What Is a 10b5-1 Plan?
Rule 10b5-1 sets forth the elements of the offense of insider trading and provides an affirmative defense for corporate insiders who trade according to a prearranged schedule. As a result, corporate insiders who have preplanned their stock sales and/or purchases in accordance with Rule 10b5-1 can use their trading schedules as a defense in the event that their trades are targeted in a securities fraud investigation.
Insider trading is a serious federal offense that carries substantial fines and prison time. Consequently, it is essential that corporate insiders who intend to trade their companies’ securities take all necessary precautions to protect themselves. Under Rule 10b5-1, one of the most-effective ways to do this is to follow a prearranged trading schedule, commonly referred to as a “10b5-1 plan.”
Rule 10b5-1: The Elements of Insider Trading and the Prearranged Trading Schedule Defense
When the U.S. Securities and Exchange Commission (SEC) investigates a corporate insider for insider trading under Rule 10b5-1, the SEC’s investigators must be able to establish four basic elements in order to substantiate an enforcement action. These are:
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A Sale or Purchase of Securities – First, the SEC must be able to prove that the corporate insider targeted in the investigation made a sale or purchase of securities in violation of the federal securities laws. Among other sources, the SEC’s investigators will often rely on the company’s filings to establish whether its insiders have made suspicious transactions.
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While Possessing Material, Non-Public Information – The SEC’s evidence must also establish that the transaction in question was made, “while the person was aware of the material nonpublic information.” A corporate insider is considered to be “aware of [material nonpublic] information if the person was aware that the information was material and nonpublic at the time of the sale or purchase.”
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In Breach of a Fiduciary Duty – The SEC must also prove that the transaction was made in breach of the corporate insider’s fiduciary duties to the company’s shareholders. This element comes from Section 10(b) of the Securities Exchange Act of 1934, which makes it unlawful to employ “any device, scheme, or artifice to defraud” in connection with the purchase or sale of any security.
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With Scienter – Finally, the SEC must also prove that the corporate insider engaged in an act of fraud “knowingly or recklessly” with the understanding that it was in violation of the law or in conscious disregard of the law. In most cases, this will be the most-challenging element for the SEC’s investigators to prove, and where the defense team’s efforts will be most heavily focused.
If there is evidence to establish all four of these elements, then the SEC’s Division of Enforcement can move forward with civil or criminal charges. Corporate insiders charged with insider trading can face substantial civil fines and possible prison time; and, in the case of criminal charges, the U.S. Department of Justice (DOJ) can take over the investigation and pursue charges that carry up to 20 years of federal imprisonment.
Using a 10b5-1 Plan as an Affirmative Defense to Insider Trading
Although each of the four elements of the insider trading offense is subject to multiple potential defenses, corporate insiders can also affirmatively defend against insider trading allegations in some cases. In particular, Rule 10b5-1 provides an affirmative defense for corporate insiders who have traded their companies’ securities according to a prearranged schedule. This defense applies, “notwithstanding [the general prohibitions of Rule 10b5-1], a purchase or sale of securities on the basis of material nonpublic information . . . if the person demonstrates that . . . the purchase or sale that occurred was pursuant to a binding contract . . . or [a] written plan . . . adopted before the person became aware of the material nonpublic information.”
Under Rule 10b5-1, a trading plan is effective to serve as an affirmative defense to an insider trading allegation only if it:
- “Specifies the amount of securities to be purchased or sold and the price at which . . . each transaction is to occur and the date on which . . . each transaction is to occur;”
- “Includes a written formula or algorithm, or computer program, for determining the amount of securities to be purchased or sold and the price at which . . . each transaction will be executed and the date on which . . . each transaction will be executed;” or,
- “Does not permit the person to exercise any subsequent influence over how, when, or whether to effect purchases or sales . . . ; provided, in addition, that any other person who, pursuant to the contract, instruction, or plan did exercise such influence must not have been aware of the material nonpublic information when doing so.”
Additionally, the corporate insider must demonstrate that the trade, “was pursuant to the contract, instruction, or plan,” and that the trade occurred, “without any alteration or deviation from the contract, instruction, or plan.” While the SEC’s regulations acknowledge that, “a contract, instruction, or plan . . . may specify any price at which the person is willing to trade,” it also states that, “the contract, instruction, or plan must specify the price at which the person is willing to trade . . . . [and] an agent’s later negotiation of a different price does not satisfy this requirement.”
10b5-1 Plan: Best Practices for Corporate Insiders
Given these requirements, how can corporate insiders best use 10b5-1 plans to protect themselves? With the federal government’s heightened enforcement of the federal securities laws, it is more important than ever for corporate insiders to ensure that they are not putting themselves at risk unnecessarily. Here are some best practices for using 10b5-1 plans to protect against insider trading allegations:
1. Establish a 10b5-1 Plan Before Obtaining Access to Material, Non-Public Information
In order to serve as an affirmative defense to insider trading, a 10b5-1 plan must be established before the corporate insider obtains access to material, non-public information. As a result, if corporate insiders intend to trade their companies’ securities, they must plan their trades well in advance in order to ensure that their plans are effective to afford them statutory protection.
2. Avoid Deviating from or Modifying 10b5-1 Plans
Corporate insiders must be very careful to avoid deviating from or modifying their 10b5-1 plans after they have been established. Even if it not clear that a corporate insider will not have access to material non-public information by modifying his or her plan, deviating from a preestablished plan could raise questions regarding the insider’s knowledge and intent.
3. Be Prepared to Prove the Validity of Your 10b5-1 Plan
If you need to rely on your 10b5-1 plan as a defense to insider trading allegations, you will need to be able to prove that it is valid. As a result, it is important to be able to demonstrate that you adopted a valid 10b5-1 plan prior to obtaining access to material, non-public information, and that the plan meets all of the other requirements outlined above.
4. Maintain Adequate Documentation
In order to prove the validity of your 10b5-1 plan, you will need to have sufficient documentation on hand. In addition to maintaining an executed copy of your plan, you will also need to have documentation (i.e. a copy of your company’s material, non-public information policy) that proves that you were not in possession of material, non-public information at the time you adopted your plan. You will also need documentation that proves you have not modified or deviated from your plan.
5. Seek Professional Assistance
Due to the risks involved, corporate insiders who intend to use 10b5-1 plans to protect themselves against insider trading allegations should seek professional assistance. You should work with an experienced federal securities lawyer to ensure that you have an enforceable 10b5-1 plan, and you should work with your company’s HR department or in-house counsel to ensure that you fully understand its policies regarding material, non-public information. Finally, you should ensure that you are able to produce any and all documents that may be required to substantiate your compliance with Rule 10b5-1 in the event of SEC or DOJ investigation.
What to Do if You Are Being Targeted by the SEC or DOJ for Alleged Insider Trading
If you are being targeted by the SEC or DOJ for alleged insider trading, it is important that you engage legal counsel promptly. This is true whether or not you have a valid 10b5-1 plan. Even if you have an enforceable plan in effect, you will need evidence to prove its validity, and you will also need to be able to effectively deal with the SEC’s or DOJ’s investigators in order to avoid inadvertent mistakes that could potentially lead to prosecution. Scheduling a free initial consultation with a federal securities lawyer should be among your top priorities, and you should be prepared to rely on your attorney’s advice throughout the investigative process.
Speak with a Federal Securities Law Attorney at Spodek Law Group
At Spodek Law Group, we have extensive experience in high-stakes federal securities law matters including SEC investigations and prosecutions. If you are facing an insider trading investigation, or if you have questions about preparing an enforceable 10b5-1 plan, we invite you to call 212-300-5196 or contact us online to schedule a free initial consultation.
Contact Spodek Law Group today for a confidential consultation about your federal securities law matter. Call 212-300-5196 or contact us online.
