Recent SEC Focus on Insider Trading
Insider trading has been a focus of recent regulatory rulemaking and enforcement. In December 2022, the SEC adopted significant rule changes designed to curb perceived abuse of Rule 10b5-1, which allows insiders to avoid liability for trades executed under a prearranged plan that was put in place when they did not have material nonpublic information (MNPI). In a rare display of unity, all five SEC Commissioners voted to approve these changes. March 2023 saw the first ever insider trading prosecution based exclusively on the use of Rule 10b5-1 trading plans, when the Department of Justice (DOJ) charged the CEO of a health care company for his allegedly fraudulent use of such plans to trade company stock.[1] And just a few months ago, in June 2023, the SEC announced charges against 13 individuals, including corporate executives and insiders, in four separate insider trading schemes, with the DOJ bringing concurrent criminal actions against most of the defendants.[2]
New Mandatory Disclosure of Insider Trading Policies Starting in 2025
In addition to changing the rules for trading plans, the SEC mandated greater transparency regarding companies’ insider trading policies. A new rule adopted as part of the Rule 10b5-1 changes will require domestic and foreign private issuers[3] to disclose annually whether the company has adopted an insider trading policy applicable to its directors, officers[4] and employees, and if not, why not. In the case of domestic issuers, this rule also captures policies regarding trading by the company itself. Companies that have insider trading policies will need to file them as exhibits to their Form 10-K or 20-F. This disclosure and filing requirement will apply for the first time to the annual report covering the first full fiscal period beginning on or after April 1, 2023. This means that calendar year reporters will first be required to provide this disclosure and file their insider trading policies with the SEC in 2025, with the Form 10-K or 20-F for 2024.
Insider Trading Policies: New Disclosure Requirements at a Glance
Applicability:
Domestic and foreign private issuers
Requirements:
- Annually disclose whether the company has adopted an insider trading policy applicable to directors, officers and employees, and in the case of a domestic issuer, the company itself, and if not, why not
- File insider trading policy as exhibit to annual report on Form 10-K or 20-F
Effective Date for Calendar Year Reporters: Annual Report on Form 10-K or 20-F for 2024, filed in 2025
Although companies have long been incentivized to adopt, implement and enforce insider trading policies to help avoid liability and public fallout for actual or alleged employee misconduct, making companies’ insider trading policies public is certain to shine a spotlight on the robustness of policies even in the absence of any alleged misconduct. Having a strong insider trading policy will become an even more important mark of good corporate governance, reflected in company scorecards used by institutional investors as well as by proxy advisors and other governance watchdogs. Once policies are public, reporters and researchers alike are likely to compare their scope and strictness across companies, and regulators may use the information to ask questions and identify enforcement targets and, importantly, use them as a basis for enforcement actions if the requirements of the policy were not followed.
Now is a good time for companies to start getting their policies “camera ready” for 2025. Companies will want to allow for sufficient lead time for review and input from advisers and stakeholders before policies are exposed to public scrutiny. In addition to a general refresh, companies should consider recent developments in SEC rules and enforcement, including new disclosure requirements for trading plans of directors and officers, and the increased regulatory focus on those plans by the SEC. This article highlights these and other insider trading policy design questions.
Should the Insider Trading Policy Cover Trading by the Company Itself?
Existing insider trading policies typically do not extend to the company’s own purchases and sales of securities. Unlike insiders, companies have control over public disclosure of MNPI and may choose to make such disclosure in order to trade, such as by disclosing preliminary earnings information to conduct a securities offering after quarter-end but before their scheduled earnings release. Companies can also make nuanced and real-time determinations of whether any information they have is in fact material before transacting, avoiding the need for bright-line blackouts which are imposed on insiders for administrative convenience.
However, given that, at least for domestic issuers, the new disclosure requirement specifically references trading by “the registrant itself,” companies should address their approach to trading by the company in their insider trading policies, ideally in a way that continues to allow for the flexibility that companies should have with respect to trading in their own securities.
How Long Should Quarterly Earning Blackouts Be?
The new public filing of insider trading policies will for the first time provide comprehensive information about the duration of quarterly earnings blackouts. These blackout periods—or their counterparts, trading windows—are a typical feature of insider trading policies, designed to restrict trading by insiders with access to earnings information and other MNPI for a defined period of time surrounding the end of each fiscal quarter and prior to the release and market absorption of quarterly financial results, thereby helping to avoid the risk that such insiders could engage, or be perceived to engage, in trading during this sensitive period.
When precisely these goalposts should be set can vary from industry to industry and company to company. For example, a quarterly blackout which begins two months into the quarter may be appropriate for a manufacturer which by that time has a good sense of how its sales are tracking, especially if forward visibility is enhanced by an order book. However, the same period may be unnecessarily long for a biotechnology company whose stock price is primarily driven by clinical progress rather than financial results or whose revenue derives largely from third-party royalties, the amount of which is not known to the company until some time after quarter end.
Although the SEC recently tied the new cooling-off periods for Rule 10b5-1 plans of directors and officers to the filing of a Form 10-Q/10-K, as opposed to the earnings release, it does not appear to be necessary for companies to follow this approach in their insider trading policies. Ultimately, companies should consider the blackout duration that would be appropriate for their business, be mindful of how such duration compares to peers and be prepared to defend their decision if questions arise.
Rule 10b5-1 Trading Plans and Non-Rule 10b5-1 Trading Arrangements
As an exception to the general prohibition against trading while in possession of MNPI, insider trading policies have often permitted trading pursuant to a Rule 10b5-1 trading plan adopted in good faith during an open trading window, subject to a coolingoff period after plan adoption. In fact, the policies of many companies have encouraged or perhaps even required directors and officers to conduct their trading in company securities exclusively through Rule 10b5-1 trading plans to provide additional protection against allegations that individual trades were conspicuously well-timed.
The SEC’s recent changes to Rule 10b5-1 may cause companies to revisit prior recommendations or mandates for the use of Rule 10b5-1 trading plans by their directors and officers. In particular, the new cooling-off period of at least 90 days has made these plans less attractive. It exposes the insider to three months of market risk and makes it challenging to use these plans for near-term liquidity. Upon weighing the burden on the individual against the benefits to the company, requiring executives to use these plans may no longer seem like the right result.
New disclosure rules for trading plans may also affect insider trading policies. Since earlier this year, domestic companies have been required to disclose, on a quarterly basis, whether their directors and officers adopted, terminated or modified any Rule 10b5-1 trading plan or “non-Rule 10b5-1 trading arrangement”[5] during the quarter. Against this backdrop, companies may want to expressly require directors and officers to obtain company approval before they adopt, terminate or modify Rule 10b5-1 trading plans or non-Rule 10b5-1 trading arrangements, even if they already prohibit modification or termination of Rule 10b5-1 plans during a blackout or when otherwise in possession of MNPI. This would help companies make required disclosures in a timely manner. Such approval rights would also provide companies additional control in managing the risk that the timing of plan adoption, modification or termination, even if it is in principle legal, could create a perception that insiders have timed company disclosures in a way that would benefit their trading activities or that they have otherwise taken advantage of their positions at the company to time their trades.
Gifts
In its adopting release for the new disclosure requirements, the SEC called out gifts as being among the dispositions of company securities where MNPI could be misused, and which should therefore be covered by a company’s insider trading policy. According to the SEC, a donor violates the law if the donor gifts a security when the donor was aware of MNPI and knew or was reckless in not knowing that the donee, whether it is a family member or a charity, would sell the securities before that MNPI was disclosed. Companies will have to choose among a variety of potential approaches in their policies, ranging from treating a gift like a sale and subjecting it to all of the same blackouts and pre-approvals, to demanding that the donee agree not to sell the donated securities until the insider donor themselves could sell, to simply stating the law or the SEC’s view of it.
Shadow Trading
Last year, the SEC prevailed in court with the argument that the law of insider trading prohibits not only trading in the securities of the company to which the inside information relates, but also “shadow trading,” which is the use of information relating to one company to trade in securities of other “economically linked” firms, such as competitors or business partners.[6]
The case involved the employee of an oncology-focused biotech company who allegedly traded the securities of another, but similar, company within minutes of learning that his own company would be acquired. The SEC alleged that given the limited number of mid-cap, oncology-focused biotech companies with commercial-stage drugs at the time, the acquisition of one such company would make the remaining ones more attractive investments and cause their stock prices to rise (which they did). The employee tried to have the SEC’s case dismissed as impermissibly expanding the law, but the U.S. District Court for the Northern District of California held that the SEC’s allegations were sufficient to sustain a charge of insider trading. In finding that by trading the employee had violated a duty to his employer, the court focused on the text of the employer’s insider trading policy, which expressly prohibited using MNPI obtained in the course of employment to trade in “the securities of another publicly traded company.”[7]
Companies will want to consider the SEC’s court-affirmed stance on shadow trading when updating their own insider trading policies. Many companies’ policies already spell out that information about third parties, such as collaboration partners or M&A targets, gained in the course of work for the company cannot be used to trade securities of such third parties. This can be expanded to proscribe using any information gained in the course of an insider’s role at the company to trade the securities of any company. Companies should be mindful, however, that so sharpening their policies may have consequences for their insiders. For example, in certain circ*mstances, an institutional investor with a board seat at a company with such a policy may have to consider whether to restrict trading in securities of certain other companies where that investor has no board seat or other access to MNPI.
Mutual Funds and ETFs
The prevalence of mutual, exchange-traded and other funds as vehicles for wealth creation and retirement planning raises an important question: should insiders be permitted to purchase or sell shares in funds that invest in the company’s securities at times when insiders would not be permitted to trade the company’s own securities? Many insider trading policies currently stay silent on this point, although some explicitly exempt trading in mutual funds from the scope of the policy.
As a legal matter, the answer to the question depends on whether MNPI about the company is also MNPI about the fund. While it seems unlikely that company MNPI would be material for a typical broad-based fund, there could be situations where the analysis may be less clear. Those could involve more narrow-focused funds, companies that make up a fairly large portion of the fund, and information that is of particular significance. Maintaining lists of “approved” or “prohibited” funds, however, is not practical for most company legal departments, and subjecting trading in any funds to all of the same blackouts that apply to trading in the company’s own securities would be too expansive.
Absent special circ*mstances, it may make sense for most companies to continue not to subject trading in broad-based funds to company trading blackouts, but to use their policies and related trainings to remind insiders that they are responsible for their own compliance with insider trading laws, drawing their attention to the fact that trading in funds while in possession of company MNPI may, in some circ*mstances, constitute insider trading.
Companies may also want to discourage insiders from trading in funds in circ*mstances that could imply that the trading was in fact based on company MNPI.
Pruning Policies for Non-Insider Trading Content
Companies often use their insider trading policies to deal with issues that go beyond compliance with insider trading laws, addressing matters like margin loans and hedging or confidential treatment of sensitive company information. The new public filing requirement for insider trading policies, however, covers only policies “reasonably designed to promote compliance with insider trading laws.” Some companies may want to streamline their insider trading policies by focusing them on insider trading law compliance and addressing other matters in separate policies that do not need to be publicly filed. Others may feel comfortable or even prefer publicizing their stance on these other matters.
Special Considerations for Dual-Listed Companies
Companies that, in addition to their U.S. listing, maintain a listing in another country, face special considerations when it comes to designing policies against insider trading. The insider trading laws of different jurisdictions vary, such that an activity that may be considered insider trading in the United States might not be insider trading elsewhere, or vice versa. As a notable example, unlike U.S. law, the European Union’s Market Abuse Regulation (MAR) defines as “insider dealing” not just purchasing or selling, but also cancelling an order to purchase or sell a security on the basis of “inside information.” There are also nuanced differences between the U.S. concept of MNPI and its MAR counterpart of “inside information.”
Dual-listed companies must thus design insider trading policies that satisfy the insider trading laws of all relevant jurisdictions, without making their policies overly complex or difficult for insiders to understand or for companies to administer. For example, a company that is subject to both U.S. laws and Europe’s MAR regime may want to restrict order cancellation on the basis of MNPI generally, regardless of where the order would have been executed, and to apply a definition of relevant “information is broad enough to capture both U.S. and MAR concepts.
This article highlights just a few potential issues for companies to consider as they review their insider trading policies to get them camera ready. Many other considerations exist, and practices in the area will continue to evolve as companies grapple with issues raised by new disclosure rules and legal developments and benchmark themselves against peers whose policies will soon be disclosed. With barely a year and a half until showtime, insider trading policy review will soon be on everyone’s agenda.
Endnotes
1See U.S. Department of Justice Press Release, “CEO of Publicly Traded Health Care Company Charged for Insider Trading Scheme,” https://www.justice.gov/opa/pr/ceo-publicly-traded-health-care-company-charged-insider-trading-scheme (March 1, 2023).(go back)
2See U.S. Securities and Exchange Commission Press Release, “Statement on Insider Trading Enforcement Actions Announced on June 29, 2023,” https://www.sec.gov/news/statement/20230629 (June 29, 2023).(go back)
3The rule amendments do not apply to multi-jurisdictional disclosure system (MJDS) filers. All references to foreign private issuers in this article exclude MJDS filers.(go back)
4Unless otherwise specified, references to “officers” are to Section 16 officers of domestic companies and senior management of foreign private issuers.(go back)
5“Non-Rule 10b5-1 trading arrangements” are effectively securities trading plans, entered into by directors or officers at a time when they did not have MNPI, which comply with the requirements of Rule 10b5-1 as in effect prior to the recent changes, but that do not meet all of the additional conditions newly required by the SEC, such as the cooling-off period of 90 to 120 days for directors and officers and 30 days for anyone else (other than the company itself) using a Rule 10b5-1 plan.(go back)
6See Order Denying Mot. To Dismiss, ECF No. 26, No. 3:21-cv-6322-WHO (N.D. Cal. Jan. 14, 2022).(go back)
7Id.(go back)
