In late 2012, The Wall Street Journal published a number of articles that analyzed the trading practices of certain public company executives, in many cases under trading plans that were entered into in accordance with the affirmative defense provisions adopted by the U.S. Securities and Exchange Commission (SEC) pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934. [1] The trades examined in the Journal articles were called into question because they were sizable and were reported to have occurred shortly before company news updates. The articles also compared returns by executives who traded irregularly against those who followed a consistent pattern, and concluded that irregular trading resulted in greater gains. These articles have reignited interest in “best practices” for Rule 10b5-1 trading plans.

The Council of Institutional Investors (CII), a group of pension funds that oversees more than $3 trillion in assets, has picked up on the issue of potential misuse of Rule 10b5-1 trading plans and submitted a rulemaking petition to the SEC requesting interpretive guidance or amendments to Rule 10b5-1. [2] CII recommends that the SEC:

…continue reading: Getting Back to Basics with Rule 10b5-1 Trading Plans

Recent press stories have revived speculation that corporate insiders may be abusing rule 10b5-1 trading plans to reap unfair profits from inside knowledge of their companies. [1] The SEC is reported to have expanded its probe beyond trades highlighted by the press to cover a larger range of executive trading activity. [2] Other regulators have launched their own investigations, and investor groups have joined the conversation. [3]

In light of this widespread and intensifying scrutiny, companies and executives should consider techniques that make it easier to demonstrate compliance with the requirements of rule 10b5-1, such as:

• having the first trade under a 10b5-1 plan take place after some reasonable “seasoning period” has passed from the time of adoption of the plan,
• having each executive use only one 10b5-1 plan at a time, and
• minimizing terminations and amendments of 10b5-1 plans.

The current controversy centers on trading by executives under 10b5-1 plans that, in hindsight, appears “well-timed.” Much like in the stock option pricing controversy from a few years ago, the press and some analysts have employed a retrospective statistical analysis of 10b5-1 plan trades to argue that insiders using the plans seem to be doing surprisingly well.

…continue reading: SEC Expands Probe into Rule 10b5-1 Plans

In the world of insider trading, Rule 10b5-1 plans are a blessing and a curse: a blessing, because they enable executives to diversify their company holdings in a stable, law-abiding manner; a curse, because they tempt cheaters into hiding their malfeasance in a cloak of invisibility.

For years, 10b5-1 plans received little scrutiny. In private shareholder lawsuits, plaintiffs’ lawyers generally scrunched their eyes shut and tried to ignore them. The SEC, having created the structure, lost interest postpartum. As a result, aggressive insiders sometimes were able to use the plans in ways the framers never intended.

Recently, journalists have started to focus on the specifics of 10b5-1 plans, along with perceived abuses of them. [1] Those articles appear to have roused the SEC. So this may be a good time for counsel, both inside and outside, to revisit their existing plans. In this post, I address what I consider to be best practices under 10b5-1. This does not mean that contrary practices are improper or unlawful. Think of it, rather, as 10b5-1 for the risk averse.

…continue reading: The Best-Laid Plans of 10b5-1

Rule 10b5-1 plans are back in the news. These plans are widely used by officers and directors of public companies to sell stock according to the parameters of the affirmative defense to illegal insider trading available under Rule 10b5-1, which was adopted by the SEC in 2000. Several recent Wall Street Journal articles suggest that some executives may have achieved above-market returns using the plans. [1] These articles are reported to have drawn the interest of federal prosecutors and the SEC enforcement staff. Rule 10b5-1 plans are no strangers to controversy. An academic study published in December 2006 found that, on average, trades under 10b5-1 plans outperformed the market by about 6% after six months. The resulting scrutiny did not lead to a significant uptick in insider-trading prosecutions, but did cause many companies to revisit their executives’ use of the plans. We suggested then that the potential for controversy was not by itself a reason to forego the benefits of employing 10b5-1 plans. We continue to believe that using properly designed plans is a good idea in many cases and can be at least as prudent as discretionary selling under normal insider-trading policies, with trading windows, blackouts and the like. Although regulators and the media may scrutinize trades made under 10b5-1 plans even when above board and done according to best practices, a well-thought-out and implemented 10b5-1 plan may help a company and its executives avoid or ultimately refute accusations of impropriety.

In light of the renewed focus on 10b5-1 plans, companies should review their 10b5-1 policies for conformity with current best practices. Below we provide an overview of 10b5-1 plans and some guidelines for their use.

…continue reading: Rule 10b5-1 Plans: What You Need to Know

In many respects, 2012 was another year of aggressive SEC enforcement. The SEC’s Division of Enforcement again logged a near record number of enforcement actions. More important, the cases reflected a marked increase in the number and proportion of actions against registered investment advisers and broker-dealers, and their associated persons. This increased focus derives from a culmination of factors, including Enforcement’s creation of specialized units for the asset management industry and for structured products, the hiring of industry experts, and the close collaboration between staff from Enforcement and the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). With the expansion of the registered private fund adviser population under financial reform legislation, and the launch of an initiative to conduct focused, risk-based examinations of these new registrants, this trend will likely continue for the foreseeable future.

At the same time, in the latter half of 2012 the SEC confronted significant challenges in litigating previously filed enforcement actions against individuals in cases related to the financial crisis. Whether these cases will cause the SEC to reevaluate its approach with respect to charging decisions in the future is unknown. However, in the short term, Enforcement seems undeterred by individual litigation results in its pursuit of continued enforcement actions.

The last six months of 2012 mark the beginning of another transition for the SEC generally, and for Enforcement in particular. As the year drew to a close, Mary Schapiro announced her departure as Chairman, followed by several division directors. Most notably, on January 9, 2013, the SEC announced that Robert Khuzami would step down as Director of Enforcement. As we look ahead to 2013, a new leadership team at the SEC and in Enforcement will seek to make their own imprint on the SEC’s priorities and processes. In addition, as more time has passed since the depth of the financial crisis, Enforcement’s priorities will shift to more recent conduct and emerging industry risks.

…continue reading: 2012 Year-End Securities Enforcement Update

Across the globe, many view insider trading as a threat to stock market integrity and efficiency. This is evidenced by the fact that, as of 2000, eighty-seven countries had enacted insider trading legislation and thirty-eight had prosecuted insider trading at least once. However, these laws vary in stringency and many of them were enacted only recently. Enforcement intensity also varies across countries, with some countries regularly enforcing insider trading laws and others allowing insiders to trade with impunity notwithstanding the laws on the books. The aim of this study, The Political Economy of Insider Trading Law and Enforcement: Law vs. Politics? International Evidence, is to provide a greater understanding of the political and economic determinants of the differential timing of insider trading legislation and enforcement across countries.

Those who oppose insider trading regulation often rely on the private interest theory of regulation to explain how these laws, despite their presumed inefficiency, are enacted to satisfy influential private interests. In contrast, those who support insider trading restrictions rely on the public interest theory of regulation to explain how insider trading regulation is enacted to address market failures. The two theories are rarely merged into a single framework. However, because insider trading and its regulation concern the distribution of property rights to use private corporate information, the issue has both private (distributional) and public (efficiency) dimensions. I take both dimensions into account in this study.

…continue reading: The Political Economy of Insider Trading Law and Enforcement

While the insider trading conviction of Rajat Gupta and SEC settlement with Hall of Fame baseball player Eddie Murray attracted headlines — and the 12-year prison sentence imposed earlier this summer on former corporate attorney Matthew Kluger set a new standard for criminal insider trading penalties — there have been several other legislative, regulatory and judicial developments in recent months relating to insider trading that are of equal or greater significance. All reflect an increased focus on preventing and prosecuting the trading of securities and commodities based on material nonpublic information.

Congress has passed legislation expressly prohibiting its members and other government officials from trading on nonpublic information they learn from their official positions, even as a prominent Congressman was investigated regarding (though ultimately not charged with) such alleged trading. Meanwhile, the Department of Justice and the SEC have continued their active pursuit of those they believe supplied and traded on inside information obtained and disseminated via “expert network” investment research firms. Finally, courts and prosecutors have demonstrated an inclination to find at least the possibility of illegal insider trading even when the information came from an indirect source or via seemingly benign means.

These recent developments all suggest that, in the current environment, investors and investment advisers should be particularly vigilant in ensuring that they and their employees do not acquire and trade on nonpublic information obtained directly or indirectly from an individual or entity who was not authorized to disclose it, or that otherwise is not in the public domain.

…continue reading: Insider Trading Developments — Summer 2012

In the latest of a string of litigation victories it has scored in the Second Circuit, the Securities and Exchange Commission convinced a panel of the Second Circuit on September 6, 2012, to vacate a district court’s grant of summary judgment to the defendants in Securities and Exchange Commission v. Obus, No. 10 Civ. 4749. In so doing, the Circuit clarified, and to some extent modified, the standards for tipper/tippee insider trading under the misappropriation theory.

The SEC alleged that Thomas Strickland, an employee of General Electric Capital Corporation (“GE Capital”), tipped a friend of his, Peter Black, who worked for a hedge fund, about a planned acquisition of Sunsource, Inc., by Allied Capital Corporation, that GE Capital was financing. The SEC alleged that Black relayed the tip to his boss, Nelson Obus, who then traded on the information. The SEC argued that all three participants were liable under the misappropriation theory, alleging that Strickland owed a fiduciary duty to GE Capital to keep the information about the acquisition confidential, that he breached this duty by disclosing the information to Black, and that Black and Obus knew or should have known that Strickland was breaching a duty by providing the tip.

…continue reading: Second Circuit Clarifies Standards for Insider Trading Claims

On its face, the connection between insider trading regulation and the state of mind of the trader or tipper seems fairly intuitive. Insider trading is a form of market abuse: taking advantage of a material, non-public secret to which one is not entitled, generally in breach of some kind of fiduciary-like duty. It is an exploitation of status or access, typically coupled with some form of faithlessness. Certainly the extraordinary public attention that insider trading enforcement and prosecutions command reflects the idea that the essence of unlawful insider trading is cheating. These prosecutions are main-stage morality plays, with greed as the story line. The SEC in particular seems to sense that it garners public political support by casting itself in the role of tormentor of the greedy.

If this is right, then what the legal system should be looking to proscribe is deliberate exploitation—trading on the basis of information in order to gain an unfair, unlawful advantage over others in the marketplace. That involves a fairly tight causal connection between knowledge of the information and the decision to buy or sell.

…continue reading: Insider Trading and the Scienter Requirement

My paper, Insider Trading via the Corporation, recently posted on SSRN, critically examines the regulations applicable to U.S. firms trading in their own shares and puts forward a proposal for reform.

Publicly-traded U.S. firms buy and sell a staggering amount of their own shares in the open market each year. Open-market repurchases (“OMRs”) alone total hundreds of billions of dollars per year; in 2007, they reached $1 trillion. Firms are also increasingly selling shares in the open market through so-called “at-the-market” issuances (“ATMs”).

When a U.S. firm trades in its own shares, its trade-disclosure requirements are minimal. The firm must report only aggregate trading activity, and not until well into the following quarter. Thus, the firm can secretly buy and sell its own shares in the open market for several months, and never disclose the exact details of its trades to shareholders and regulators. The lack of detailed disclosure, I explain, makes it difficult to detect illegal trading on material inside information; the lack of timely disclosure makes it difficult for investors to determine when the firm is trading on valuable but sub-material information.

…continue reading: Insider Trading via the Corporation