Insiders: Trading, Section 16, and Rule 10b5-1

What Insider Trading Is

In general terms, insider trading is buying or selling a security while in possession of material, nonpublic information, in breach of a duty of trust or confidence. That duty may be owed to the company's shareholders, as in the case of an officer or director, or to the source of the information, as in the case of someone who misappropriates confidential information. Tipping, meaning passing the information to someone else who trades, can create liability for both the tipper and the tippee.

Materiality here means what it means everywhere: information a reasonable investor would consider important. Upcoming earnings, a pending acquisition, a regulatory decision, a major contract, a financing, or a cybersecurity incident can all be material.

How Cases Are Built

Insider trading cases are often built from trading data. Surveillance identifies unusual trading ahead of a significant announcement. The staff then works backward: who traded, what connection do they have to the company or its advisors, and what communications occurred before the trade. Phone records, emails, text messages, and calendar entries fill in the story. The staff is patient, and the data is extensive.

Section 16

Directors, officers, and beneficial owners of more than ten percent of a class of registered equity securities are subject to Section 16 of the Exchange Act. They must file an initial statement of ownership on Form 3, report most changes in ownership on Form 4 within two business days, and file an annual statement on Form 5 for certain transactions not previously reported.

Section 16(b) also requires insiders to disgorge to the company any profit from a purchase and sale, or sale and purchase, within any period of less than six months. Intent is irrelevant. The rule is mechanical, and it catches people who had no idea they were doing anything wrong.

Late Section 16 filings must be disclosed by the company, and they are an area in which the SEC has brought sweeps against both insiders and issuers.

Rule 10b5-1 Plans

A Rule 10b5-1 trading plan allows an insider to establish, at a time when the insider does not possess material nonpublic information, a written plan for future trades. Trades made under a properly adopted and operated plan have an affirmative defense against insider trading claims.

The SEC amended the rule in 2022 to tighten it. Directors and officers must now observe a cooling-off period before trading under a new or modified plan, generally the later of ninety days after adoption or two business days after the company files its financial results for the quarter in which the plan was adopted, up to a maximum of one hundred twenty days. Others are subject to a thirty-day cooling-off period. Directors and officers must certify certain matters in the plan, overlapping plans are restricted, single-trade plans are limited, and the plan must be entered into and operated in good faith. Companies must disclose quarterly the adoption and termination of plans by directors and officers, and annually disclose their insider trading policies.

The Company's Role

Every reporting company should have a written insider trading policy, blackout periods around earnings, pre-clearance of trades by directors and officers, and a person responsible for administering it. The policy protects the insiders and the company. It also creates a record, which in a later investigation may matter a great deal.