Client Alert
Answers to Common Questions about Rule 10b5-1 Plans
28 Feb 2020
Answers to Common Questions about Rule 10b5-1 Plans
In light of the 20-year anniversary of the Rule 10b5-1 plan, we are reissuing our previous guidance on Rule 10b5-1 plans with updates. For additional information on government oversight of Rule 10b5-1 plans, litigation involving the plans, and proposed legislative changes to Rule 10b5-1 plans, please refer to our recent alert, “Rule 10b5-1 Plans At 20: Enforcement Trends & Best Practices.”
A Rule 10b5‐1 plan is a written plan for trading securities that is designed in accordance with Rule 10b5‐1(c) of the Securities Exchange Act of 1934 (the “Exchange Act”).
Section 10(b) and Rule 10b‐5 of the Exchange Act prohibit the purchase or sale of a security on the basis of material non‐public information. However, any person executing pre‐planned transactions pursuant to a Rule 10b5‐1 plan that was established in good faith at a time when that person was unaware of material non‐public information has an affirmative defense against accusations of insider trading, even if actual trades made pursuant to the plan are executed at a time when the individual may be aware of material, non‐public information that would otherwise subject that person to liability under Section 10(b) of the Exchange Act or Rule 10b5‐1. Accordingly, Rule 10b5‐1 plans are especially useful for people presumed to have inside information, such as officers, directors, and other affiliates.
Rule 10b5‐1 specifies that a purchase or sale constitutes trading “on the basis of” material non‐public information where the person making the purchase or sale was aware of material non‐public information at the time the purchase or sale was made. Rule 10b5‐1, adopted in August 2000, codifies the position of the SEC that “possession,” not “use,” of material non‐public information is sufficient to establish liability in insider trading cases.
Prior to Rule 10b5‐1, the U.S. Supreme Court had described insider trading as trades made “on” or “on the basis of” material non‐public information. The federal Courts of Appeals did not interpret these terms uniformly. For example, the Second Circuit suggested that “knowing possession” of material non‐public information was sufficient, while the Eleventh and Ninth Circuits required “use” of material non‐public information. In addition, the Eleventh Circuit indicated that proof of possession provided a strong inference of “use,” while the Ninth Circuit required that “use” be proven in a criminal case.
These disparate results prompted the SEC to establish Rule 10b5‐1, which provides greater clarity by specifying that trades are made “on the basis of” material non‐public information when the person making the purchase or sale was “aware” of material non‐public information when the purchase or sale was made. While the rule creates more liability by prohibiting trades made while someone is merely “aware” of material non‐public information (rather than “using” such information), the rule also provides the affirmative defense of a Rule 10b5‐1 plan, which is available to any person or entity.
Rule 10b5‐1 plans provide the following benefits:
The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, non-public information about the security.
A trading plan created under Rule 10b5‐1(c) provides for an affirmative defense against allegations of insider trading. An affirmative defense allows a person to refute allegations of wrongdoing–in this case, trading on the basis of material non‐public information. However, an affirmative defense will not protect a person from allegations of wrongdoing.
A Rule 10b5‐1 plan can be used as an affirmative defense if the person trading can demonstrate that the purchase or sale occurred pursuant to the terms of the plan. Once violations are alleged, the trader will need to set forth all of the elements of the defense, demonstrate that the Rule 10b5‐1 plan was properly designed, and show that the trades at issue complied with the terms of the plan.
The affirmative defense provided by a Rule 10b5-1 plan, which is available to both individuals and entities, provides that trades pursuant to such a plan are not made “on the basis of” material non‐public information, even if the person is actually aware of material non‐public information at the time of the actual transactions provided for by the plan. To utilize this defense, the person or entity must be able to demonstrate that the plan meets all the required elements. See “What are the elements of a Rule 10b5‐1 plan?”
Any person or entity can establish a Rule 10b5‐1 plan to sell or buy securities at a time when the person is not aware of material non‐public information, so long as the plan is not part of a plan or scheme to evade the insider trading prohibitions of the rule. For example:
Yes. Typically it is insiders who establish Rule 10b5‐1 plans; however, a person does not have to be an insider of the issuer of the relevant securities in order to establish such a plan. The concern is whether the person has access to material non‐public information of the issuer. For example, an intern or a secretary at an issuer or a supplier or customer may set up a Rule 10b5‐1 plan to purchase securities of the issuer to avoid potential insider trading liability.
A Rule 10b5‐1 plan provides an affirmative defense only if the following elements are met:
A Rule 10b5‐1 plan must be entered into in “good faith,” meaning not as part of a plan or scheme to evade the prohibitions of Rule 10b5‐1. The “good faith” provision gives the SEC the right to challenge the affirmative defense created by the rule when the agency suspects abuse. In litigation, the plan-holder may have to present evidence showing good faith.
Material means that the information is such that there is a substantial likelihood that a reasonable investor would attach importance to it in determining whether to buy or sell the security. Non-public information is information that is not legally available to the public.
Rule 10b5‐1(c)(1)(iii)(A) defines “amount” as either a specified number of shares or other securities or a specified dollar value of securities.
There is no restriction on the amount of securities a Rule 10b5‐1 plan may cover. A plan may be designed to cover all or a small portion of a person’s holdings. The plan should be carefully constructed to include an amount that is suited to the purposes of the person trading. To avoid the need for frequent modifications, a plan should not cover too few securities. On the other hand, a plan should not cover too many securities because it may be difficult for the trader to take advantage of legitimate trading opportunities outside of the plan.
Rule 10b5‐1(c)(1)(iii)(B) defines “price” as the market price on a particular date or a limit price, or a particular dollar price.
A Rule 10b5‐1 plan can be set up to execute trades with minimum or maximum prices or with price targets that change over time, so long as the price targets or the method for determining the price targets is set forth in the plan.
Rule 10b5‐1(c)(1)(iii)(C) defines “date” as, in the case of a market order, the specific day of the year on which the order is to be executed (or as soon thereafter as is practicable under ordinary principles of best execution). In the case of a limit order, “date” is defined as a day of the year on which the limit order is in force.
A plan can be tailored to the specific needs of the individual who sets it up. For example, the plan can specify that trades will be made on a regular basis, such as monthly or bi‐weekly. Alternatively, a Rule 10b5‐1 plan can be designed to initiate transactions upon the occurrence of certain trigger events. For example, a plan can provide for sales several days before a tuition payment is due, with the number of shares to be linked to the average cost of tuition as published by the college.
The SEC does not require a limit on the term of a Rule 10b5‐1 plan. A plan should be designed to meet the needs of the person trading and also to avoid the appearance of manipulation. A series of short‐term plans may subject the trader to allegations of manipulation. On the other hand, plans covering more than a year may deprive the trader of the ability to control the disposition (or acquisition) of his or her securities or to react to significant changes in the issuer’s condition or his or her own obligations.
Law firms and investment banks will have forms of Rule 10b5‐1 plans with varying complexity, ranging from a simple one‐page trading instruction to a complex formula‐based plan administered by a trust company or other third party.
Rule 10b5‐1 plans can be constructed for purchases, sales, monetization transactions (like collars), and the exercise of options and the subsequent sale of the shares received.
Yes. A Rule 10b5‐1 plan can be used for debt or equity securities or derivative instruments.
Yes. A simple plan may authorize trades on specified dates or at specified prices. A more complicated plan may utilize targets based on the performance of the stock relative to various market or industry indices, or even relative to certain selected competitors. The plan itself must sufficiently identify the calculation of the relevant prices and triggers.
No. Rule 10b5‐1 prohibits the person trading from entering into or altering a corresponding or hedging transaction or position with respect to securities subject to the plan. The affirmative defense will be inapplicable to both the transaction made pursuant to the plan and the hedging transaction. See “Can trades be found to have been made outside of a Rule 10b5-1 plan?”
Yes. But a person should not maintain multiple Rule 10b5‐1 plans for a single issuer because it raises suspicion that the person is seeking to evade the requirements of the rule and could adversely affect the availability of the affirmative defense. It should be possible to incorporate different trading strategies into one plan in order to provide the trader with the desired flexibility. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
Yes. There is no mandatory “waiting period.” But Rule 10b5‐1 plans generally should not be used immediately after they are adopted. The plan should include a waiting period (e.g., 30 days) during which no trades can occur under the plan to prevent the appearance that the person designed the plan as a cover for trades based on material non‐public information. Another consideration is to adopt a Rule 10b5‐1 plan shortly after the company announces its financial results because previously material non‐public information regarding the company’s financial situation should have been publicly disclosed by then. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
Anyone other than the person establishing the Rule 10b5‐1 plan may execute trades. Typically, the person establishing the plan designates an administering broker who executes the trades pursuant to the plan specifications.
Once the Rule 10b5‐1 plan is adopted, there should be no communications between the administering broker and the trading party (other than notices that trades have been executed). Any clarification by the trader to the administering broker could be construed as an improper exercise of influence or discretion over the plan by the trader in violation of Rule 10b‐5, and any trades executed based on such communications could be considered a modification of the plan. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
Yes, trades may be made outside of the Rule 10b5‐1 plan. However, the Rule 10b5‐1 affirmative defense will not apply to trades made outside of the plan.
In addition, a trader should not sell securities that have been designated as plan securities because any such sale may be deemed a modification of the plan. Further, if the trader is subject to the volume limitations of Rule 144, the sale of securities outside the plan could effectively reduce the number of shares that could be sold under the plan, which could be deemed an impermissible modification of the plan. See “Changes to or Termination of Rule 10b5‐1 Plans” and “Interaction Between Rule 10b5‐1 Plans and Other Federal Securities Laws.”
Yes. Rule 10b5‐1(c)(1)(i)(C) specifies that a purchase or sale is not made pursuant to the plan if, among other things, the person who entered into the plan altered or deviated from the plan to purchase or sell securities (whether by changing the amount, price, or timing of the purchase or sale) or entered into or altered a corresponding or hedging transaction or position with respect to those securities.
A public announcement by any person of the adoption of a Rule 10b5‐1 plan is not required. A company may choose to disclose the existence of certain Rule 10b5‐1 plans in order to reduce the negative public perception of insider stock transactions. A company making such disclosure generally will disclose the existence of a plan but not the specific details. Typically, the disclosure will be for executive officers, directors, and 10% shareholders required to file ownership forms under Section 16(a) of the Exchange Act (that is, Forms 3, 4, and 5).
A company can choose whether to announce the existence of a Rule 10b5‐1 plan by a press release followed by a Form 8‐K or solely by a Form 8‐K. The applicable Form 8‐K item is Item 8.01, although Item 7.01 may be used under appropriate circumstances.
If a company decides to publicly announce the adoption of a Rule 10b5‐1 plan, it is advisable to publicly announce changes to or the termination of such plan as well. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
While amendments to Rule 10b5‐1 plans are permitted as long as the modifier does not possess material non‐public information at the time of the modification and meets all of the elements required at the inception of the plan, modifications should be avoided because they create the perception that the person is manipulating the plan to benefit from material non‐public information, jeopardizing the good faith element and the availability of the affirmative defense. As a result, Rule 10b5‐1 plans should be modified rarely and should be designed to prevent the need for amendment. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
Voluntary suspension of a Rule 10b5‐1 plan should be avoided. The affirmative defense will be unavailable if it appears that the person trading under the plan is exerting subsequent influence over the plan, so such persons should not be permitted to suspend and reinstate trading. In addition, suspension of a Rule 10b5‐1 plan can lead to the same issues as modification of a plan: it may appear that the plan is being manipulated, jeopardizing the good faith element and the availability of the affirmative defense. When reinstating the ability to trade under the plan, all of the elements required at the inception of the plan must be met again. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
It is not advisable for the trader to terminate a Rule 10b5‐1 plan except under unusual circumstances. Termination of a plan, by itself, is not a violation of Rule 10b‐5 because the termination does not occur in connection with the sale or purchase of securities. However, termination of a plan may create the appearance that the plan is being manipulated, jeopardizing the good faith element and the availability of the affirmative defense.
The SEC has made clear that once a Rule 10b5‐1 plan is terminated, the affirmative defense may not apply to any trades that were made pursuant to that plan if such termination calls into question whether the good faith requirement was met or whether the plan was part of a plan or scheme to evade Rule 10b5‐1. The problem is increased if the trader terminates and establishes plans serially. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
To allow individuals to make decisions in connection with major corporate transactions and to avoid potential problems under other provisions of the federal securities laws, Rule 10b5‐1 plans often include a provision that automatically terminates or suspends trading under the plan upon, among other occurrences, the issuer’s announcement (or notice from an issuer’s general counsel or compliance officer) of a merger or acquisition transaction or an underwritten public offering. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
A person trading pursuant to a Rule 10b5‐1 plan still must comply with other regulatory reporting requirements.
Yes. If a person is selling plan securities without registration under the Securities Act of 1933, the person may need to file a Form 144. The seller should indicate on the Form 144 that the sale is being made pursuant to a Rule 10b5‐1 plan. In addition, the seller may need to comply with the aggregation and volume restrictions of Rule 144.
Yes. The Forms 4 and 5 filing requirements apply to trades made pursuant to a Rule 10b5‐1 plan. It is advisable to specifically note on the Form 4 or 5 that the trades were made pursuant to a Rule 10b5‐1 plan to ensure that investors or analysts monitoring sales by insiders will know that the trades do not represent a current investment decision by the insider.
Yes. Trades made pursuant to a Rule 10b5‐1 plan must be reported under the applicable requirements of Schedule 13D and/or Schedule 13G.
Yes. Officers, directors, and 10% shareholders utilizing Rule 10b5‐1 plans should be careful about trading in violation of Section 16(b) of the Exchange Act. If such a person conducts a purchase and sale, in any order, within a six‐month time frame and realizes a profit, then the profits must be disgorged to the issuer.
Trades made pursuant to Rule 10b5‐1 plans are subject to company‐specific trading restrictions. Trades made pursuant to a Rule 10b5-1 plan do not absolve liability for trades that are in violation of a company’s insider trading policy. Typically, a company’s insider trading policy indicates whether an employee or director may establish a Rule 10b5‐1 plan.
This depends on the company’s insider trading policy. At a minimum, most companies require notice that a plan has been established for its securities. It may also be possible that a company could require notice if an employee or director establishes a plan to trade securities of a significant customer or supplier.
An employee or director should review the company’s insider trading policy to determine whether the company permits establishment of a plan during a blackout period or permits trades during a blackout period pursuant to a plan. See “Best Practices to Consider for Rule 10b5‐1 Plans.”
To avoid the appearance that insiders are engaging in abusive practices, companies should consider the following requirements for Rule 10b5‐1 plans to be adopted by their directors, officers, and other employees:
In addition, the company should develop robust training programs regarding its insider trading and disclosure policies and the use of Rule 10b5‐1 plans and should consider periodic reviews of insiders’ trading plans to ensure compliance with securities laws and company policies.
Please refer to our recent alert, “Rule 10b5-1 Plans At 20: Enforcement Trends & Best Practices.”