TheCorporateCounsel.net

As noted above, in a rather striking departure from the SEC’s recent rulemaking decisions, the commissioners unanimously voted in favor of the Rule 10b5-1 rule proposal.  Despite the commissioners’ unanimity, I think there are still some things to take issue with in terms of the substance of the proposal.  In an earlier blog, Liz cited comments from a number of in-house lawyers suggesting that some Rule 10b5-1 reforms – like a mandatory 120-day cooling off period – may represent a solution in search of a problem.

On that point, I think a recent back & forth between Commissioner Lee and three Democratic senators is kind of illuminating. Earlier this year, when Commissioner Lee was serving as Acting Chair, the senators sent her a letter on Rule 10b5-1 issues. Among other things, the senators asked for a response to the following question: “how many enforcement actions has the agency taken with regard to 10b5-1 plans in the past five years? Please provide a list and summary of all such actions.”

In her response, the best that Commissioner Lee apparently could come up with was a list of actions in which “public charging documents mention Rule 10b5-1 plans.” [Emphasis added.] This list included six actions, none of which directly addressed violations of the rules governing 10b5-1 plans themselves. Instead – with the exception of one action in which internal controls were at issue – these charging documents simply noted that during the pendency of the conduct in question, one of the alleged bad guys made sales under a 10b5-1 plan.

It’s an open secret that academic commentators think Rule 10b5-1 is a scam, and their concerns about the rule are cited liberally in the proposing release. But Commissioner Lee’s inability to cite a single enforcement action where a 10b5-1 plan was front & center suggests that either the SEC has been asleep at the switch for quite some time or – just maybe – Rule 10b5-1 generally works as intended.

I’ve read some of the academic commentary on Rule 10b5-1 plans, and their critique usually boils down to “the evidence irrefutably demonstrates that insiders with 10b5-1 plans outperformed other investors, so there’s obviously something fishy going on here.”  I don’t necessarily agree with that generalization, particularly since 10b5-1 plans are adopted during window periods and, under most insider trading policies, must be pre-cleared by counsel. 

The SEC seems to have relied heavily on a recent Stanford study in deciding to propose a mandatory cooling off period. But that study itself acknowledges that it’s the first one to attempt to empirically address the relationship between the length of cooling off periods & “red flags” relating to the avoidance of losses. A single non-peer reviewed study seems like a slender reed upon which to base a key component of a rule proposal.

I don’t think all of the proposed changes are a bad idea, but the cooling off period seems unreasonably long & the certification requirement is something that only a bureaucrat could love. On the other hand, I think that multiple plans are potentially abusive and that ensuring that the good faith requirement applies not only to the establishment, but also to the operation, of a 10b5-1 plan is an appropriate change. But what I mostly think is that the debate on 10b5-1 reform has been too heavily weighted toward the academic side, and that there’s a need for those with real world experience in working with these plans to weigh in. I hope they’ll do so during the comment process.

– John Jenkins