Structuring Insider Trading Plans

Issuers through their corporate counsel are reassessing their insider trading policies to reflect a recent addition to the regulation of insider trading. This addition is Rule 10b5-1, promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). The rule operates in conjunction with Section 10(b) and Rule 10b-5, both of which, among other things, proscribe what is commonly termed insider trading. Rule 10b5-1 was promulgated by the Securities and Exchange Commission (SEC) to clarify the definition of insider trading and to provide for certain related affirmative defenses (Release Nos. 33-7881; 34-43154). In this article, I first provide some brief background information, analyze the mechanics of the rule and its accompanying affirmative defenses, and then describe how a Rule 10b5-1 insider trading plan should be structured along with suggestions for altering a company's insider trading policies.

Insider trading policies are implemented by issuers and govern the trading conduct of corporate insiders. These policies exist to protect insiders against claims of insider trading. They also help protect the issuer from claims of reckless conduct with respect to such trading. These policies regulate when an insider may trade in the company's securities. For example, most policies proscribe insiders from trading during the time leading up to the end of the quarter when financial information regarding the company's impending earnings release is becoming known by company insiders.

Section 10(b) of the Exchange Act and related Rule 10b-5 proscribes, among other things, the purchase or sale of a security of an issuer on the basis of material nonpublic information in breach of a duty of trust or confidence that is owed directly, indirectly or derivatively, to the issuer of that security or the shareholders of the issuer, or to any other person who is the source of the material nonpublic information. Under Rule 10b5-1, the SEC seeks to resolve a judicial conflict over the definition of what "trading on the basis of" means. Some circuits ruled that the requirement of "trading on the basis of" was shown by "possession" of the information, while others ruled it is shown by "use" of the information. Rule 10b5-1 is meant to resolve this issue. The SEC in Rule 10b5-1 now defines "on the basis of" as mere "awareness" of the material nonpublic information when the person made the trade. Thus mere "possession" of the information, and not the...

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