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More Guidance on 10b5-1

Melissa Klein Aguilar | April 21, 2009

Heads up: In light of recent clarifications by the SEC’s Division of Corporation Finance staff on Rule 10b5-1 and heightened scrutiny by the Enforcement Division, experts say careful consideration should be given to the timing of the creation, alteration, or suspension of any Rule 10b5-1 stock sale plans.

The Division of Corporation Finance recently updated its Exchange Act Rules Compliance and Disclosure Interpretations to provide additional guidance on Rule 10b5-1. While some of the new C&DIs incorporate Rule 10b5-1 interpretations previously addressed by the SEC staff in its Fourth Supplement to the Manual of Publicly Available Interpretations in May 2001, the C&DIs also include some important new guidance, DLA Piper attorneys Sanjay Shirodkar and Nicolas Morgan note in an April 17 Corporate Governance Alert.

Shirodkar and Morgan say that the clarification by the SEC staff “comes at a time of heightened and well-publicized scrutiny by the Enforcement Division of the SEC regarding trading activity in and around Rule 10b5-1 plans.”

As an example, the authors note a settled case filed March 4, 2009, against the former CEO, COO, and CFO of a public company in which the officers were alleged to have created 10b5-1 plans “within days” of participating in what the SEC called “misleading” conference calls with analysts about earnings information. The SEC complaint alleged that the officers created the 10b5-1 plans while in possession of material non-public information about the company’s earnings, and the newly created plans essentially guaranteed the immediate sale of company stock. As a result of settling the action with the SEC, each of the former officers disgorged all gains, paid civil penalties, and agreed to be subject to a federal court injunction.

Among the new guidance included in the C&DIs:

The cancellation of one or more plan transaction affects the availability of the Rule 10b5-1(c) defense. C&DI 120.19 explains that the cancellation of one or more plan transactions is considered an “alteration or deviation” from the plan which automatically terminates the plan. The C&DI also notes that in establishing a new contract after terminating a prior plan, “all surrounding facts and circumstances, including the period of time between the cancellation of the old plan and the creation of the new plan” are relevant in determining the person’s “good faith” intent.

New C&DI 120.20 indicates that the Rule 10b5-1(c) affirmative defense isn’t available in instances where a person establishes a Rule 10b5-1 written trading plan while aware of material non-public information, even if the plan is structured so that the plan transactions won’t begin until after the material non-public information is made public.

New C&DI 220.01 provides timely guidance on what happens when a person enters into a written trading plan with a broker, when the broker subsequently goes out of business. The interpretation indicates that the initial trading plan isn’t considered cancelled if the plan is transferred to a new broker, so long as the timing of such transfer doesn’t cancel any transaction scheduled under the initial plan and the new broker effects the sales in accordance with the terms of the initial plan. Interestingly, the interpretation doesn’t require that the person not be aware of material non-public information at the time he or she transfers the initial plan to the new broker.

New C&DI 220.02 provides additional guidance on the manner in which a company can effect a stock repurchase plan in accordance with Rule 10b5-1(c) and 10b-18.