Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes Insider Trading via the Corporation (discussed on the Forum here) by Jesse M. Fried.
It may look like just another run-of-the-mill insider trading case, but there’s one difference in this settled SEC Enforcement action: according to the SEC, it involved sales under a purported 10b5-1 trading plan while in possession of material nonpublic information. As you probably know, to be effective in insulating an insider from potential insider trading liability, the 10b5-1 plan must be established when the insider is acting in good faith and not aware of MNPI. Creating the plan when the insider has just learned of MNPI, as alleged in this Order, well, kinda defeats the whole purpose of the rule. That’s not how it’s supposed to work, and the two executives involved here—the CEO and President/CTO of Cheetah Mobile—found that out the hard way, with civil penalties of $556,580 and $200,254. The company’s CEO was also charged with playing a role in the company’s misleading statements and disclosure failures surrounding a material negative revenue trend. According to the Chief of the SEC Enforcement Division’s Market Abuse Unit in this press release, “[w]hile trading pursuant to 10b5-1 plans can shield employees from insider trading liability under certain circumstances, these executives’ plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it.”
Background. Corporate executives, directors and other insiders are constantly exposed to material non-public information, making it sometimes difficult for them to sell company shares without the risk of insider trading, or at least claims of insider trading. To address this issue, in 2000, Congress developed the Rule 10b5-1 affirmative defense. In general, Rule 10b5-1 allows a person, when acting in good faith and not aware of MNPI, to establish a formal trading contract, instruction or plan that specifies pre-established dates or formulas or other mechanisms—that are not subject to the person’s further influence—for determining when the person can sell shares, without the risk of insider trading. According to the SEC, people are “aware” of MNPI “if they know, consciously avoid knowing, or are reckless in not knowing that the information is material and nonpublic.” To be effective, the contract, instruction or plan must also conform to the specific requirements set forth in the Rule. In effect, the Rule provides an affirmative defense designed to demonstrate that a purchase or sale was not made “on the basis of” MNPI. If a 10b5-1 contract, instruction or plan is properly established, the issue is not whether the person had MNPI at the time of the purchase or sale of the security; rather, that analysis is performed at the time the instruction, contract or plan is established.
