrictions beyond what securities laws require. For example, company insider trading policies often include trading blackout periods that ban trading for a certain period of time before and after the release of a company’s quarterly earnings reports.

Pay Attention to Other Laws and Regulations, Too

Additionally, officers, directors, and shareholders holding at least 10% of the total company’s issued stock must be careful of potential short-swing liability under Section 16(b) of the Securities Exchange Act of 1934. In the event that a company insider both purchases and sells company shares within six-month period, the insider may have to forfeit the profits unless the insider had properly filed a Form 4. Form 4 is known as the “Statement of Changes in Beneficial Ownership” and must be filed whenever material changes in stock ownership occur. To avoid Section 16(b) liability, a Form 4 would have to have been submitted specifying that the trade was made pursuant to a Rule 10b5–1 plan.

Despite their potential benefits, critics have noted that some corporate executives may have used 10b5–1 plans to achieve above-market returns. A 2006 empirical study illustrated that trades under 10b5–1 plans produced returns averaging about 6% above the market. In 2009, 10b5–1 plans came under SEC scrutiny after former Countrywide CEO Angelo Mozilo was accused of selling shares based on material insider information pursuant to his company’s 10b5–1 trading plan.

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John A. Wells

“Wells” Notice Under Rule 10b5–1

The affirmative defense provided by Rule 10b5–1 plans remain an essential tool to enable executives and other corporate insiders to trade their company’s stock without liability. Although they provide a significant degree of flexibility, it is also important to understand the specific details of Rule 10b5–1 to develop a trading plan that complies with the securities laws and company-specific policies.

Originally published at https://carpenterwellington.com on December 1, 2020.

Ryan Carpenter serves as Attorney and Managing Director of Carpenter Wellington. Ryan advises clients across a broad set of corporate and commercial matters.

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