The NASPP Blog

Heading into the new year, many companies will be starting the annual grant process. If your insiders are due for a new grant this year, they may be looking to modify their Rule 10b5-1 Trading Plan or enter into one for the first time. So, now is the time to review your company’s policy and make sure that it’s solid.

Affirmative Defense

Section 10(b) of the Securities Exchange Act of 1934 prohibits the use of any “manipulative and deceptive device” in connection with the purchase or sale of securities. In 2000, the SEC released Rule 10b5-1, clarifying that trading on the basis of material nonpublic information is just such a “device”. Additionally, the Rule states that entering into a trade while aware of material nonpublic information constitutes trading on the basis of that information. Fortunately, paragraph c of Rule 10b5-1 provides an affirmative defense that basically allows an individual to demonstrate that she or he is not trading on the basis of material nonpublic information.

In order to rely on the affirmative defense, an individual must enter into a contract, instruction, or plan to trade at a point in which she or he isn’t in possession of material nonpublic information. And that is the problem. When exactly is an officer of your company not privy to some piece of nonpublic information? When can an insider enter into a Rule 10b5-1 trading plan?

Timing of Plan Creation

In May of last year, the SEC published interpretive guidance on Rule 10b5-1. Question 120.20 really caught my eye. The question is whether or not the Rule 10b5-1 affirmative defense is available if an individual is aware of material nonpublic information at the time the plan is created, but the trade doesn’t take place until that information is made public.

The SEC answered with a single word: no. Just no. What that means is that no length of “cooling off period” is long enough; in order to garner the protection provided by Rule 10b5-1 a person simply must not be in possession of material nonpublic information at the creation of the trading plan.

When is That Even Possible?

So, what does that mean for companies trying to create a solid policy on Rule 10b5-1 trading plans? How is it even possible that insiders can find a period of time when they are not in possession of information that would negate the affirmative defense? To help me with this dilemma, I called on one of our fabulous panelists from the “10b5-1 Plans: Practical Advice and Implementation” session at our 2009 Conference, Michael Andresino of Boston’s Posternak Blankstein & Lund. (If you missed this session, take time to listen to it now!)

First, I still feel very strongly (and Michael agrees) that companies should require at least their Section 16 insiders to trade exclusively through a plan designed to comply with Rule 10b5-1. You have zero chance of relying on the Rule 10b5-1 affirmative defense if there is no plan in place. Second, the most basic precaution to take on the timing of the creation of these plans is to only allow insiders to enter into a plan after the company has made its quarterly financial disclosures; during an open trading window after the quarterly or annual press release (and conference call) is complete. A lot of companies take the position that at that point all material information has been made public.

Material Nonpublic Information

After that, it’s important to keep in mind that it isn’t just any nonpublic information that creates an issue with the Rule 10b5-1 affirmative defense. The problem is with material nonpublic information. It may be difficult to decide what information is material and what is not. An obvious distinction is that if the information could lead to an event that must be disclosed on a Form 8-K, then it’s reasonable to consider that information to be material. For example, if an individual is aware that your company is in the middle of negotiating a merger or acquisition, then it may be inadvisable for that person enter into a trading plan at that point. On the other hand, if the individual is aware of regular ongoing sales deals or the status of the new widget a company is producing that is part of the normal course of business, these pieces of information may not be considered material.

Situations must be considered on a case-by-case basis. Some companies approach this issue by requiring individuals to disclose to the legal department any nonpublic information that they are aware of at the time they enter into a new plan. This allows the legal department to help insiders determine if that information could be considered material before approving the plan.

How Does Your Policy Measure Up?

Does your company’s insider trading policy address Rule 10b5-1 trading plans? If not, now is the perfect time to have that conversation with your legal team. If you do have a policy, check to see what it says about the timing of the creation of new plans. Confirm that the policy contains components that help ensure that the insider may rely on the Rule 10b5-1 affirmative defense and review those components with your legal team to be sure that everyone is still comfortable that they are adequate.

-Rachel