June 17, 2008

More Rule 10b5-1 Plan Research

Last week, I was moderating a panel at the NIRI Annual Conference on SEC Enforcement developments, and the topic of 10b5-1 plans inevitably came up. Andrew Petillon, Associate Regional Director of the SEC’s Los Angeles Regional Office, confirmed that, while no SEC actions have been announced yet, Rule 10b5-1 remains an area of focus for the Staff.

Now, a new paper published by Stanford Business School Professor Alan Jagolinzer. Penn State Business School Professor Karl Muller and University of Chicago Law Professor Todd Henderson – entitled “Scienter Disclosure” – explores the relationship between voluntary disclosure regarding Rule 10b5-1 plans and the trading returns of the executives who have implemented the plans. (Professor Jagolinzer published the paper “Do insiders trade strategically within the SEC Rule 10b5-1 safe harbor?” which originally piqued the SEC Enforcement Staff’s interest in potential 10b5-1 plan shenanigans.)

The concept of “scienter disclosure” from the title of this new study refers to “the voluntary disclosure of either information or the intention to act on the information in advance of acting on it.” Through this, the authors are focusing on disclosure that attempts to mitigate litigation risks associated with any potential wrongdoing. The authors believe that disclosure of an insiders’ participation in a Rule 10b5-1 trading plan is an example of scienter disclosure, given that participation in a Rule 10b5-1 plan provides “clear, legal risk-reduction benefits.”

The study focuses on returns for executives participating in Rule 10b5-1 plans at firms that choose to disclose the existence of the plans and at firms that do not provide voluntary disclosure. The authors conclude from the study:

“Our evidence indicates that voluntary Rule 10b5-1 disclosure is associated with the level of firm legal risk and a proxy for insiders’ potential strategic trade. Our evidence also indicates that Rule 10b5-1 disclosure is associated with greater abnormal returns to insiders’ trades, especially for firms disclosing specific plan details. Finally, our evidence indicates that investors do not respond negatively to Rule 10b5-1 participation disclosure. Collectively, our work has three salient implications for voluntary disclosure: 1) litigation risk can play a key role in the propensity to disclose information prior to strategic trade; 2) Rule 10b5-1 participation disclosure does not fully reveal insiders’ private information; and 3) disclosure in this setting may actually enhance insiders’ strategic trade opportunities, which is seemingly inconsistent with the SEC’s intent for the Rule.”

Based on these findings, the authors suggest that courts might more carefully consider whether 10b5-1 disclosure mitigates scienter – given that strategic trading appears to be associated with enhanced disclosure – and that the SEC should also consider that if it were to require disclosure of Rule 10b5-1 plan participation, such disclosure might not mitigate strategic trading by those implementing Rule 10b5-1 plans. The SEC proposed, but never adopted, disclosure requirements concerning participation in Rule 10b5-1 plans, and the Staff has recently said that “asymmetric” voluntary disclosure around Rule 10b5-1 plans could be problematic.

Posted: Proposing Release on Credit Ratings

Yesterday, the SEC posted the proposing release for changes to the rules applicable to credit ratings and NRSOs, focusing particularly on structured products.

One of the interesting components of the proposed rule changes is the amendment to Rule 17g-5 that is designed to addressed the “issuer/underwriter pay” conflict by requiring that – as a condition to the NRSRO rating a structured finance product – the information provided to the NRSRO and used by the NRSRO in determining the credit rating would need to be disclosed through a means designed to provide reasonably broad dissemination of the information. The proposed amendment would require the disclosure of information provided to an NRSRO by the “issuer, underwriter, sponsor, depositor, or trustee.” The goal of this amendment is to purportedly level the playing field between the “issuer/underwriter pay” NRSROs and the subscription-based credit rating agencies, by giving all credit rating agencies equal access to information.

The release of this sort of loan level data (referred to as the “loan tape”) about a structured finance product could obviously create some complications under the Securities Act, for both registered and exempt transactions. The SEC has sought to address these concerns by issuing some proposed guidance. For registered deals, the SEC says that the information would need to be disclosed on the pricing date for the transaction. In offerings that are not registered under the Securities Act, the information would need to be disclosed to investors in the offering and credit rating agencies on the pricing date, and then disclosed publicly on the first business day after the transaction closes.

For registered deals, the SEC indicates that the loan tape information may constitute ABS informational and computational materials that need to be filed on Form 8-K, or as free writing prospectuses filed under Securities Act Rules 433 and 426. For private deals, the SEC says that general solicitation/general advertising concerns could be avoided by providing the information to investors, NRSROs, and credit rating agencies through posting on a password-protected website (as is often done today for investor access to the information), and then removing the password protection so the public may access the information after the offering closes. Similar guidance is provided for Reg. S offerings.

Conference Brochure: 16th Annual Naspp Conference

We just posted a brochure for the upcoming “16th Annual Naspp Conference,” listing the 45-plus panels, etc. Take advantage of the early bird discount – which expires June 30th – by registering for the Naspp Conference (or the combined “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference” & “5th Annual Executive Compensation Conference“) today.

– Dave Lynn