Rule 10b5-1 To The Rescue

The SEC has created an affirmative defense to allegations that a person engaged in insider trading while in possession of material nonpublic information. Rule 10b5-1, put into place in 2000, establishes that a person’s purchase or sale of securities is not “on the basis of” material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have been implementing trading plans for their sales of company stock.
Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. Since the implementation of Rule 10b5-1, however, it has been an open question whether this inference can be refuted by the fact that the trading was done pursuant to a previously established trading plan. A partial answer may be found in the decision in Wietschner v. Monterey Pasta Co., No. C 03-0632 (N.D. Cal. Nov. 4, 2003) (will add Westlaw cite and link when available).
In Wietschner, the court held that the individual defendants’ stock sales were not sufficiently unusual or suspicious to raise a strong inference of scienter. In addition to evaluating the size and timing of the transactions, the court noted: “Plaintiffs state that both Defendants sold shares under individual SEC Rule 10b5-1 trading plans, which allows corporate insiders to set a schedule by which to sell shares over a twelve to fifteen month period. This could raise an inference that the sales were pre-scheduled and not suspicious.”
Holding: Motion to dismiss granted.
Addition: The opinion is now available on Westlaw – Weitschner v. Monterey Pasta Company, 2003 WL 22889372 (N.D. Cal. Nov. 4, 2003).

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