For the past two decades, officers and directors of publicly traded US companies who sought to illegally trade inside information have had an almost infallible ticket to get out of jail.
All they had to do was use pre-determined trading plans when buying and selling their companies’ stocks. The chances that the government would target them for enforcement action were slim. It was an unintended consequence of a rule enacted in 2000 called Rule 10b5-1, which scholarly research suggests was abused by some executives.
This regime will change. A new Securities and Exchange Commission rule promises to eliminate many of the loopholes that allowed company insiders to hide behind these trading schemes. New disclosure requirements will come into effect on April 1 for most US-listed companies.
Highlights: Officers and directors must wait at least 90 days after initiating or modifying a 10b5-1 plan before acting under the arrangement. The forms used to report their trades will contain mandatory checkbox disclosures stating whether they have used such a plan and the plan’s acceptance date. Companies must also disclose the contents of the 10b5-1 plans in their quarterly and annual reports.
WHEN EXECUTIVES STOP SELLING STOCKS, THERE COULD BE A BIG DEAL
“Before the change came, you could have an executive use a $100 million 10b5-1 plan and there would be no trace in the public disclosures that they were using such a plan,” said Daniel Taylor, an accounting professor at the University of Pennsylvania and the co-author of a 2021 study on 10b5-1 abuse cited in the SEC’s final rule.
Some insiders sold shares less than a month after their plans were approved, sometimes on the same day, or approved and initiated trading plans right before earnings were announced. Another trick was to adopt multiple 10b5-1 plans and later selectively cancel those that would not work to the insider’s advantage. Possible abuse of 10b5-1 plans was the subject of a Wall Street Journal article in June that was cited in the SEC’s final rule.
LEGISLATORS HEAR FROM INVESTORS RESTRICTED BY THE SEC’S ACCREDITED INVESTOR RULE
Under the old rule, company insiders were only allowed to draw up the plans if they had no knowledge of material, nonpublic information. Company insiders did not have to disclose that they were relying on such plans when reporting their trades, although many did anyway. The companies did not have to disclose the existence of the plans. Due to the lack of information, investors often wondered if a top executive’s well-timed trades were too good to be legal.
Just as the old rule spawned new manipulations, the new rule will not eliminate them all. The SEC raised concerns that some insiders may schedule market-moving disclosures around insiders’ scheduled trading dates, delay the release of bad news until after scheduled sales, or rush releases of good news so that it comes out beforehand.
The SEC said its new rule addresses this by requiring all users of 10b5-1 plans “must act in good faith.” Mr Taylor said that could be difficult to enforce. “If the executive knows they have a proposed sale and changes the timing for announcing bad news to a day or two after the sale, it can be very difficult for regulators to demonstrate that the timing was appropriate for the purpose of his sale.” was changed,” he said.
An SEC advisory committee had recommended requiring companies to disclose assumptions and changes to the 10b5-1 plan more timely — within four days, rather than waiting for quarterly reports — which could help make manipulation easier to spot. The SEC declined.
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The same committee also recommended requiring all US-listed companies to follow the same insider trading reporting requirements and use the same disclosure forms. Under current regulations, many foreign companies trading on US exchanges do not have these filing requirements. Under the new rules, insiders at foreign filers are still not required to follow the same disclosure rules for stock sales and purchases as insiders at US-based companies.