Client Alert

COVID-19 and Rule 10b5-1 Plans: Best Practices

16 Mar 2020

As the coronavirus (COVID-19) outbreak continues to rapidly unfold and create uncertainty in the market, companies are considering whether to opportunistically buy back stock, or to otherwise take advantage of the current market turbulence. Companies on fiscal quarters will also enter their trading blackout periods shortly, which could curtail buyback opportunities. Because stock buybacks are sometimes made pursuant to Rule 10b5-1 plans, companies are raising a number of questions about establishing or modifying Rule 10b5-1 plans in light of the current market conditions.

This client alert presents a brief discussion regarding Rule 10b5-1 plans and addresses questions related to their adoption and modification in light of current events surrounding the COVID-19 outbreak. It reiterates that the best practices relating to such plans remain unchanged and should be considered in assessing the risks and benefits of engaging in stock repurchases pursuant to such plans.

Rule 10b5-1 Plans Generally

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”). While 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 (“MNPI”), any person or entity executing pre-planned transactions pursuant to a valid Rule 10b5-1 plan has an affirmative defense against accusations of insider trading. This is so even if actual trades made under the Rule 10b5-1 plan are executed at a time when the person or entity may be aware of MNPI. The affirmative defense of a Rule 10b5-1 plan is available if the person or entity can demonstrate that the plan meets all the required elements, including:

  • The plan was entered into in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5‐1;
  • The plan was adopted at a time when the person or entity trading was not aware of any MNPI;
  • The terms of the plan specified the amount, pricing (such as trigger price if applicable), and date of the transaction(s) (or included a written formula, algorithm, or computer program for determining the amount, pricing, and date);
  • The person or entity trading under the plan did not exercise any subsequent influence over how, when, or whether to make purchases or sales; and
  • The purchase or sale was made pursuant to the plan.

Reiterating Best Practices for Rule 10b5-1 Plans in Spite of Current Market Conditions

Companies that do not currently have Rule 10b5-1 plans but are considering stock buybacks should discuss with their boards whether to establish a plan or to authorize any stock buyback program. The best practices for adopting such plans apply even in these turbulent times and are set forth below. They help ensure that the company will be able to use the plan as an affirmative defense if any claim is brought against it for allegedly trading on insider information. Note that these best practices are not bright line rules, and companies should carefully weigh the advantages and disadvantages when deciding whether to adopt a Rule 10b5-1 plan, including how adoption of such a plan during the COVID-19 outbreak might be viewed in hindsight by the public, outside investors, or law enforcement agencies.

  • Establishment of a Rule 10b5-1 Plan: Plans should be established only when the company is not aware of any MNPI. Companies often look to the trading window and blackout procedures applicable to insiders that are specified in their insider trading policies as guidelines for determining when a company may be aware of MNPI. It is advisable to enter into a Rule 10b5-1 plan during an open trading window under the company’s insider trading policy to avoid the appearance of establishing a plan while in possession of MNPI and to bolster the good faith element. Note that while there is no prohibition upon entering into a Rule 10b5-1 plan during a blackout period (assuming no prohibition in the company’s insider trading plan), doing so may raise suspicion of trading on the basis of MNPI. Companies seeking to adopt a Rule 10b5-1 plan during the COVID-19 outbreak should carefully weigh these considerations and make an affirmative determination that the company is not aware of MNPI, including information about the impact on the company from COVID-19.
  • Waiting Period: Companies may want to consider imposing a waiting period between the establishment of a plan and the date the initial trade is made. Brokers executing trades pursuant to Rule 10b5-1 plans may ask that the company impose such a waiting period. The establishment of a waiting period, however, will not insulate a company from regulatory and other scrutiny if the company is aware of MNPI. The Securities and Exchange Commission staff has indicated in Exchange Act Rules Compliance and Disclosure Interpretation Question 120.20 that the Rule 10b5-1(c) affirmative defense is not available where a person establishes a Rule 10b5-1 written trading plan while aware of MNPI, even if the plan is structured so that plan transactions will not begin until after the MNPI is disclosed.
  • Modifications, Terminations, or Suspensions: Resist the urge for frequent modification, termination, or suspension of the plan. In the event of any modification, termination, or suspension, companies should consider imposing a waiting period before trades can be reinstated under a plan.
  • Trades Outside of the Plan: Once a plan is established, limit transactions outside of the plan.
  • Term of Plan: Adopt a specific term for the plan that is aligned with the company’s objectives. Some companies may choose to enter into a short-term plan to facilitate trades during a blackout period, so as to preserve the flexibility to conduct buybacks without a Rule 10b5-1 plan in place when the company is no longer aware of MNPI after the blackout period ends. Other companies choose to enter into longer term Rule 10b5-1 plans so that buyback activities will not be interrupted by MNPI that can arise on a more infrequent basis, such as the negotiation of mergers and acquisitions or other significant corporate transactions, as well as MNPI about the impact on the company from COVID-19. Companies should establish term and plan parameters that will minimize the need for future modifications, terminations, or suspensions.
  • Disclosure: There is no requirement of public disclosure for a company’s entry of a Rule 10b5-1 plan or the terms and conditions thereof. Companies should consider their prior practice regarding public disclosures of company 10b5-1 plans to determine if public disclosure is advisable should a current plan be implemented.
  • Trading Parameters: Consider prohibiting large sales at the initiation of the plan. Also consider plans that prohibit implementing broker discretion on sales, and plans that are simpler to execute and that would not require significant interpretation by the broker. This reduces the likelihood of communications between the plan creator and broker, and avoids any inference of the plan creator’s improper influence or discretion over the plan.

Conclusion

Companies seeking to engage in stock buybacks pursuant to 10b5-1 plans during current market conditions should still be mindful of best practices relating to Rule 10b5-1 plans.

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