Above Board: 10b5-1 Plans

MoFo Perspectives Podcast

16 Mar 2021

In this episode of the Above Board podcast, Morrison & Foerster partner Dave Lynn speaks with Jina Choi, San Francisco partner and former director of the SEC’s San Francisco Regional Office, about Rule 10b5-1 Plans. Jina discusses what these plans are, how they get implemented, and how they are intended to mitigate the risk of insider trading. Dave and Jina examine the recent scrutiny around Rule 10b5-1 plans. Jina also gives valuable advice on what boards should be considering in relation to Rule 10b5-1 plans.


Speaker: Welcome to MoFo Perspectives, a podcast by Morrison & Foerster, where we share the perspectives of our clients, colleagues, subject matter experts, and lawyers.

David Lynn: Hello, this is David Lynn. I’m a partner in the Washington, D.C., office of Morrison & Foerster, and today I’m very pleased to be joined by my colleague, Jina Choi, who’s a partner in Morrison & Foerster’s San Francisco office, and who previously served as regional director of the SEC San Francisco office. Jina, thanks so much for joining me today.

Jina Choi: Oh, Dave, thanks so much for having me.

David Lynn: Today we’re going to talk about what seems to be really a perennial topic of debate. And that is the use of Rule 10b5-1 plans for trading in the securities of public companies by the public companies insiders or by the company itself. And it seems like every few years this topic comes up and, um, we find ourselves again in a timeframe where people are talking about Rule 10b5-1 plans, what is actually a 10b5-1 plan and then how does it get implemented at a company?

Jina Choi: Rule 10b5-1 plans are written plans or a set of instructions by which corporate insiders, officers, directors, and employees at a public company can buy or sell stock according to a set plan. These plans can be used to mitigate against the risk of claims of insider trading. And, Dave, as you know, insider trading is prohibited under the federal securities laws. You can’t trade on the basis of material non-public information in breach of a duty. And because corporate insiders, by definition, almost tend to have, inside or nonpublic information about their companies, Congress set up a kind of safe harbor, so that officers and directors of public companies can use 10b5-1 plans to help them buy or sell shares of stock without the risk of having to prove affirmatively that they weren’t engaged in insider trading. The idea is if you set up a Rule 10b5-1 plan that would provide an affirmative defense against an allegation of insider trading. You still have to show that the plan was properly designed, that it was instituted with good faith, that you didn’t have material non-public information when you were setting up the plan.

Jina Choi: But if all that checks out, Rule 10b5-1 plans generally provide a layer of protection for corporate insiders when they’re trading in their company’s stock. You know, generally plans can be put together by an executive with the help of a lawyer. The terms of the plan have to specify the amount of shares, the pricing—the date of the transaction. And that could include a written formula, an algorithm, a macro to determine the amount, the price, the date. And you can see how this works. You know, life happens. Events come up, especially if a lot of an executives comp is made through the grant of shares or options. You want to be in a position to be able to liquidate those shares or diversify one’s portfolio. So a plan can take into account when taxes might come due, or when a college tuition bill comes due, or other life events where an individual might need liquidity. So a 10b5-1 plan can come in handy, especially when you consider that some companies have blackout periods as part of their insider trading policies that restrict employees’ abilities to trade at particular times. An executive who’s put a 10b5-1 plan in place, quarters or years in advance, can be in a really good position to show that the determination to trade was made way before news that comes out that with hindsight can look suspicious.

David Lynn: That’s helpful. And I think one thing that I alluded to earlier is just how this topic has come up again and people have been talking about 10b5-1 plans and criticisms have arisen about their implementation. What has been said recently about 10b5-1 plans, and are these issues that the SEC might address at some point?

Jina Choi: You know, that’s exactly right. Dave. I’ve told you some of the good things about Rule 10b5-1 plans and why public companies and officers and directors might want to adopt plans and reference them in their insider trading policies. But there is a good amount of cynicism surrounding these plans since they came into existence about 20 years ago. And especially most recently, the press, members of Congress, academics, have taken a hard look at trades made pursuant to 10b5-1 plans, and there is a narrative out there and certain academics have done data analysis that corporate executives are taking advantage of these plans, that there’s abuse of 10b5-1 plans, or that corporate executives are gaming the system with these plans. Years ago, the enforcement division of the SEC announced that they would be looking closely at these plans, but there haven’t been very many enforcement actions charging insider trading pursuant to a 10b5-1 plan.

Jina Choi: And that makes sense considering how these, how the plans are designed, but the scrutiny persists. Recently academics have analyzed trading pursuant to these plans and have published findings that public companies disproportionately announce good news on days when corporate executives are selling shares under 10b5-1 plans, and another study found that certain trading pursuant to 10b5-1 plans seemed particularly opportunistic and avoided losses to a greater extent than their industry peers. And just this past November, in the last few weeks of his tenure, then-SEC Chairman Jay Clayton talked about good corporate hygiene and discussed a cooling off period for 10b5-1 plans. So you’re not trading days or even weeks after you’ve put a plan in place. Last month, Senators Elizabeth Warren, Sherrod Brown, and Chris van Hollen sent a letter to the SEC asking it to review rules for 10b5-1 plans.

Jina Choi: And it was clear that they thought something fishy was going on. In the letter, the senators wrote, “These plans were designed to prevent insider trading, but new evidence indicates that executives, especially those in the healthcare industry, are abusing these plans to obtain huge windfalls at the expense of ordinary investors.” A couple years ago, the house passed a bill directing the SEC to study Rule 10b5-1 plans and see whether Rule 10b5-1 itself should be amended. The Senate didn’t do anything with that bill, but now you have three senators, all on the Senate banking committee, now in the majority, sending a letter to the SEC to have them look at these plans. I think the stars might have aligned, and you may see some new rules or even some new legislation regarding these plans.

David Lynn: Yeah. A lot of the focus is on the plans and their use by insiders, executives, and directors, but also companies use these plans in connection with their share of purchase activities. Are there any particular concerns there with how companies utilize real 10b5-1 plans?

Jina Choi: Dave, I’m so glad you asked. I think you’re right. Most lawyers, board members, executives, or anyone who knows a little bit about 10b5-1plans. They think about them in the context of individual officers, directors, or significant shareholders, but entities can also set up a Rule 10b 5-1 plan for risk mitigation, and that could include asset managers, hedge funds. And in the context of a stock buyback companies can do so with a Rule 10b5-1 plan in place. What’s really interesting, I think, is that recently the SEC brought an enforcement action just last October against and Andeavor, a Texas-based oil company, that involved a stock buyback and a 10b5-1 plan. And Dave I’ve already told you that enforcement actions involving 10b 5-1 plans are pretty rare. So to see this case in the context of a stock buyback is extremely rare.

Jina Choi: I think it’s a first-in-kind case. And interestingly, the case charged a controls violation. Let me tell you a little bit about the facts in the case, and here the dates and the timing matter. According to the SEC’s order, Andeavor was engaged in discussion about being bought by another public company in 2017, but they suspended negotiations in October of 2017. In January 2018, just three months later, the acquiring company’s CEO came back to Andeavor’s CEO to resume talks. Two days before a meeting that had been scheduled between the CEOs, Andeavor’s CEO directed a repurchase of $250 million of Andeavor’s stock pursuant to a board authorization from several years ago that the company used from time to time. On February 23rd, the company executed a 10b5-1 plan and repurchased $2.6 million shares over the next two months at an average price of $97 per share.

Jina Choi: And on April 30th, 2018, just a couple months later, Andeavor announced that it would be acquired in a deal at a share price of more than $150 per share. So the SEC did not charge insider trading or bring a fraud charge, but rather it claimed that Andeavor had violated the internal controls provisions of the Exchange Act, which requires that public companies have appropriate internal accounting controls to make sure that they’re complying with their company’s policies. Basically, the SEC said that Andeavors internal controls were insufficient to ensure that their insider training policy was being followed. The SEC found that even though Andeavor’s legal department approved the plan, its process was informal and it didn’t take into account conferring with people like the CEO, who had information regarding the takeover, and whether that takeover was likely. The case was settled, but the penalty was significant for a controls provision violation—$20 million. Even though enforcement cases involving stock buybacks and 10b5-1 plans are rare, companies should make sure that the decision to engage in a stock buyback is subject to a controls process that is well‑thought out. It’s well-followed and it’s well‑documented. This is especially true if your company is going through a major M&A transaction.

David Lynn: And how should the board be involved in overseeing a company’s insider trading policy and the use of Rule 10b5-1 plans?

Jina Choi: You know, with all the scrutiny on 10b5-1 plans, I would strongly advise boards of public companies to pay attention to their company’s insider trading policy and the use of 10b5-1 plans. This is an area that doesn’t just expose your company at its executives to legal risk—reputational risk. First, make sure that you get the basics right. Use 10b5-1 plans as an important tool for insider who want or need to trade, but make sure Rule 10b5-1 plans are well-documented and include the required terms. Make sure that executing and modifying plans only occur during open trading windows and at times when individuals are not aware of material nonpublic information. When they execute their plans, executives should certify that they’re not in possession of material, non-public information. Audit committees should flag Rule 10b5-1 plans as an area of interest, and make sure internal audit is routinely reviewing compliance of these plans.

Jina Choi: Look for suspicious trading. Investigate those instances, if and when they come up. Look for instances of trading outside the plan. Once a plan is in place, executives and companies are exposing themselves to risk if they trade outside the plan. Look for instances where individuals have canceled or modified a plan. Look at plans that involve a single trade and consider mandating a cooling off period between creation of a plan and the first trades under that plan. Think about what that period of time should be for your organization. Chairman Clayton suggested four months—six months. That all seems reasonable if trading ensues days or weeks after a plan is put in place. That can expose companies and executives to reputational risk.

David Lynn: And what sort of questions should the directors be asking of management when they’re talking about insider transactions in the company’s securities and the company’s share with purchase activity?

Jina Choi: If I were on a board or advising the audit committee for a board, I would make sure that management understood that insider transactions and share repurchases are an area of interest for the board, particularly now when there’s heightened legislative, regulatory, and public scrutiny. As strategic advisors who can provide perspective for management and can highlight areas of risk, just by asking questions, you can elevate attention to this area and by doing so you can mitigate risk. I would ask and determine whether your company is following best practices when it comes to 10b5-1 plans. Make sure that plans are only instituted in open trading windows and not while in possession of material non‑public information. In the case of stock buybacks, make sure internal controls are robust. They’re thoughtful. They’re followed, and they’re documented. Ask about multiple or overlapping plans that cover the same securities. Ask about modifications, suspensions, or terminations with plans.

Jina Choi: I would discuss instituting the cooling off period. And I would also discuss whether there should be public disclosure about plans adopted by the company itself or by senior executives of the company. Neither of these are required under Rule 10b5-1, I would say yet, but I do think that putting scrutiny on these issues, making it a priority at the board level can go a long way to show leadership, show integrity, good corporate hygiene, transparency, and good corporate governance, which the SEC has already identified as a priority area in this new administration.

David Lynn: Great. Thank you, Jina, for all those insights.

Jina Choi: Thanks for having me.

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