Trading Plans To Avoid Insider Trading Presumptions

An insider of a public company who trades in the company’s stock while aware of material but nonpublic information about the company is presumed to be trading on the basis of that information in violation of Securities and Exchange Commission (SEC) Rule 10b-5. To counter that presumption, companies may adopt Rule 10b5-1 trading plans.

Trading plans establish binding agreements for insiders of a company under which securities of the company will be traded in specified volumes at particular prices on set dates. A trade by an insider pursuant to such a plan then will provide an affirmative defense to the presumption of trading upon inside information raised by Rule 10b5-1.

Rule 10b5-1 was adopted by the SEC in response to judicial precedent that for civil or criminal liability for insider trading to arise, it must first be shown that a defendant possessing inside information actually used the inside information in making trading decisions. Under Rule 10b5-1, possession of inside information raises the presumption that such information was used in making trading decisions. Trading plans provide an exception to that presumption.

A trading plan must be adopted by an insider at a time when the insider does not have material nonpublic information available that could be viewed as having an impact on purchase or sale decisions under the plan. Thus, a plan may be adopted that would not go into effect until after the materiality of information known to the insider will have dissipated. Also, a viable plan could establish purchase or sale points that would not be related to company results. For example, the plan could call for the periodic purchase or sale of company shares by an insider based solely upon market variables. Turning purchase or sale discretion over to an independent third party through a blind trust mechanism is an additional alternative for demonstrating that investment decisions were not based on material inside information.

While Rule 10b5-1 does not bar changing trading plans at any time, companies may wish to set periodic windows during which the plans may be changed in order to avoid any appearance that changes in plans are being made in order to take advantage of inside information.

Rule 10b5-1 provides a detailed description of a trading plan that will avoid the presumption of trading on the basis of inside information. Such a plan must use a written formula, an algorithm or a computer program to specify the amount and price of securities to be purchased or sold on particular dates. Also, the plan must not allow an insider to exercise any subsequent influence over how, when or whether purchases or sales are made. Any subsequent purchase or sale shown to be pursuant to the plan then will not be presumed to have been on the basis of inside information.

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