My Crypto Lawyer
Thank you, Chair Gensler. While this rulemaking is more prescriptive and restrictive than I would have preferred, I support it for likely doing more good than bad. It should help insiders to trade without fear of liability, while making it more difficult to misuse 10b5-1 plans.
Some evidence cited in the adopting release suggests that some executives may illegally trade based on material non-public information (“MNPI”) and try to cover their tracks through 10b5-1 plans.[1] For example, insiders might try to game Rule 10b5-1 by selectively canceling overlapping plans to avoid a lousy trade. Much of the Commission’s solution to this problem is reasonable. Most importantly, the rule imposes a cooling-off period for entering and exiting plans. The rule also limits overlapping plans, but allows overlapping plans to facilitate sales to cover tax obligations related to the vesting of a compensatory award like a restricted stock.[2]
Further, in response to commenters, the final rule is better than the proposed rule. Among other improvements, the final rule:
While I generally support tailored 10b5-1 plan reforms, the new regime in the final rule is unnecessarily restrictive. For example, the final rule:
Despite these concerns with some of the details of the new rule, addressing the kind of regulatory gaps that may have enabled the abuse of 10b5-1 plans is an excellent example of what should occupy the Commission’s rulemaking agenda.[25] While I disagree with some of the policy choices, I am pleased that my colleagues and I were able to settle on a final rule that I could support. Instrumental in getting to this point were staff across the Commission, including Corey Klemmer on the Chair’s staff; numerous staff in the Division of Corporation Finance; Dorothy McCuaig, David Lisitza, and Bryant Morris in the Office of General Counsel for helping me work through a particularly difficult issue; the Division of Economic and Risk Analysis; the Division of Enforcement; and others. Thank you all for your hard work.
[1] See, e.g., Alan D. Jagolinzer, SEC Rule 10b5-1 and Insiders’ Strategic Trade, 55 Mgmt. Sci. 224 (2009) (presenting evidence that Rule 10b5-1 plans “appear[] to enable strategic trade” because “insiders’ sales systematically follow positive and precede negative firm performance, generating abnormal forward-looking returns larger than those earned by non-participating colleagues.” It concludes that evidence suggests that “trading within the Rule does not solely reflect uninformed diversification.”); Artur Hugon & Yen-Jung Lee, SEC Rule 10b5-1 Plans and Strategic Trade Around Earnings Announcements, (2016), https://ssrn.com/abstract=2880878 (finding “large-sample evidence that [10b5-1] plan sell trades occur in advance of weak results, and that non-plan sell trades do not exhibit this same pattern” and that “insiders appear to divert trades in advance of bad earnings news into planned trading accounts . . . revealing an unintended consequence of Rule 10b5-1”).
[2] 17 CFR § 229.10b5-1(c)(1)(ii)(D)(3)
[3] See, e.g., Comment letter from Cravath, Swaine & Moore LLP at 3 (March 31, 2022) [hereinafter, “Cravath”], https://www.sec.gov/comments/s7-20-21/s72021-20122075-275460.pdf (“Unlike the statistical data cited in the Rule 10b5-1 Proposal with respect to incremental trading returns and loss avoidance associated with trading plan transactions by insiders, no data is cited to suggest that Rule 10b5-1 plans have similar consequences for issuers. There is simply no evidence set forth in the Rule 10b5-1 Proposal to suggest that issuers are abusing the affirmative defense.”); Comment letter from NYSE Group, Inc. at 5 (Apr. 1, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122352-278386.pdf (“[W]e do not believe that a cooling-off period for issuers is necessary. Any issuer cooling-off period would increase volatility and decrease the market quality for an issuer’s securities by forcing issuers into more limited windows in which they would be in a position to repurchase their shares for capital management and other business purposes.”); Comment Letter from Home Depot at 4 (March 31, 2022) [hereinafter “Home Depot”], https://www.sec.gov/comments/s7-20-21/s72021-20121990-275239.pdf (“We believe that this 30-day cooling-off period is excessive and that the risk it is intended to mitigate is not present when issuers are repurchasing their securities to execute share repurchase authorization.”).
[4] See, e.g., Cravath. at 3-4 (arguing that “applying a cooling-off period of any length to issuers would needlessly limit issuers’ flexibility to enter into transactions that are in the best interests of their shareholders without addressing the perceived abuses of Rule 10b5-1 plans” and listing various costs it would impose on issuers, including inhibiting the ability of a company’s board of directors to return money to shareholders and harming “the ability of issuers to undertake a variety of legitimate and beneficial financing and capital management transactions”); Comment Letter from Dow at 9 (Apr. 1, 2022) [hereinafter, “Dow”], https://www.sec.gov/comments/s7-20-21/s72021-20122205-278243.pdf (“The imposition of a 30-day cooling off period on issuer share repurchase programs conducted under Rule 10b5-1 as described above would be significantly detrimental to an issuer’s ability to rely on share repurchases to return value to shareholders by substantially reducing the number of trading days during which an issuer could access the market.”); Comment Letter from Wilson Sonsini at 4 (Apr. 11, 2022) [hereinafter “Wilson Sonsini”], https://www.sec.gov/comments/s7-20-21/s72021-20125146-284365.pdf (“the issuer cooling off requirement will have a significantly negative impact on the ability of our clients to repurchase their shares by widespread and entirely legitimate methods”); Comment Letter of Society for Corporate Governance at 3 (Apr. 1, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122264-278309.pdf (“By mandating that issuers have a 30-day cooling-off period, the SEC is moving away from its core mission of protecting investors and toward regulating companies’ management of their capital allocation and other business strategies. The proposed cooling-off period also would hamper an issuer’s decision-making process by creating an unnecessary delay, reducing flexibility in repurchase activities by issuers and creating barriers to issuers’ use of capital for repurchases.”).
[5] Comment letter from Cleary Gottlieb Steen & Hamilton LLP at 7 (March 23, 2022) [hereinafter “Cleary”], https://www.sec.gov/comments/s7-20-21/s72021-20120948-273094.pdf (arguing that if insiders started trading their stock through non-10b5-1 arrangements, “oversight by the Commission and investors will be fully enabled by the existing disclosure requirements under Section 16”); Wilson Sonsini at 9 (“[S]uch information is already publicly available through multiple sources, including, among others, Forms 4 and 5 and annual proxy statements. Requiring issuers to disclose this same information in its Forms 10-Q and Forms 10-K would impose an unnecessary burden on issuers and add unnecessarily duplicative information to documents that are already lengthy.”).
[7] See, e.g., Cleary at 8 (“The [proposed] language [defining non-10b5-1 plans] captures a ‘contract, instruction, or plan’ but . . . every transaction involves some form of contract or instruction.”).
[8] 17 CFR § 229.408(a)(2). Requiring pricing information could have been costly for insiders, including by facilitating strategic trading by non-insiders in anticipation of trades under the plan. See Comment letter from Davis Polk & Wardwell LLP at 9 (March 28, 2022) [hereinafter “Davis Polk”], https://www.sec.gov/comments/s7-20-21/s72021-20121495-273483.pdf (“Disclosing pricing terms would obviously expose companies and their insiders to front-running by hedge funds and other professional traders. If the pricing is set lower than the current stock price, insiders may be publicly criticized as anticipating stock price declines. Wide variation in pricing terms among executives established for personal financial planning reasons may fuel additional public speculation, and ultimately executives would therefore feel forced to set pricing terms that are highly optimistic for reputational reasons, which would limit their ability to actually sell shares under the plans.”).
[9] Requiring award information 14 days before and after a material event (see proposed 17 CFR § 229.402(x)(2)) could have unnecessarily covered almost all year for some companies and confused investors. See, e.g., Comment letter from Davis Polk at 11 (“[W]e expect that for most companies, all or nearly all option grants will be made within the 28-day period specified in the proposed rule, with the result that the disclosures will be meaningless and therefore ignored by the market.”).
[10] See, e.g., Comment letter from National Association of Manufacturers at 3 (April 1, 2022) [hereinafter “NAM”], https://www.sec.gov/comments/s7-20-21/s72021-20122034-275415.pdf (generally recommending 30 days); see also Comment letter from HR Policy Association Center on Executive Compensation at 5 (April 1, 2022) [hereinafter “HRPA”], https://www.sec.gov/comments/s7-20-21/s72021-20122207-278246.pdf (recommending “a much shorter [than the proposed 120-day] period (e.g., 30 days) or a requirement to wait until after the next earnings release (as some companies do now)”); Comment letter from the American Bar Association Business Law Section at 4 (April 29, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20127542-288684.pdf (proposing either 60-day period or “one business day after the applicable earnings announcement”); Comment letter from Manulife at 4 (March 28, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20121578-273641.pdf (recommending “a cooling off period that ends the earlier of 60 days after the trading plan is entered into or 48 hours after the next release of quarterly or annual financial results”).
[11] See, e.g. Comment letter from Davis Polk at 2 (“[R]equiring an inflexible 120-day cooling-off period and denying the flexibility to make immaterial modifications is likely to discourage companies from maintaining policies that require their officers and directors use Rule 10b5-1 plans.”). Comment letter from Simpson Thatcher & Bartlett at 4 (March 31, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122060-275448.pdf (“A 120-day period would prevent trades from commencing for more than one full quarterly earnings cycle, which we believe would strongly discourage insiders from adopting 10b5-1 plans and therefore result in larger, more concentrated volumes of insider-directed sales taking place during open window periods rather than spread out over the duration of 10b5-1 plans, leading to increased market volatility.”);
[12] 17 CFR § 240.10b5-1(c)(1)(ii)(A).
[13] Proposed 17 CFR § 240.10b5-1(c)(1)(ii)(A).
[14] See, e.g., Comment letter from DLA Piper LLP at 3 (Apr. 1, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122354-278387.pdf (“While we understand the intent of the Proposed Amendments, we believe the term “operated in good faith” is ambiguous and would subject insiders to uncertainty, and ultimately second-guessing with the benefit of hindsight, when implementing their 10b5-1 plans and fulfilling any duties as to the timing of corporate disclosures, a matter which already is subject to review under state corporation law.”); Comment letter from PNC Financial Services Group, Inc. at 11 (March 30, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20121994-275244.pdf (“We are not convinced that anything beyond what is already available to the Commission is required to regulate post-commencement conduct with respect to such arrangements.”).
[15] 17 CFR § 229.402(x).
[16] See Comment letter from Home Depot at 6 (“The tabular disclosure required by the 10b5-1 Rule Proposal would suggest that there is somehow a relationship between the timing of the equity grant and the release of MNPI if the dates occur within 14 days of each other [which was the proposal’s time frame for the table] when, in fact, the timing of equity grants has been determined based on the board and board committee calendar.”); see also Comment letter from Dow at 7 (“The only purpose of the new table appears to be to present the information about option grants and stock price in a format that would encourage readers to presume that there is a causal link between the timing of option grants and public disclosures where no such links exist. The issuer would be open to allegations that grant dates were cherrypicked to coincide with the release of material information that may benefit the grant recipients even though the two events are, in the overwhelming majority of cases, completely independent.”).
[17] 17 CFR § 229.402(x).
[18] Comment letter from Dow at 7 (arguing that “the Commission’s concern with ensuring that options are not granted in a way that permits ‘spring-loading’ (granting options shortly before the release of positive information) or ‘bullet-dodging’ (granting options just after the release of negative information) is sufficiently addressed by proposed new Item 402(x) of Regulation S-K”).
[19] See Comment letter from Dow at 8 (“We suggest, as an alternative, that issuers be asked to post their insider trading policy on their website and direct readers to the posting in their annual report on Form 10-K or file their insider trading policy as an exhibit to the annual report on Form 10-K, and that neither such filing nor a description of the policy be required in connection with proxy statements. This will provide investors access to all information they may consider material in this regard, while dramatically reducing the burden of compliance on issuers. Issuers who elect to post the insider trading policy on their website would also have more flexibility in promptly disseminating revised policies.”); see also Comment letter from NAM at 9 (“[D]isclosing the specifics of such policies could create costs for companies while providing limited new information to investors given the similarities likely to emerge between most issuers’ plans. If the SEC chooses to move forward with annual disclosures of businesses’ insider trading policies, the NAM respectfully encourages the Commission to allow for a significant degree of flexibility with respect to the specifics of these plans and the associated disclosures. Such flexibility would decrease cost and liability for public companies without negatively impacting the availability of useful information for investors.”); Shearman & Sterling at 7 (Apr. 1, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122368-278403.pdf (arguing that “issuers should have flexibility to amend an insider trading policy without considering whether a previously filed insider trading policy needs to be updated”).
[20] Specifically, this requirement applies to executives that are subject to Section 16 of the Exchange Act, which means directors, officers, and individuals with more than 10% of any of the company’s class of equity securities.
[21] Release at 110, n. 336.
[22] Comment letter from NAM at 10 (“The NAM is concerned that this tight timeframe will be functionally unworkable. There is often a significant time lag between when an individual executes a trade order and the broker and gift recipient confirm and finalize a transaction. Many bona fide gifts are given to non-profits and other third parties with often-complex processes for receiving gifts of equity; others involve complicated family trusts and similar estate-planning tools. In many cases, it will simply be impossible to file an accurate report within two days of a trade’s execution. . . . We also urge the SEC to consider a longer reporting deadline than two days given the significant departure from current law that the proposed change would represent.”); Comment letter from HRPA at 8-9 (“Earlier reporting will impose substantial burdens on insiders and companies for little gain. . . . [R]eporting complex gift transactions, such as those sometimes present in estate planning, could pose a substantial burden on insiders because reporting implications would need to be fully determined in advance to ensure compliance with a two business day deadline. . . . If [the Form 4 requirement] is retained, the Commission should consider limiting the requirement to charitable gifts to charities affiliated with the insider and retaining a longer reporting time period (e.g., 45 days).”); Comment letter from Davis Polk at 12 (“[G]iven the complexity of certain estate planning transactions involving gifts (including, for example, gifts of equity securities among trusts established by an insider and gifts of interests in limited partnerships or limited liability companies established by an insider for estate planning purposes), insiders, companies who file on their behalf and their advisors will often spend substantial time and resources analyzing these transactions to ensure proper reporting in compliance with Section 16. By providing for a sweeping requirement that all bona fide gifts be reported on a Form 4 within two business days, the proposal places undue administrative burdens and compliance costs on insiders and issuers in respect of transactions that are exempt from the short-swing profit disgorgement rules under Section 16(b).”).
[23] 17 CFR § 240.10b5-1(c)(1)(i)(A); see also 17 CFR § 240.10b5-1(c)(1)(ii)(C)(1) (certification requirement for directors and officers).
[24] See, e.g., Comment letter from Committee on Securities Law of the Business Law Section of the Maryland State Bar Association at 4 (April 4, 2022), https://www.sec.gov/comments/s7-20-21/s72021-20122741-279046.pdf (suggesting “that the requirement should be that the affirmative defense is only available if either (i) the trader was not aware of any material nonpublic information about the issuer or the security when he or she entered into the 10b5-1 trading arrangement, or (ii) any such material nonpublic information is either public or no longer material at the time of the trade.”).
[25] For an explanation of where the Commission should focus its attention, see Hester Peirce, Commissioner, SEC, Rip Current Rulemakings: Statement on the Regulatory Flexibility Agenda, (June 22, 2022), https://www.sec.gov/news/statement/peirce-statement-regulatory-flexibility-agenda-062222 (The Commission should “recalibrat[e its] agenda to focus on issues core to the protection of investors and operation of our markets and . . . slow[] down [its] pace to ensure that we and the public can think about what we are doing.”).
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