Gensler Plans to “Freshen Up” Rule 10b5-1

[On June 7, 2021], in remarks before the WSJ’s CFO Network Summit, SEC Chair Gary Gensler scooped the Summit with news of plans to address issues he and others have identified in Rule 10b5-1 plans. Problems with 10b5-1 plans have long been recognized—including by former SEC Chair Jay Clayton—so it will be interesting to see if any proposal that emerges will find support among the Commissioners on both sides of the SEC’s aisle. In an interview, Gensler also responded to questions about climate disclosure rules, removal of the PCAOB Chair, Enforcement, SPACs and other matters.

Rule 10b5-1 background. Corporate executives, directors and other insiders are constantly exposed to material non-public information, making it sometimes difficult for them to sell company shares without the risk of insider trading, or at least claims of insider trading. To address this issue, Congress developed the Rule 10b5-1 safe harbor. In general, Rule 10b5-1 allows an insider, when acting in good faith and not in possession of MNPI, to establish a formal trading contract, instruction or plan that specifies pre-established dates or formulas or other mechanisms—that are not subject to the insider’s further influence—for determining when the insider can sell shares, without the risk of insider trading. To be effective, the contract, instruction or plan must also conform to the specific requirements set forth in the Rule. In effect, the Rule provides an affirmative defense designed to demonstrate that a purchase or sale was not made “on the basis of” MNPI. If a 10b5-1 contract, instruction or plan is properly established, the issue is not whether the insider had MNPI at the time of the purchase or sale of the security; rather, that analysis is performed at the time the instruction, contract or plan is established.

After the plan has been established, there is no requirement for a cooling-off period—that, is the plan can provide for immediate trades. In addition, the insider can modify it, so long as he or she is not aware of MNPI at the time of the modification, and can terminate it at any time—even if the insider is in possession of MNPI at the time. Why is that? Because the termination (and related cancellation of any planned trades) is not “in connection with the purchase or sale of any security.” Plans can be used for a single trade, and there is no requirement that multiple trades be spaced apart. An insider can also adopt multiple plans that operate at the same time. Although there are requirements that insiders report transactions on Forms 4 and 144, there is no independent public reporting requirement for 10b5-1 plans (other than the requirement on Form 144 to provide the date of plan adoption if the sale was under a 10b5-1 plan). However, some insiders do provide that information voluntarily. The wide berth the Rule gives executives to conduct transactions under these plans, together with the absence of public information requirements, has long fueled controversy about Rule 10b5-1 plans. In particular, some view the ability to adopt multiple plans and to amend or cancel the plans as providing opportunities to exploit the Rule.

Gensler’s view. To Gensler, 10b5-1 plans “have led to real cracks in our insider trading regime,” and, as a result, he has asked the staff to make recommendations for a proposal to “freshen up” Rule 10b5-1.

Below are some of the new limitations Gensler suggests should be considered in a proposal:

• Cooling-off period. Gensler is concerned that the absence of any cooling-off period after adoption of 10b5-1 plans might be perceived by “some bad actors…as a loophole to participate in insider trading. Research has shown that 14 percent of sales of restricted stock in 10b5-1 plans initiate the planned transactions within 30 days of plan adoption, and about two in five plans within the first two months. Former Chair Clayton and Commissioners Allison Lee and Caroline Crenshaw have all advocated four- to six-month cooling-off periods, and Gensler believes that “this approach deserves further consideration.”

• Limitations on cancellation. As noted above, insiders can cancel a 10b5-1 plan even if they do have MNPI that could influence the decision to cancel. That, to Gensler, “seems upside-down” because cancellation could be “as economically significant as carrying out an actual transaction.” Accordingly, Gensler has asked the staff to consider limitations on when and how plans can be canceled.
• Mandatory disclosure. Gensler advocates mandating “disclosure regarding the adoption, modification, and terms of Rule 10b5‑1 plans by individuals and companies.”
• Limits on number of plans. Because insiders can enter into and cancel multiple plans, “insiders might mistakenly think they have a ‘free option’ to pick amongst favorable plans as they please.” As a result, the staff will consider imposing limits on the number of 10b5-1 plans an individual can adopt.
• Other potential reforms. Gensler mentioned that the staff was also asked to consider other potential reforms, noting only the use of 10b5-1 plans by companies to conduct share buybacks.

Gensler emphasized that, although rule changes may take some time to implement, under the current rule, “cancelling or amending any 10b5-1 plans calls into question whether they were entered into in good faith. If insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense.”

While some companies have already adopted some of these limitations as best practices, Gensler believes that mandating these changes would enhance investor confidence in the markets, which “helps both investors and businesses seeking to raise capital, grow, and innovate.”

[Below is based on my notes, so standard caveats apply.]

Interview. In an interview segment, Gensler also addressed a number of other topics.

• Climate disclosure rules. Gensler was asked whether he was leaning toward principles-based or prescriptive rulemaking and whether it would be mandatory? (See, e.g., this PubCo post.) Gensler replied that there were economic trade-offs involved in mandating the type of consistent, comparable and reliable disclosure regarding both physical and transition risks that he believes investors are seeking, and that he expected to see a balance. He was later asked whether the SEC would standardize ESG disclosure requirements with European and other global disclosure requirements. He said that, in developing a proposal, he expected the SEC to learn from work performed globally and by independent standard-setters, as well as to take public comments into account. (But see this PubCo post.) The proposal would then be subject to a notice-and-comment process. He viewed a proposal on climate disclosure, as well as a more detailed mandate on human capital disclosure, to be high priorities. He hoped to see requirements for “decision-useful” information that can be relied on. (Note the emphasis on “reliability”—does that imply an audit or attestation requirement?)
• Removal of PCAOB Chair. Gensler thanked the interviewer for her question about the reason for the dismissal of the PCAOB chair. (Really?) First, he noted that the SEC has the authority to remove the chair from this at-will position. Then, he observed that the PCAOB plays an integral role in the audit process and that he didn’t think that it was living up to its potential as a standard-setter or in its enforcement role. By disbanding its investor advisory committee, the PCAOB was also not being sensitive to the needs of investors. The SEC has a comparable committee and he viewed it as important to hear the committee’s views. With new members, Gensler hoped to reinvigorate the PCAOB. So was he saying that the PCAOB was too soft on auditors? He responded that reliability of the financial statements is important to companies and to the investing public. Ensuring reliability and integrity of audits through PCAOB oversight helps to ensure the integrity of the capital markets. Sorry, nothing much to dish here. (See this PubCo post.)
• More aggressive enforcement. Gensler was asked whether, given his reputation as a tough watchdog at the CFTC, SEC Enforcement would play a more aggressive role? He responded that Enforcement plays a critical role for the entire capital markets system and that Enforcement would bring cases where companies and individuals have crossed the line. (He advised CFOs who might be asking advisers and counsel whether a particular action might be over the line to step back and away from the line.) The public, he said, needs to be able to rely on the capital markets, and, to the extent that Enforcement can help to lower the incidence of fraud and manipulation in the markets, that helps the markets function better, it’s better for investors and it promotes better returns for working families and companies.
• SPACs. Here, Gensler expressed concern about whether there is a level playing field for retail investors with regard to cost, disclosure and other matters. For example, do retail investors receive the same disclosure as PIPE investors? Where there is a new technology or approach, the SEC needs to be neutral but seek to ensure that investors are getting the best, most appropriate disclosure at all stages of the transaction and are protected against fraud to the extent possible. Our capital markets, he said, rest on an effective disclosure regime. He dodged the question of when any new rules regarding SPACs would be proposed—the SEC has a robust agenda and the staff is stretched with the boom in SPACs as well as in traditional IPOs, he said.

• Social media/gamification. Fraudulent activity used to be conducted on paper, he said, then on the internet and now on social media. The SEC will use its resources to stamp out fraud that is promoted on new technologies. He has also asked the staff to look at gamification and market structure. With regard to gamification, many of us are now tethered to our cell phones—the question is how do behavioral prompts lead us to engage in more activity? Studies show that the returns of day traders are lower than others. With regard to market structure, the staff will be looking at payment for order flow and whether there is an inherent conflict with best execution.
• Corporate governance. Gensler was asked what weak points he would identify in corporate governance. Given that much of corporate governance is not within the SEC’s remit, he mentioned 10b5-1 plans and oversight of risks in accounting and appropriate disclosure for investors.
• Other. Gensler also noted, in response to a question, that the staff was continuing to look at current disclosure, such as non-GAAP financial measures. Asked about the LIBOR transition, he observed that there was a move away from LIBOR as a reference rate when it was discovered that it was subject to manipulation after the LIBOR rigging scandals. He said there was still a need to coalesce around a new reference rate. (See, e.g., this PubCo post and this PubCo post.)