10b5-1 Plans: Modifications and Terminations

Last week I explored the connection between the affirmative defense provided under Rule 10b5-1(c) and appropriate timing of Rule 10b5-1 trading plans. The same interpretive guidance that got me thinking about creating 10b5-1 trading plans also clarified some issues around the modification or termination of trades under existing Rule 10b5-1 trading plans.

Modifying a Transaction

Any investor may have situations where they want to change their trading behavior based solely on circumstances that are not connected to insider information, including your company's own insiders. For example, an insider may have an existing plan that includes the sale of 20,000 shares, intending to use the cash generated from the sale to cover a balloon payment that is due on his or her mortgage. If the stock price drops unexpectedly before the trade takes place, the insider may wish to increase the number of shares being sold under the trading plan. In fact, the SEC does say that modifications made "in good faith" may be acceptable.

However, modifications of trades under a Rule 10b5-1 trading plan are not a good practice for insiders. The interpretive guidance from the SEC makes it very clear why. In response to question 120.16, the SEC clarifies that the modification of a trade is the same as terminating the existing trade and entering into a new plan for that trade. Since the modified transaction is considered to be under a new trading plan, the new plan is subject to the same requirements in order to qualify for the affirmative defense under Rule 10b5-1(c), the insider should not be in possession of material nonpublic information at the time of the modification.

One Transaction, One Plan

What's more, in response to question 120.19 the SEC clarifies that the termination of one or more transactions within a plan is the same as terminating the entire plan and entering into a new plan for all transactions under the plan. Therefore, at the point of the termination of one transaction, all the remaining transactions must still meet the requirements of Rule 10b5-1(c) in order to rely on the affirmative defense. Because this is virtually impossible for your company's insiders during a closed window, it's a good idea to require pre-clearance for both modifications and terminations of trades within a plan to ensure that the "new" trading plan created by the modification or termination of a trade still falls within the parameters of your insider trading policy.

Terminating the Entire Plan

So, what about the termination of an entire plan? In isolation, there isn't necessarily an issue with terminating an entire plan. However, in most cases, an insider terminating a plan will want to enter into a new one. This is where the concept of "good faith" comes into play. In addition to not being in possession of material nonpublic information at the creation of a Rule 10b5-1 trading plan, the insider may not enter into a plan that is "part of a plan or scheme to evade" the prohibitions under Rule 10b5-1(c). Therefore, what happens after the termination of a Rule 10b5-1 trading plan will be key to determining if the termination of the plan was in good faith. In real terms, that means that the insider will want to avoid any appearance that the plan was terminated based on inside information.

As an example, let's assume that an insider has an existing Rule 10b5-1 trading plan that includes a market sale of 10,000 shares. At some point prior to the sale, that insider learns about an upcoming acquisition that is anticipated to greatly increase the value of the company's stock. In response to this knowledge, the insider terminates the existing plan and enters into a new plan in the next open trading window, after the acquisition has been disclosed or completed and when the company share price has gone up. The new plan has all the appearances of meeting the requirements for a Rule 10b5-1 trading plan. However, in this case the old plan wasn't terminated in good faith, and the affirmative defense of Rule 10b5-1(c) may not be available.

Cooling Off Period

One of the reasons that a "cooling off" period between the creation of a Rule 10b5-1 trading plan and the first trade under that plan is highly recommended is to maintain the appearance of good faith. So, what about a situation where an insider wishes to terminate an existing plan and enter into a new one for the purposes of adding a new transaction to the plan and one or more of the original transactions is set to take place almost immediately? Obviously, each situation needs to be analyzed individually, but in most cases this shouldn't cause an issue with complying with Rule 10b5-1(c). Even though each of the transactions within the new plan, including those carried over from the old plan, are subject to the prohibitions under Rule 10b5-1(c), your company should be able to take the position that trades carried forward unmodified from an old plan are considered to be made in good faith.

You can find more information on Rule 10b5-1 trading plans on our Rule 10b5-1 portal.