Considerations for public company directors establishing Rule 10b5-1 plans.
Public company directors seeking to sell stock in the companies they serve are at enhanced risk for insider trading claims. This risk stems from the fact that directors frequently have material non‐public information (“MNPI”) about the companies they serve, and MNPI is a key element of an insider trading claim under the securities laws.
In order to reduce — if not eliminate — the risk of insider trading claims, public company directors should take advantage of Rule 10b5-1 plans. Rule 10b5-1 facilitates the adoption of written trading plans that allow directors and other insiders to sell stock pursuant to pre-set instructions over a period of time. Trades made pursuant to a Rule 10b5-1 plan that was established in good faith at a time when the director was unaware of MNPI carry an affirmative defense against allegations of insider trading. This defense will apply even if trades made pursuant to the Rule 10b5-1 plan occur at a time when an insider is aware of MNPI that may otherwise carry insider trading liability.
While Rule 10b5-1 plans may be designed in a variety of ways, the presence of certain elements contribute to satisfying the Rule’s key requirement that a plan be adopted in good faith at a time when the director is unaware of MNPI. This post outlines a few of those key elements.
Adopt a single plan per company
Establishing a single, straightforward Rule 10b5-1 plan that governs the sale of stock in a particular company is best. The presence of multiple, overlapping plans for the sale of stock in a single company calls into question whether the plans were designed and adopted in good faith and may even be viewed as prohibited hedging.
Most public companies already have a pre-approved form of Rule 10b5-1 plan that has been vetted by the company’s counsel, as well as a pre-selected broker who has previously set up plans for the company. Even if a director wishes to use her own broker and her own broker’s plan, a director should ask the company’s counsel to review the plan for compliance and best practices. In fact, many companies require all 10b5-1 plans to be reviewed by the company’s legal department or outside counsel.
Observe a meaningful waiting period before the first trade
Rule 10b5-1 plans should include a meaningful waiting period before the first trade under the plan can occur. A waiting period helps to establish that an insider was not motivated to trade on the basis of MNPI, such as information about the company’s near-term prospects, at the time the plan was adopted, which is a critical element of establishing a good 10b5-1 plan. Many companies already require a waiting period of some length or prohibit trades until after the announcement of results for the quarter in which the plan was adopted. For directors who want to be beyond reproach, the director can choose to go beyond company requirements by taking the extra step of ensuring that a full fiscal quarter has been both completed and announced after the adoption of the plan and before the first trade occurs. In addition, directors can choose to adopt a plan only during an “open window” under the company’s insider trading policy.
Adopt a plan that will be in place for 6 – 12 months
Another important element of a Rule 10b5-1 plan is its duration. Plans that are too short in duration may be viewed as falling short of the Rule’s good faith requirement, while plans that are too long in duration limit flexibility and may not be realistic. A plan that lasts six months to a year is recommended.
Set it and forget it — structure the plan to avoid future modifications
While modifications, suspensions and terminations of Rule 10b5-1 plans are not per se prohibited, such changes can create complications and attract SEC scrutiny. Changing the number of shares that will be traded or the target price raises red flags about whether the plan continues to be a valid plan under the rule.
In addition, suspending or terminating a Rule 10b5-1 plan may be viewed as violating the intended purpose of the plan and may affect the availability of the Rule’s defense against allegations of insider trading if the timing calls into question whether the plan was established in good faith.
If nevertheless a plan needs to be modified or suspended, a director that wishes to be beyond reproach can treat the modification of the plan as if she were adopting a new plan and observe the same waiting period discussed above before the next trade occurs. And a director that is terminating a plan can self-impose a waiting period before adopting a new plan.
Flag 10b5-1 plan trades in Form 4 filings to reduce scrutiny
Very little disclosure is required today about a director’s 10b5-1 plans. However, public company directors who sell stock in their company are required to report those sales in a Form 4 filing made pursuant to Section 16 under the Exchange Act. These filings are due within two business days of the sale and are available to the public on the SEC’s website. As a result, automated sales that occur pursuant to a plan will be known to the public and can trigger scrutiny if sales appear to have been made at a time when a director would seem to have MNPI, such as after the company receives a takeover offer, becomes the subject of a regulatory investigation or endures a cyber attack. Plan sales made during the pendency of these events are valid (assuming the plan was established in good faith and not on the basis of MNPI) but can be potentially awkward without further explanation. As a result, although not required under current rules, to help stave off questions about trading during awkward times, a director may wish to establish a regular practice of notating in her Form 4 filings when sales are made pursuant to a 10b5-1 plan. This enhanced transparency, combined with a pattern of sales that are similar in amount and timing, will help position a director to benefit from the extra protection offered by Rule 10b5-1.
The SEC is currently reviewing Rule 10b5-1 practices and perceived abuses. We expect new rulemaking, which will likely include some of the best practices outlined above as well as other requirements.
Sarah Solum, US Managing Partner and Head of US Capital Markets of Freshfields Bruckhaus Deringer LLP