43 Pages Posted: 10 Oct 2009
Date Written: May 1, 2007
The SEC adopted Rule 10b5-1 to define what it means to trade securities “on the basis of” material nonpublic information. This was to address decisions and commentary that found no insider trading violation of Rule 10b-5 where the defendant did not “use” inside information in deciding to trade, even if one “possessed” the information when the decision was made. Rule 10b5-1 specifies exclusive affirmative defenses for one charged with trading on the basis of material nonpublic information, the essence of which are that there is no violation if the trade was made pursuant to a pre-arranged plan, even if the seller or buyer later became aware of the information before the trade was made. There is, however, a substantial argument that the SEC exceeded its powers in adopting exclusive criteria for what it means to trade “on the basis of” material nonpublic information, rather than creating a safe harbor. Non-use of inside information in deciding to trade remains a defense even if the trade was not made pursuant to a Rule 10b5-1 plan. Although the SEC abandoned a proposal to require detailed disclosure of some Rule 10b5-1 plans, other SEC rules require disclosure of a plan in some circumstances, although compliance may be deficient. Irrespective of mandated disclosure, there are reasons both for and against voluntary disclosure of a Rule 10b5-1 plan. Some have suggested that Rule 10b5-1 is being misused in that executives establish such plans, know when a trade will occur under the plan and then, in order to maximize their profits when the trade is made, delay or accelerate disclosure of corporate news that would affect the stock price. In most situations, any such timing of corporate disclosure would not violate the securities laws.
Keywords: insider trading, Rule 10b5-1, Rule 10b5-1, stock trading plan
JEL Classification: K20, K22, K10
Suggested Citation: Suggested Citation
Horwich, Allan, The Origin, Application, Validity, and Potential Misuse of Rule 10b5-1 (May 1, 2007). Business Lawyer, Vol. 62, 2007; Northwestern Law & Econ Research Paper No. 09–37. Available at SSRN: https://ssrn.com/abstract=1483812