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ABA Section of Business Law

Business Law Today

Keeping current: securities
By David Lamarre
Recent cases and SEC staff guidance on Rule 10b5-1 trading plans
Directors and officers of public companies frequently rely on so-called Rule 10b5-1 trading plans when transacting in their companies' stock. As a safe harbor from insider trading liability under the SEC's Rule 10b-5, Rule 10b5-1 provides that a purchase or sale of securities will not be deemed to be on the basis of material nonpublic information if it is pursuant to a contract, instruction, or plan that

  • was entered into before the person became aware of the information;

  • specifies the amounts, prices, and dates for transactions under the plan (or includes a formula for determining them); and

  • does not later allow the person to influence how, when, or whether transactions will occur.
In addition, the plan must be entered into in good faith and not as part of a scheme to evade the insider trading laws.

The SEC's recent insider trading case against the former CEO of Countrywide Financial highlights the agency's continuing concern about abuses of Rule 10b5-1 plans. In addition, the SEC's Division of Corporation Finance recently updated its publicly available interpretations about these plans.

In light of these developments, executives and directors of public companies should pay renewed attention to the timing and substance of their trading plan activities. Particular care should be taken to avoid adopting or amending trading plans when in possession of material nonpublic information. Structured properly, however, Rule 10b5-1 plans remain useful tools to mitigate corporate insiders' litigation risk.

Recent Litigation on 10b5-1 Plans
Alleged abuses of Rule 10b5-1 plans have taken center stage in a number of recent insider trading lawsuits. In one high-profile example, the SEC filed a civil complaint on June 4, 2009, against the former CEO of Countrywide Financial, Angelo Mozilo, and other former Countrywide executives, alleging that they used Rule 10b5-1 plans to trade illegally on inside information (to the tune of nearly $140 million, in Mr. Mozilo's case). Although all of these sales occurred through Rule 10b5-1 plans, the SEC alleges—citing internal correspondence such as an e-mail stating that the company was "flying blind"—that Mr. Mozilo had material nonpublic information about Countrywide's deteriorating mortgage business when he instituted his trading plans. The SEC also took particular note of the fact that he implemented no fewer than four separate plans during a three-month period, and that sales under the plans began soon after their adoption. SEC v. Mozilo, No. 09CV03994 (C.D. Cal. filed June 4, 2009).

The case also highlights the advisability of avoiding amendments to Rule 10b5-1 plans. The SEC's complaint emphasizes that Mr. Mozilo amended one of
The SEC's interpretations of Rule 10b5-1 plans are available at

his plans just two months after adopting it, essentially doubling the number of shares at a time when Countrywide's stock price was at a historic high—but retaining the same time schedule for sales. This amendment also was found particularly noteworthy by the federal judge in an earlier lawsuit against Mr. Mozilo by private investors. In re Countrywide Financial Corp., 554 F. Supp. 2d 1044 (C.D. Cal. 2008). In refusing to dismiss the case, the judge stated that he "actively amended and modified his 10b5-1 plans . . . Mozilo's actions appear to defeat the very purpose of 10b5-1 plans, which were created to allow corporate insiders to 'passively' sell their stock based on triggers, such as specified dates and prices, without direct involvement."

Other aggrieved investors have seized on perceived abuses of Rule 10b5-1 plans to pursue insider trading claims. For example, in April 2009, a California federal court refused to dismiss a lawsuit against a technology company's officers, based partly on allegations that they amended their 10b5-1 plans to sell more stock before the market learned of a significant business development. This was deemed sufficient to support an inference of scienter, the state of mind required in a private Rule 10b-5 insider trading lawsuit. The judge also commented that the pattern of the executives' sales "does not square with a typical 10b5-1 plan triggering stock sales on certain dates and at certain prices," noting that the executives sold varying amounts of stock just before the adverse development became public, and on varying dates rather than regular dates such as the first of every month. Backe v. Novatel Wireless, Inc., 607 F. Supp. 2d 1145 (S.D. Cal. 2009).

New SEC Staff Guidance
The SEC's staff recently provided new guidance about Rule 10b5-1 plans in its Compliance and Disclosure Interpretations, which provide additional insight into how the rule may be interpreted by the agency's enforcement staff. Key points include:

Delaying Commencement of Sales Until Release of Nonpublic Information May Not Legitimize the Plan. The new guidance takes the position that a person may not rely on Rule 10b5-1 when he or she institutes a trading plan while aware of material nonpublic information, even if the plan is structured to delay all transactions until after the information becomes public.

Replacing a Trading Plan. The rule's affirmative defense is available only for plans that are entered into in good faith and not as part of a "plan or scheme to evade" insider trading laws. The SEC's staff has stated that this requirement will be assessed in light of all relevant facts, specifically including the time period between canceling one trading plan and establishing a new one. This reinforces the advisability of observing a "cooling off" period between terminating and establishing trading plans. It also suggests that an insider should consider carefully the potential circumstances that could cause him or her to want to stop selling, and build those into the plan, so that sales can cease automatically rather than requiring the insider to terminate the plan when those circumstances arise.

Transfers to New Broker. In a timely development given the continued turmoil in the brokerage industry, the new interpretations also confirm that a corporate insider may transfer a long-standing 10b5-1 plan to a new broker, if the broker that has been executing the plan's transactions goes out of business—even if the insider knows of material nonpublic information at the time of the transfer. The transfer must be timed to avoid any cancellation of transactions under the plan, however, and the new broker must observe the plan's original terms.

Lamarre is a partner in the Corporate and Securities section of Pillsbury Winthrop Shaw Pittman LLP in San Francisco. His e-mail is david.lamarre@pillsburylaw.com.

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